Reference no: EM131476153

When the government decides to impose a tax on sellers of a good or service, sellers try to pass the tax on to consumers by raising the price of the good being sold.

Question 1: Assume the government decides to place a $1 tax on each unit of a good sold, e.g., a gallon of gasoline. Using the simple model of supply and demand, illustrate what would happen to the price and quantity of gasoline sold.

Question 2: Would the amount of tax paid by the consumer (as opposed to the producer) be greater when demand is elastic or inelastic? Why?

The following article appeared in the Wall Street Journal (dated, but rich with economics)

The Wall Street Journal

January 30^th, 2015

The Next McDonald's Turnaround

Shake Shack's IPO is good news for anybody's whose business is burgers and fries

By Holman Jenkins

McDonald's in the mid-1990s thought its problem was the loss of baby-boomer customers because its food was not "relevant" to adults. The company spent millions and many months to develop its Arch Deluxe line of premium burgers, only to see it flop.

The real trouble turned out to be poorly structured incentives: Too many new stores were cannibalizing existing operators, promoting a spiral in food quality, cleanliness and maintenance. When McDonald's rectified these problems, customers flooded back, including boomers with their children. The stock rose eightfold in the next decade.

If there's a lesson for McDonald's latest troubles, which got CEO Don Thompson fired this week, it's that every organization keeps doing what works until it no longer works. McDonald's problems are eminently fixable. The idea that the fast-food chain is doomed because fast food is passé, a favorite press theme, is silly.

The easiest part is to stop doing what no longer works. Partly to appease critics by wadding up the menu with "healthier" choices, partly to meet emerging competitors, McDonald's allowed its menu to become unwieldy. This created cost, logistic and quality-control problems that naturally were felt by the 80% of customers who came for the traditional fries, burgers and McNuggets.

McD belatedly is doing what every chain from Burger King to Red Lobster to Olive Garden has been doing-focusing on its core mission and getting rid of extraneous menu items and costs. This will likely prove successful in boosting profits, then in boosting sales.

You could even say the gestalt is conspiring to help McDonald's fix its menu bloat. With the rise of Shake Shack and other fashionable chains, McDonald's shoulders less of a burden to defend fast food. Meanwhile, the political environment has imposed its own incentives (minimum-wage hikes, ObamaCare) that reward job-cutting.

McDonald's other problem is the image of its food. But those who imagine McDonald's falling victim to the progressive march of foodie nation should take a look at another retailer whose stock price has been nearly as disappointing lately. The Whole Foods customer has been more kindly treated in the current semi-recovery; the chain's brand is synonymous with the "natural" meme. Yet the grocer has hit a rough patch. Most customers shop at lots of places, and it turns out that it hasn't been especially hard for Costco, Safeway and even Wal-Mart to grab back a share of Whole Foods's sales.

Sara Senatore, an analyst at Bernstein Research, makes a rude habit of pointing out that terms like "fresh," "natural" and "healthy" thrown around by McDonald's competitors are nebulous and more a matter of "appearance" than "reality."

Take Chipotle's theatrical move this month to suspend deliveries from a pork producer that violated the chain's animal-welfare rules. This might suggest Chipotle only uses meat from vendors that meet these rules. It doesn't. (This is called marketing.) Chipotle constantly talks about getting rid of genetically modified food and industrially fed beef- in the future. Its burrito, meanwhile, is more fat-, cholesterol- and sodium-laden than a Big Mac.

It will drive McDonald's legion of critics crazy to say so, but McDonald's food-image problem is a marketing problem that can be solved by marketing. The McDonald's obituaries in the press are based on a simple misconception-the idea that competitors are shrinking the market for McDonald's food and eventually will kill the company.

In fact, every restaurant chain that has lately been removing items from its menu and sharpening its focus has implicitly been surrendering customers to competitors. This is what smart businesses do in a healthy, growing, diversifying consumer market, which rewards specialization. If anything, the success of burger-and-fries chains like Five Guys, In-and-Out and Shake Shack has revalidated McDonald's niche. The burger giant should gain confidence to double-down on what it does best.

That said, a fresh round of McDonald's obits will be triggered by CEO Thompson's defenestration this week and the nearly simultaneous Shake Shack IPO on Friday, which valued the tiny chain's 63 stores at roughly $1.7 billion. The number to remember, though, is 36,000. That's how many stores McDonald's and its franchisees operate globally. Competitively, Shake Shack is meaningless to McDonald's except as a marketing experiment that McDonald's should (and hopefully will) learn something from.

Question 3: Based your knowledge of economics, draw supply and demand curves, from the standpoint of the firm, that demonstrate what the author means when he states that minimum wage gains and ObamaCare reward job-cutting. 

Question 4: The author's premise includes thinking that McDonald's menu got unwieldy and costs got out of control.  If this is true, what is his premise about McDonald's cost curve, both at the current time and where he recommends they should operate?

Question 5: The article mentions that Chipotle is no longer buying from a particular pork producer. From the perspective of individual pork producers, what does their demand curve probably look like?

Question 6: Using that demand curve from (5), illustrate some assumptions about the costs of producing pork and show what quantity of output pork producers tend to produce.

Question 7: Near the end of the article, it mentions that "smart businesses...[reward] specialization".  If pork producers were able to differentiate their products, illustrate how they could change the shape of their demand curve.  What specifically could they do to create this differentiation and what changes could that make to their output and the price they could charge?

You have just been hired as CEO of a company that is about to release a unique food replacement product called Everything. Everything is designed to substitute for food altogether by providing all of the nutrients required to sustain a healthy human being without the need for consuming anything other than Everything.  (All subsequent exam questions refer to Everything.)

Question 8: Suppose after the initial release of this product, personal testimonies begin to appear on the Internet touting increased energy and weight reduction. What is the likely impact on the equilibrium price and quantity for Everything? Draw a graph.

Question 9: After the product has been on the market for six months, you raise the price and notice that revenues fall by only a little bit.  How might you explain the steepness or flatness of the demand curve?  Are you on the elastic or inelastic part of your client's demand curve?

Question 10: After a year of production, you have received a great deal of positive acclaim about the product and you are having a difficult time keeping up with demand. As you hire more workers to produce additional product, what is the likely impact on productivity? How would you illustrate this?

Question 11: As you ramp up production, you grow in size and now have a fairly large workforce. Your workers decide to unionize and you now must negotiate compensation through a collective bargaining process. This raises the cost of labor and also leads to the imposition of work rules that reduce worker productivity.  Illustrate what affect will this have on profitability?

Question 12: What options do you have in the longer run that might enable you to maintain the previous level of profits at the same level of demand?

Question 13: Suppose that there is a great deal of entry as eating whole food becomes less popular and food replacements like Everything becomes a popular fad. So many firms enter that you find yourself in a perfectly competitive industry earning negative profits. Draw a diagram. Do you exit the industry? Why/Why not?

Question 14: Instead of (13) above, you are protected by sufficient patents that only one other firm figures out how to enter this product category and becomes a direct competitor. How is that likely to change the nature of the competitive dynamic in the industry? If you each want to make as much profit as possible, what would be the best way to do that?

Question 15: To this point you have been charging everyone the same price for your product. Why might you want to engage in price discrimination? Give two examples of what you might do in order to price discriminate.