# 1. For a monopolist, present the standard diagram showing the following:

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1 ECON 202: Principle of Microeconomics Name: Fall 2005 Bellas Second Midterm - Answers You have two hours and twenty minutes to complete this exam. Answer all questions, explain your answers, label axes and curves on graphs and do your own work. Fifty points total, points per part indicated in parentheses. 1. For a monopolist, present the standard diagram showing the following: A. The three relevant curves. (3) B. The profit maximizing quantity. (1) C. The socially efficient quantity. (1) D. The dead weight loss. (1) E. The consumers surplus. (1) Page 1 of 10

2 2. Consider a competitive producer paying a wage of \$120, selling output for \$27 and facing the following production schedule: Labor Hired Total Product (Q) Marginal Physical Product (MPP) Marginal Cost (MC) Average Cost (AC) /10=12 (80+120)/10= /8=15 (80+240)/18= /6=20 (80+360)/24= /5=24 (80+480)/29= /4=30 (80+600)/33= /3=40 (80+720)/36=22.2 A. Fill in the values for MPP and MC. (2) B. If the producer s fixed costs are \$50, what is the profit maximizing quantity of labor to hire? (2) 4 units, this is where MC is still less than the price of \$27. C. If the producer s fixed costs are \$80, what is the profit maximizing quantity of labor to hire? (2) 4 units, this is where MC is still less than the price of \$27. Same as part b. D. If this is a perfectly competitive market and fixed costs are \$80, what will be the long run equilibrium price? (2) To answer this, you need to find the level of output that minimizes average cost. The long run equilibrium price will be the minimum average cost. The minimum average cost and long run equilibrium price is \$ Page 2 of 10

3 3. Imagine a monopolist facing the following demand schedule: Quantity Price TR MR 0 1 \$ \$ \$ \$ \$ \$ \$ \$ \$ \$ A. Calculate the marginal revenue schedule. (2) B. Find the profit maximizing quantity to produce if the marginal cost of production is \$8.00 and fixed costs are \$40. (1) 4 units, this is where MR is still greater than MC. C. Find the profit maximizing quantity to produce if the marginal cost of production is \$8.00 and fixed costs are \$60. (1) 4 units, this is where MR is still greater than MC. D. Calculate the efficient quantity to produce if the marginal cost of production is \$8.00 and fixed costs are \$20. (1) The efficient quantity is where MC=P. This is at a quantity of 8. Page 3 of 10

4 4. Imagine a monopolist facing the following demand and marginal cost schedules: Q P MC TR MR MC 0 1 \$35 \$ \$33 \$ \$31 \$ \$28 \$ \$25 \$ \$22 \$ \$19 \$ \$16 \$ \$13 \$ \$10 \$ A. Calculate the profit maximizing quantity for this firm. (2) 5 units, this is where marginal revenue is still greater than MC. B. What would this firm be willing to pay for a technology that cut their variable costs in half? Explain your answer. (2) With the old technology, they produced five units and had revenue of \$125 and variable costs of ( =\$30) for a different of =\$95. This is their producer surplus. With the new technology, they produced six units and had revenue of \$132 and variable costs of ( =\$21) for a difference of =\$111. The difference between these two numbers, =\$16, is the change in producer surplus resulting from adoption of the new technology instead of the old technology and is the most that they would be willing to pay to get the new technology. Page 4 of 10

5 5. The four market types we discussed are perfect competition, monopoly, monopolistic competition and oligopoly. A. Why is it that long run profits are zero in perfect competition and monopolistic competition but not in monopoly or in oligopoly? (1) Because new firms can enter the market in perfect competition and in monopolistic competition, but not in monopoly or oligopoly. B. In which type of market is collusion or the formation of cartels a potential problem? (1) In oligopoly, because there are so few firms. C. Which type of market generates the greatest benefit for consumers? (1) The answer I was looking for was perfect competition, because in this market type profits are zero and goods are produced at the lowest possible cost and sold for the lowest possible price. I accepted one answer of monopolistic competition because the answer argued that the greater variety of goods offered in monopolistic competition was a benefit for consumers that should be considered. Page 5 of 10

6 6. Imagine that a typical firm in a competitive industry has the following total cost schedule: Q TC MC AC 0 \$100 1 \$103 3 \$ \$107 4 \$ \$112 5 \$ \$118 6 \$ \$125 7 \$ \$133 8 \$ \$142 9 \$ \$ \$ \$ \$ \$ \$17.5 A. If the current price in the market is \$10 is the market in long run equilibrium? Explain why. (2) No, it is not because the marginal cost is \$10 at a quantity of 8 units, but the average cost is well above \$10 at this quantity. Thus, this firm is losing money and the market can t be in long run equilibrium. B. Explain what will happen to drive this market to long run equilibrium. (2) Some firms will exit, supply will decrease and the price will rise until the profit of a typical firm is zero. C. How will the amount produced by a typical firm operating in the market change as the market moves from a short run price of \$10 to the long run equilibrium price? (2) The amount produced by a typical firm will rise as the price rises. So, there will be fewer firms in the long run, but each of the remaining firms will be producing more than they did before. Page 6 of 10

7 7. Consider an industry with five firms with market shares of 0.40, 0.20, 0.20, 0.15 and A. Calculate the four firm concentration ratio. (2) This is the combined market share of the four largest firms = 0.95 B. Calculate the HHI. (2) This is the sum of the squared market shares = = C. Why do we care about these measures of concentration in an industry? (2) Because as an industry becomes more concentrated the likelihood of collusion increases. Page 7 of 10

8 8. Find the equilibria for the following games. Each game may have zero, one or multiple equilibria. (1 each) Equilibria are shaded. Page 8 of 10

9 9. Opportunity cost is one of the most important concepts in economics. Imagine that you receive a free ticket to see a hockey game and that there are no other costs associated with attending the game. However, at the same time as the game, the band Me First and the Gimme Gimmes will be performing at a nearby club. On any given evening, you would be willing to pay up to \$40 to hear the band and their punked-out renditions of 1970 s pop hits. Tickets for the show cost \$15. What is the opportunity cost of attending the hockey game? (2) The opportunity cost of attending the hockey game is the consumer surplus that you would have gotten from attending the show, which is \$40 - \$15 = \$25. Page 9 of 10

10 10. Consider the following diagrams of a perfectly competitive market and firm: A. Why is the short run price of \$12 not a long run equilibrium price? (1) Because at a price of \$12, the firm is making positive profits. B. What is the long run equilibrium price? (1) This is the minimum average cost, or \$6. C. What happens in the market that causes it to move to long run equilibrium? (1) New firms enter, increasing the supply and driving the price down. D. How many firms are in the market in the long run, assuming that all firms in this market are identical? (1) Total quantity in the market is 40,000, and each firm is producing 8 units, so there must be 5,000 firms in the market. E. What will happen to the long run equilibrium price if fixed costs rise? (1) It will rise, because the average cost will rise and long run equilibrium price must be equal to minimum average cost. Page 10 of 10