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

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1 ECON 202: Principle of Microeconomics Name: Fall 2006 Bellas Second Midterm You have two hours and thirty 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) F. The monopolist s average cost curve, assuming that the monopolist is suffering a loss. (1) Page 1 of 1

2 2. Consider a competitive producer paying a wage of $60, selling output for a price of $9 and facing the following production schedule: Labor Hired Total Product (Q) Marginal Physical Product (MPP) Marginal Cost (MC) /10= /9= /8= /7= /6= /5=12 A. Fill in the values for MPP. (1) B. If the producer s fixed costs are $20, what is the profit maximizing quantity of labor to hire? (1) 4 units of labor C. If the producer s fixed costs are $10, what is the profit maximizing quantity of labor to hire? (1) 4 units of labor D. What will be the profit maximizing quantity of labor to hire if the output price rises to $12? (1) 5 or 6 units of labor Page 2 of 2

3 3. Imagine a monopolist facing the following demand and marginal cost schedules: Quantity Price MC TR MR 0 1 $24 $ 4 $24 $24 2 $22 $ 7 $44 $20 3 $20 $10 $60 $16 4 $18 $13 $72 $12 5 $16 $16 $80 $ 8 6 $14 $19 $84 $ 4 7 $12 $22 $84 $ 0 8 $10 $25 $80 $ -4 9 $ 8 $28 $72 $ $ 6 $31 $60 $ -12 A. Find the profit maximizing quantity to produce if fixed costs are $40. (1) Based on MR=MC, 3 units of output B. Find the profit maximizing quantity to produce if fixed costs are $20. (1) Again, 3 units of output C. What is the socially efficient quantity? (1) This is where P=MC at a quantity of 5. Page 3 of 3

4 4. Imagine a monopolist facing the following demand schedule: Q P TR MR 0 1 $12 $12 $12 2 $11 $22 $10 3 $10 $30 $ 8 4 $ 9 $36 $ 6 5 $ 8 $40 $ 4 6 $ 7 $42 $ 2 7 $ 6 $42 $ 0 8 $ 5 $40 $ -2 9 $ 4 $36 $ $ 3 $30 $ -6 A. Calculate the profit maximizing quantity for this firm if its marginal cost is $5. (2) Based on MR=MC, 4 units of output. B. What is the maximum amount that this firm would be willing to pay for a technology that cut its marginal cost from $5 to $0? Explain your answer. (2) At MC=5, the profit maximizing quantity was 4, price was $9 and TR = $36. Variable costs were $5 x 4 = $20. The difference between these was $36 - $20 = $16. At MC=0, the profit maximizing quantity is 6 or 7 and price is $7 or $6 and TR = $42. Variable costs will be zero. The difference between these is $42. So, the new technology would increase profits from $16 to $42, an increase of $26, so $26 is what they would pay for the new technology. C. Imagine that a merger cut this monopolist s fixed costs in half. How would her profit maximizing price change as a result? (1) It wouldn't change. Page 4 of 4

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? (2) Because there is entry (no barriers to entry) in perfect competition and monopolistic competition, but not in monopoly or oligopoly. B. Under what conditions and in which types of markets will a decrease in fixed costs result in a decrease in the market price? (2) A decrease in fixed costs will result in a decrease in prices only in competitive and monopolistically competitive markets in the long run, but not in the short run. C. In which type of market is collusion or the formation of cartels a potential problem? (2) In an oligopoly. Page 5 of 5

6 6. Imagine that a typical firm in a competitive industry has the following total cost schedule: Q TC AC 0 $ $13 13/1= $17 17/2= $22 22/3= $28 28/4= $35 35/5= $43 43/6= $52 52/7= $62 62/8= $73 73/9= $85 85/10=8.50 If the current price in the market is $10 is the market in long run equilibrium? Explain why. (2) No, because profits are positive, or because the price is greater than the minimum average cost. 7. Imagine that the firms in a perfectly competitive market are making positive economic profits. Now, imagine that this market moves toward long run competitive equilibrium. Will the output of a typical firm rise or will it fall as the market moves toward long run competitive equilibrium? Explain. (2) It will fall, because the positive economic profits will attract new firms to the market. As new firms enter the market the price will fall and, as the price falls, a profit maximizing firm will decrease its output. Page 6 of 6

7 8. Consider an industry with five firms with market shares of 0.60, 0.20, 0.10, 0.05 and A. Calculate the four firm concentration ratio. (1) = 0.95 B. Calculate the HHI. (2) = = C. Why do we care about the level of concentration in an industry? (1) The more concentrated an industry is, the more likely it is to have a cartel. Page 7 of 7

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

9 10. Elasticity is one of the most important concepts in economics. Imagine that demand for Bulgarian wine is elastic. What will happen to total expenditures on Bulgarian wine if its price rises? Explain your answer. (2) Expenditures will fall because even if the price rises just a little bit, the quantity sold will fall a lot because demand is elastic. 11. Why is a production possibilities frontier typically drawn as a bowed-out curve? To put this somewhat differently, why does this opportunity cost of producing bikes increase as the number of bikes produced in an economy increases? Explain. (2) This is because some productive resources are more efficient at producing bikes and others are more efficient at producing other goods. If we begin producing bikes using the most efficient bike makers, then as we increase production of bikes we will have to bring in resources that are less and less efficient at bicycle production. This causes the opportunity of bicycle production to rise. 12. What happens to a competitive firm s demand for labor as: A. the wage rate rises? Explain. (1) Nothing. This would result in a change in the quantity of labor demanded, not a change in the demand for labor itself. B. the market price of their output rises? Explain. (1) This would increase their demand for labor. Page 9 of 9

10 13. Consider the following diagrams of a perfectly competitive market and firm: A. Why is the short run price of $8 not a long run equilibrium price? (1) Because it is below the minimum average cost. Firms profits will be negative at that price. B. What happens in the market that causes it to move to long run equilibrium? (1) Some firms will exit. C. How many firms are in the market in the long run, assuming that all firms in this market are identical? (1) The long run market quantity is 20,000 and the long run firm quantity is 10, so there will be 20,000/10 = 2,000 firms in the market in the long run. D. What will happen to the long run equilibrium price if fixed costs rise? (1) The long run equilibrium price will rise if fixed costs rise. Page 10 of 10

11 14. A sports team receives public assistance in building its new stadium and, as a result, its fixed costs are reduced by $150M. How does this impact their profit-maximizing ticket price? (1) It doesn't change their profit maximizing price. 15. In terms of the concepts discussed recently in this class, why would you expect that gasoline prices might be lower in a small city than they would be in a very small town. Explain. (1) There is greater competition in the small city than in the very small town and this competition is likely to push gasoline prices lower. Page 11 of 11