Problems Previous Finals

Problems from previous finals
1. João is enthusiastic about green mobility and has decided to build customized bikes.
Since he prefers to be cautious he has decided to open his business by either operating
out of one garage or two. When it operates out of one garage, its average total cost of
production is ATC1=Q2-6Q+14. If it operates out of two garages, its average total cost
of production is given by ATC2=Q2-10Q+30.
(i) What is the role played by garages in João’s new business?

Garages play the role of scale of production or the amount of fixed input.
So, either K1=1 or K2=2, measured in # of garages.
(ii) If he decides to operate out of only one garage, how many bikes would he
choose to build, and at what cost? And in the case of two? Show your work.
The best he could do would be to produce at the minimum efficient scale, that
is, at its min: ATC1=MC1, that is, at Q1=140.5=3.7, and ATC1=6.2.
With two garages: ATC2=MC2, that is, at Q2=300.5=5.5, and ATC2=4.5.
(iii) How does this firm’s long-run average cost curve (LAC) look like? Sketch it
graphically.
They cross at ATC1=ATC2, that is, at Q=4, and ATC1 =ATC2 =6. For Q<4, one
garage is chosen as it minimizes average total cost, and for Q>4 João chooses
two garages. The LAC is the outer envelope of the two ATC.
(iv) Would João be willing to operate out of one garage independently of the amount
of bikes demanded? Explain.
No, as explained in (iii). Only for Q<4.See graph.
2. Suppose that in Lisbon the daily market demand for taxi rides is Q = 2100 - 100P where
P is the price. Suppose also that the daily cost of operating each cab is a fixed 100 euros
rental cost per vehicle, plus a variable cost of q2/100, where q is the number of cab rides
per cab per day. Assume that the market is a constant cost perfectly competitive one.
(a) Characterize a constant cost perfect competitive industry.

U-shaped, free entry and identical firms
inputs prices not responding to changes in output: horizontal at min LAC=LMC
(b) What is the long run total cost function of each cab?
LTC = 100 + q2/100 per day.
1
(c) What is the long-run price of a cab ride?
Minimum cost: MC=LAC, q/50 = 100/q + q/100, solved to find q = 100. Then p =
MC = 100/50 = 2.
d)What is the number of rides each cab supplies and the number of cabs operating in
the long run? Illustrate graphically the equilibrium for the representative firm and for
the industry.
Found above that q=100. Then Q = D(2) = 2100 - 200 = 1900, and n = Q/q = 19.
(e)What is the long-run supply for the industry? Represent it graphically.
Horizontal at p=2
(f)Derive the corresponding short-run supply for the industry, that is, the short-
run equilibrium that is associated to the long-run one.
19q=Q=19(50)p= 95p, that is, Q=95p

(g) What is consumer surplus and producer surplus in the taxi cab market in the LR
equilibrium and in the corresponding SR equilibrium? Show graphically the
corresponding areas.
Inverse demand function: P = 21 – Q/100
Consumer Surplus in LR and SR: ½hb = ½ (21-2)(1900) = $18,050
Producer Surplus in the LR: $0 (horizontal supply curve)
Producer Surplus in the SR: 2(1900)/2=1900
3. Suppose you are responsible for managing firm Alpha in the technological sector,
which production function is given by Q = 2KL. The price of skilled labor services w
is 4 and of capital services r is 5 per unit.
(a) Characterize Alpha’s production function. Support your statement formally.
Technology characterized by IRS (degree 2)

(b) In the short run, the plant’s capital is fixed at K = 9. What is the amount of
skilled labor services the firm has to hire to produce Q = 45 units of output?
MPL=2K, MPK=2L
Q=18L, so L=Q/18=45/18=2.5
(c) Define conditional demand for an input. Derive the conditional demands for
labor and capital for Q=45, stating formally the decision problem of the firm.
Definition and formal statement of Min wL+rK s.to 45=2KL.
K/L=4/5 K=4/5L ; L= (Q r/w)0.5 for Q=45

