Practice Exam for Section III Material

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1 Practice Exam for Section III Material 1) If a monopolist s demand curve has slope - δ, then its marginal revenue curve has slope δ/2. 2) A market with 10 firms must have a lower HHI than a firm composed of 3 firms. 3) The reason a monopolist does not have a supply curve is that whatever market price they face, they can adjust quantity appropriately. 4) In a Bertrand oligopoly, firms compete in prices. 5) Every normal form game has at most one Nash Equilibrium. 6) Every Nash Equilibrium coincides with the collective utility maximizing outcome for all players. 7) A monopolist always produces on the elastic portion of the demand curve. 10) A monopolist s long run fixed cost curve sits above its average cost curve. 11) In the case of a positive externality the market on its own will produce a quantity of the good below the social optimum level. 12) The economically efficient level of pollution tax sets marginal private cost equal to marginal social benefit and results in the socially optimum output quantity. 13) A risk averse individual will always prefer a sure thing to a lottery. 14) A larger negative number for the Absolute Risk Aversion measure implies a more risk averse individual.

2 15) Moral hazard describes the tendency of actors to take risks beyond their natural level due to an everyone else is doing it mentality. MC 1) Coca Cola holds 25% market share, A&W holds 15% and Pepsi holds 60% in a certain market where these are the only soft drinks available. Which of the following statements is not correct? a) The DOJ would classify this market as highly concentrated. b) HHI in this market is greater than 0.15 but less than 0.75 c) HHI in this market is calculated by summing the market shares of the individual firms and then squaring the sum d) The HHI in this market is greater than 0.25 yet less than 0.55 e) None of the above is false 2) Which of the following is true of a negative externality? a) The externality exists because an actor fails to internalize the full negative social impacts of their behavior. b) The economically efficient solution sets the level of the negative externality to zero. c) Taxes are a quantity based approach to dealing with a negative externality. d) Quantity based approaches are generally economically more efficient than price based approaches when correcting for a negative externality. e) When the externality is uncorrected for, deadweight loss occurs in some but not all cases.

3 3) Given the graph of a monopoly above, which of the following statements is correct? a) Area A represents producer surplus b) Area B represents total revenue c) Area B plus area C together represent profit d) Area B plus area C plus area D together represent total cost e) None of the above is correct

4 4) Given the normal form game above, which of the following statements is true? a) Strategy Defend is dominated by strategy Hold b) Strategy Retreat is dominated by strategy Advance c) Strategy Engage is dominated by strategy Hold d) Strategy Defend is dominated by strategy Engage e) None of the above is true

5 Long Answer 1) United Airlines and Delta are engaged in a simultaneous move route expansion game. If both companies expand their routes, they each earn 1 million in profits. If neither expands their routes, United earns a half million in profits, and Delta earns three quarters of a million. If only Delta expands, Delta earns 5 million, while United takes a 3 million dollar loss. If United expands while Delta does not, United earns 7 million in profit while Delta loses 2 million. Represent this game with a normal form game diagram, labeling players, strategies and payoffs. Solve for the Nash Equilibrium, labeling the NE clearly. What aspect of this game would you change in order for a game tree ( expanded form ) representation to be more appropriate than the standard form? 2) A monopolist faces market demand curve: P = Q. The monopolist s marginal cost curve is given by: MC = 2Q. Derive equations for the firm s marginal revenue curve and average revenue curve. Then solve for the monopolist s profit maximizing quantity, Q*, and price, P*. Sketch the monopolist s demand curve, marginal revenue curve and marginal cost curve on a single graph, labeling relevant intercepts and the intersection point of MR and MC. Also make sure to label axes, curves, Q* and P*. (you need not solve for or label the intersection point of MC and demand).

6 3) Identify one strategy of Player 2 which is dominated. For clarity, write it using a full sentence (ex: Player 1 s strategy right is dominated by strategy left ). Solve for the Nash Equilibrium and write it out clearly as shown in class. Is the NE unique, or are their multiple equilibria in this game? Player 2 In Stay Out Player 1 Forward 1, -3-2, -3-1, -2 Backward 0, 2 3, -1-2, 0 4) A competitive market produces electricity. A by-product is the release of carbon dioxide which may contribute to climate change. The inverse demand curve (MB) for electricity is given by P = 36 Q, where Q is megawatts. Marginal private cost (supply) is given by 3+Q. Production of 1 megawatt of electricity releases 1 ton of CO2 into the air. For fewer than 1 ton of CO2 there are no marginal damages, but above that level MEC is given by MEC = -1+2Q. The government applies an emissions tax of $T/ton CO2 to achieve the social optimum. Graph D, S, MEC and MSC on one graph. Label the price and quantity for market equilibrium and social optimum equilibrium, and shade the deadweight loss

7 area. Solve numerically for both equilibria and label these on your graph. Add the MPC + Tax curve to your sketch and solve numerically for the size of tax T ($ per ton). 5) You have two job options: The first is to work for your friend s kayak company. If his firm is successful in establishing a retail outlet, you will get $40,000. If the firm is not successful, he will make sure that you get $15,000 for your time. Based on what you know of your friend s business, you judge there to be a 60% chance he will be successful in establishing the retail outlet. Your other option is to work for another friend s online retail business. If she successfully launches her IPO by the end of the year, you will earn half a million dollars. Magazines are suggesting the chances of a successful launch of her IPO are slim they estimate only a 5% chance of success and if she fails, you get nothing back for your year of work. Calculate the expected return on each job and explain what would have to be true about your risk aversion preferences for you to take job number one. If you take job number two, can we infer anything about your risk preferences? 6) Don t bother with oligopoly example for the exam. I will not test you on how to solve for one (but definitely know about) Cournot versus Bertrand oligopolies.