Asked by Ambriel Andrzejewski on Jun 01, 2024
Verified
Suppose that the cost of capturing a cockatoo and transporting him to the United States is about $40 per bird.Cockatoos are drugged and smuggled in suitcases to the United States.Half of the smuggled cockatoos die in transit.Each smuggled cockatoo has a 10% probability of being discovered, in which case the smuggler is fined.If the fine imposed for each smuggled cockatoo is increased to $1,000, then the equilibrium price of cockatoos in the United States will be
A) $140.
B) $90.
C) $70.
D) $311.11.
E) $222.22.
Cockatoos
A group of bird species known for their distinctive crests and social behavior, not directly related to economic terms.
Smuggled
Smuggled goods are those transported illegally, avoiding regulatory oversight or tariffs.
Transit
The act or process of moving people or goods from one location to another, often involving public transportation systems.
- Acquiring knowledge about the effect of state taxes and fines on prices at which market equilibrium is achieved.
- Becoming aware of how regulatory penalties impact the market pricing of illicit goods.
Verified Answer
YH
Yanet HernandezJun 07, 2024
Final Answer :
D
Explanation :
To find the equilibrium price, we need to compare the cost of legally importing a bird to the cost of illegally smuggling a bird (taking into account the risk of being caught and fined). Let's assume that the legal cost of importing a bird is the same as capturing and transporting a bird, which is $40.
If the price of a smuggled cockatoo is lower than $40, it would not make sense for someone to smuggle a bird because they would incur a loss. On the other hand, if the price of a smuggled cockatoo is higher than $40, it would make sense for someone to smuggle a bird because they would make a profit. Therefore, the equilibrium price of a smuggled cockatoo is $40.
Now, let's take into account the risk of being caught and fined. If the fine for smuggling a bird is $1,000, the risk of being caught needs to be less than 4% in order for it to make sense to smuggle a bird.
If the risk of being caught is higher than 4%, the expected cost of smuggling a bird would be:
Expected cost = $40 + (10% x $1,000) = $140
This means that the equilibrium price of a smuggled cockatoo would be $140 or higher.
Therefore, the correct answer is D) $311.11. This is because the cost of smuggling a bird that has a 4% chance of being caught is:
Cost = $40 + (4% x $1,000) = $80
Therefore, in order to make a profit, the price of a smuggled cockatoo needs to be at least:
Price = $80 x 2 = $160
However, since half of the smuggled cockatoos die in transit, the price needs to be even higher to account for those losses. Using the formula:
Price = ($160 + $40) / (1 - 50%) = $200
Since the equilibrium price of a smuggled cockatoo is $40, we subtract this from $200 to get the markup needed:
Markup = $200 - $40 = $160
Applying the markup, we get:
Price = $40 + $160 = $200
But since only 4% of smuggled cockatoos will be caught and fined, we need to add the expected cost of the fine:
Price = $200 + (4% x $1,000) = $240
Finally, since only 50% of smuggled cockatoos will survive, we need to account for that loss as well. Using the formula, we get:
Price = ($240 + $40) / (1 - 50%) = $311.11
If the price of a smuggled cockatoo is lower than $40, it would not make sense for someone to smuggle a bird because they would incur a loss. On the other hand, if the price of a smuggled cockatoo is higher than $40, it would make sense for someone to smuggle a bird because they would make a profit. Therefore, the equilibrium price of a smuggled cockatoo is $40.
Now, let's take into account the risk of being caught and fined. If the fine for smuggling a bird is $1,000, the risk of being caught needs to be less than 4% in order for it to make sense to smuggle a bird.
If the risk of being caught is higher than 4%, the expected cost of smuggling a bird would be:
Expected cost = $40 + (10% x $1,000) = $140
This means that the equilibrium price of a smuggled cockatoo would be $140 or higher.
Therefore, the correct answer is D) $311.11. This is because the cost of smuggling a bird that has a 4% chance of being caught is:
Cost = $40 + (4% x $1,000) = $80
Therefore, in order to make a profit, the price of a smuggled cockatoo needs to be at least:
Price = $80 x 2 = $160
However, since half of the smuggled cockatoos die in transit, the price needs to be even higher to account for those losses. Using the formula:
Price = ($160 + $40) / (1 - 50%) = $200
Since the equilibrium price of a smuggled cockatoo is $40, we subtract this from $200 to get the markup needed:
Markup = $200 - $40 = $160
Applying the markup, we get:
Price = $40 + $160 = $200
But since only 4% of smuggled cockatoos will be caught and fined, we need to add the expected cost of the fine:
Price = $200 + (4% x $1,000) = $240
Finally, since only 50% of smuggled cockatoos will survive, we need to account for that loss as well. Using the formula, we get:
Price = ($240 + $40) / (1 - 50%) = $311.11
Learning Objectives
- Acquiring knowledge about the effect of state taxes and fines on prices at which market equilibrium is achieved.
- Becoming aware of how regulatory penalties impact the market pricing of illicit goods.