45=2KL K= 4/5(Q r/w)0.5 for Q=45
(d) In a social event, a good friend of yours, Manuel, comments that “most likely
Alpha is losing money by not having the ability to choose its level of capital
optimally”. Do you agree with Manuel? Explain and show whether your friend
is right or wrong. Show our work.
For Q=45 the optimal plant scale is:
2
In case K is adjustable (LR), K=4.2 and L=5.36, so LTC=42.44 if in LR; in SR
STC=55. The firm saves 55-42.44= 12.56
(e)What is the Alpha’s long run total cost curve?

LTC= wL(Q, w,r)+rK(Q,w,r)= 4 (Q 5/4)0.5 + 5 (4/5)(Q 5/4)0.5=9 (Q 5/4)0.5
It is strictly concave, as it should be given technology IRS
(e) What is the Alpha’s long run average cost curve? And the long run marginal
cost curve? How would you expect the market structure where this industry is
operating? Explain your arguments.
LAC=LTC/Q=9 Q-0.5 (5/4)0.5
LMC= 4.5 Q-0.5 (5/4)0.5
LMC<LAC . LAC is decreasing and LMC is below it
Natural monopoly: only one firm operating
4. Ticketline used an Internet auction to sell tickets for a “fado-singer” concert.
(i) The floor seats were auctioned in a uniform price format where all winning
bidders paid the same price: the lowest bid (90 euros) at which all the seats were
sold. Is this price discrimination? If so, what type? Explain briefly.
No, it is perfect competition: P=MC, efficient solution. CS and PS are
maximized, that is, total welfare for society. The price at which all seats are sold
is the price for the marginal consumer.
(ii) Suppose, instead, that each ticket was sold at the highest bid for the
corresponding seat. Is this price discrimination? If so, what type? Explain
briefly.
Perfect price discrimination monopolist. The monopolist has a large amount of
information about consumers which allows him to sell each seat at the highest
amount each consumer is willing to pay for it. It is efficient as the cheaper seat
and the last sold is sold at p=MC, but all consumer surplus is transferred to the
monopolist so CS=0. Total welfare is captured by the monopolist. So from a
distributive perspective it is worth than perfect competition as consumers loose
CS.
5. The olive oil industry is perfectly competitive. Every producer has the following long-
run total cost function: LTC= 2Q3-15Q2+40Q, where Q is measured in tons of olive oil.
(i) What is the long-run equilibrium price of olive oil? Explain.

LAC= 2Q2-15Q+40 LMC=6Q2-30Q+40
3
Price at the long-run equilibrium is the one that min LAC, that is, for the quantity for
which LAC=LMC, implying that Q=15/4=3.75. Therefore p=min LAC=11.75.
(ii) How many units of olive oil will each firm produce in the long run? Show your
work.
From (i) Q= 3.75
(iii) If the market demand for olive oil is given by Q=999-0.25P, how many tons of
olive oil will consumers demand? Show your work.
Q= 999-0.25(11.75)= 996
(iv) How many firms will operate when the industry is in long-run equilibrium?
Show your work.
N=996/3.75= 266 (approx)

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Problems Previous Finals

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Problems from previous finals

(i) What is the role played by garages in João’s new business?

No, as explained in (iii). Only for Q<4.See graph.

(a) Characterize a constant cost perfect competitive industry.

19q=Q=19(50)p= 95p, that is, Q=95p

Technology characterized by IRS (degree 2)

K/L=4/5 K=4/5L ; L= (Q r/w)0.5 for Q=45

(e)What is the Alpha’s long run total cost curve?

4. Ticketline used an Internet auction to sell tickets for a “fado-singer” concert.

(i) What is the long-run equilibrium price of olive oil? Explain.

From (i) Q= 3.75

N=996/3.75= 266 (approx)

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