Economics 1

Fall 2020
UC Berkeley

PROBLEM SET #3
Submit via Gradescope by Tuesday October 13, 10:00pm

Write your answers on separate pieces of paper and upload your answers to Gradescope. Late problem
sets will not be accepted. While you may discuss the problems with your classmates, all submitted work
must be your own. Problem sets that are identical (in whole or in part) to another student’s problem set
will receive a zero.

1. A firm operating in a perfectly competitive industry has the cost curves depicted below:

150

100

50

50 70 80 Q

a. On your own paper, re-sketch the cost curves and label the curves: Marginal Cost (MC), Average
Variable Cost (AVC), and Average Total Cost (ATC). Note: you can determine which curve
corresponds to which cost based on the placement of each curve.
b. Over what price range will the firm be making a profit?
c. Over what price range will the firm be operating (continuing production), at a loss?
d. Over what price range will the firm choose to shut down?

2) A firm’s cost curves are given in the following graph:

a. Re-sketch the cost curves and label the curves depicted.

b. Identify the profit-maximizing level of output, as q*. Why is this the profit-maximizing quantity?
c. Identify total revenue (TR), total costs (TC), and profits or losses (p) in your graph.
3. In our last problem set, we completed the following cost table.

Quantity Total Variable Marginal Average Total Average Average

(bushels) Cost ($) Cost ($) Cost ($) Cost ($) Variable Cost ($) Fixed Cost ($)

0 24 0 -- -- -- --

1 39 15 15 39 15 24

2 46 22 7 23 11 12

3 54 30 8 18 10 8

4 64 40 10 16 10 6

5 75 51 11 15 10.2 5.4

6 90 66 15 15 11 4

7 112 88 22 16 12.6 3.4

a. Consider four possible market prices. Determine the short run profit-maximizing quantity at each
price and the economic profit at each price. Be sure to consider whether the firm might be better
off shutting down (producing quantity = 0). Recall the equation we use to calculate profit !
(where TC is “total cost”):
! = # × % − '(

i. A market price of $22

ii. A market price of $15
iii. A market price of $11
iv. A market price of $8

b. Above, you (hopefully!) found that at a price $11, the firm will exit in the long run, but will
produce in the short run and incur a loss.

i. Sketch a graph of ATC and MC only. Add the MR curve corresponding to this price.
ii. Label areas indicating the firm’s total revenue, total cost, and loss (negative profit) in
your graph.
iii. Calculate the size of the loss (negative profit), in dollars.
iv. Suppose this firm does exit the market in the long run. What happens to the market
supply/demand and equilibrium price and total market quantity sold? Please sketch a
graph of your answer.
4. The figure below shows the demand and cost curves for a monopoly.

a. What quantity of output maximizes the monopolist's economic profit?

b. What price does the monopolist set for the good?
c. Calculate the firm’s total revenues (TR), total costs (TC), and profits (p).

5. The table below shows the demand schedule and costs for a monopoly.

Quantity Marginal
Price Total Cost Marginal Cost
Demanded Revenue
(dollars) (dollars) (dollars)
(units of good) (dollars)
30 0 0 25 --
27 1 27 28
24 2 21 33
21 3 15 40
18 4 9 49
15 5 3 60
12 6 -3 73
9 7 -9 88

a. Explain how marginal revenue is calculated. Write down two example calculations, i.e., explain why
MR=27 for Q=1 and MR=21 for Q=2.
b. Calculate the marginal cost of producing each quantity listed. On your own paper, copy three columns
from the table only: Quantity Demanded, Marginal Revenue, and Marginal Cost.
c. What quantity of output maximizes the monopolist's economic profit?
d. What price does the monopolist set for the good?
e. Calculate the firm’s profits at the profit-maximizing quantity and price.
6. In Busytown there are only two lawyers— Doug and Lucy. Doug and Lucy can each choose to advertise
their services or not. There are four possible scenario: they both advertise, they both decide not to
advertise, Doug advertises and Lucy does not, and Lucy advertises with Doug does not. For each
scenario, the incomes (in thousands of dollars) of each lawyer are given in the payoff matrix below.
Lucy’s payoff is in the upper right corner of the cell, and Doug’s payoff is in the lower left corner.

Lucy

Advertise Don't advertise

$800 $600
Advertise
$700 $1,100
Doug
$1,200 $1,000
Don't advertise
$600 $900

a. Does Doug have a dominant strategy? Explain.

b. Doug Lucy have a dominant stragey? Explain.
c. Name the strategies that each player plays in the Nash equilibrium. What are each player’s
payoffs in this Nash equilibrium?
d. Explain what this game has in common with the Prisoner’s Dilemma game.

7. A monopolist retires and hands her company over to her two children. The children have an argument and
decide they cannot work together, and split the company into two-- Firm 1 and Firm 2. Each firm can
choose to produce a high level of output, or a low level of output. For each scenario, Firm 1’s profits are
written in the lower left corner of the cells, while Firm 2’s profits are written in the upper right corner of
the cells.

Firm 2

High Output Low Output

$1,600 $1,500
High Output
$1,600 $2,000
Firm 1
$2,000 $1,800
Low Output
$1,500 $1,800

a. Explain why both firms producing “Low Output” gives higher profits to each firm than
both firms producing “High Output”. (Recall: the two firms are the only sellers in the
market.)
b. Explain why each firm would have an incentive to “cheat” on an agreement to keep
production low.