Sample examination paper for familiarity and practice only

London Business School

Emre Ozdenoren
Applied Microeconomics Sample C
Total Points: 100
Questions 1 – 10: 4 points each Question 11 – 13: 20 points each

Examination Description and Instructions:

This is a closed-book and individual exam. The actual final exam will have a similar format.
The exam covers all the topics we study during the course. As a result, the actual exam
questions might cover different topics.

There are 10 multiple choice questions and 3 open questions. All questions should be
answered. Make sure that you leave enough time to attempt all questions, so that you do not
miss out on whichever ones are easier (for you).

Each multiple choice question has only one correct answer. If several answers seem possible,
answer with the best answer. A correct answer is worth 4 points. No answer or a wrong answer
is worth 0 points. If you change your mind on an answer, please completely erase or cross out
your old answer. If it is not clear what your intended answer is, you will receive 0 points for
that question. Please use the answer sheet at the end for the multiple choice questions.

Good Luck!
1) Assume that the world avocado market is perfectly competitive. Suppose that the world
avocado market is hit by the following two shocks: (i) there is a growers strike in Mexico
which is one of the major avocado producing countries and (ii) avocados have recently turned
into a major food trend around the world. In the short run, these two factors will:

a) Lead to a higher price of avocados and higher quantity of avocados sold.

b) Lead to a higher quantity of avocados sold and have an ambiguous effect on the price of
avocados.
c) Lead to a higher price of avocados and have an ambiguous effect on the quantity of
avocados sold.
d) Have an ambiguous effect on the price of avocados and the quantity of avocados sold.

2) Pharmacorp has recently obtained a patent on the new drug Calpor which is sold in pill
form and each pill must be specially wrapped. Pharmacorp is about to put the new drug on
sale and has already picked what it believes is the profit maximizing price. However,
Pharmacorp has just realized that it can use a new type of wrapping which is cheaper than the
wrapping it originally intended to use. As a result Pharmacorp should:

a) Charge a lower price than it had planned on; it will earn higher profits.
b) Charge a higher price than it had planned on; it will earn higher profits.
c) Charge a lower price than it had planned on; it will earn lower profits.
d) Charge a higher price than it had planned on; it will earn lower profits.

3) Suppose that the markets for potato crisps and popcorn are perfectly competitive and
potato crisps and popcorn are substitutes. Recent advances in agriculture made corn, the main
input in the production of popcorn, cheaper. All else equal, this would lead to:

a) an increase in the price of popcorn and a decrease in the price of potato crisps
b) a decrease in the price of popcorn but an increase in the price of potato crisps
c) an increase in the price of popcorn and potato crisps
d) a decrease in the price of popcorn and potato crisps
4) A company with market power sells two types of digital camera: a high end camera with
zoom and a low-end camera without. There are rich consumers ready to pay 160 for the high-
end camera and 100 for the low-end and poor consumers ready to pay 120 for the high-end
and 80 for the low-end. There are a 100 rich and a 100 poor consumers. Among the following
strategies which yields the most revenue:

a) a price of 160 for the high end and 80 for the low end
b) a price of 110 for the high end and 60 for the low end
c) a price of 150 for the high end and 60 for the low end
d) a price of 120 for the high end and 50 for the low end

5) An industry faces a demand curve D(P)=600-2P. The short-run market supply curve is
S(P)=4P. Suppose firms in this industry have constant MC which equals AVC. Suppose
existing firms are all identical with the same capacity, AVC of £50/unit and a minimum level
of ATC of £70/unit when they produce at capacity. Potential entrants have a minimum level
of FR-ATC of $90/unit when they produce at capacity. In this industry

a) existing firms will suspend production in the short run and exit in the long run. There will
be entry in the long run.
b) existing firms will produce in the short run and exit in the long run. There will be entry in
the long run.
c) existing firms will produce in the short run and in the long run. There will be no entry in
the long run.
d) existing firms will produce in the short run and in the long run. There will be entry in the
long run.

6) The market demand curve for gasoline is Qd = 2000 – 500P, where P is the price in pounds
per gallon and Qd is millions of gallons demanded per year. Suppose P=2. Consumer surplus
is:

a) £1,000,000,000
b) £2,000,000,000
c) £100,000,000
d) £200,000,000

7) A monopolist sells a product for which the demand curve is D(P) = 120 – P, where P is the
price in euros per units and D(P) is the units demanded per month. Suppose marginal cost is
constant and equal to 20 and the monopolist can produce up to 40 units per month. The
optimal price for the product is:

a) 50
b) 60
c) 70
d) 80
8) Consider a monopolist facing a downward sloping linear demand curve Q = a - bP.
Suppose the monopolist has a constant marginal cost and does not face a capacity constraint.
If the demand curve for the product doubles, i.e. new demand is Q = 2(a-bP) then:

a) The new price is twice the old price and the new quantity is less than twice the old
quantity.
b) The new price is the same as the old price and the new quantity is twice the old quantity.
c) The new price is less than twice the old price and the new quantity is less than twice the
old quantity.
d) The new price is more than twice the old price and the new quantity is less than twice the
old quantity.

9) You are told that the price elasticity of demand is -2. You are also told that the market
price is 5. You also happen to know that the equation of the demand curve is linear and given
by Q = a - 10P where a is a constant. The value of a is:

a) 25
b) 50
c) 75
d) 100

10) It is sometimes said that a monopolist creates “dead-weight loss”. By this it is meant that
a monopolist

a) Produce a quantity (below its capacity) where average total cost is not minimized.
b) Produce a quantity (below its capacity) where price is above marginal cost.
c) Produce a quantity (below its capacity) where price is below average total cost.
d) Need not be efficient and therefore tend to have excessively high cost levels.
Question 11

The market demand curve for apartments in a Canadian city is Qd = 2,000 – P, where Qd is
thousands of “standard-sized” apartment units demanded per month, and P is the monthly
rental rate for a “standard-sized” apartment. The market supply curve is Qs = -125 + 0.25P,
provided P ³ $500 per apartment per month (with quantity supplied being zero otherwise),
where Qs is thousands of standard-sized supplied per month.

(a) Find the market equilibrium rental rate for housing in this price in this market
(b) Calculate consumer, producer, and total surplus at the market equilibrium price.
(c) Suppose now the government imposes a price control in this market, limiting the monthly
rental to be no higher than $1,000 per month. Fill in the table below, and identify the
deadweight loss from price controls. (Assume that available apartments go to the tenants with
the highest willingness to pay.)

Hint: The best way to approach this problem is to sketch a very careful picture of the demand
and supply curves, being careful to put P on the vertical axis and Q on the horizontal axis.

Table for Problem 11

Free market Price control Change: Price

control less
free market
Consumer
surplus
Producer
surplus
Total surplus
Question 12

A monopolistic manufacturer of high-end leather goods sells a particular type of leather

handbag through company-owned stores. The company operates two different types of stores.
Type 1 stores are located in upscale shopping malls and are visited by consumers who highly
value the company’s brand name. The demand curve for handbags sold through these types of
stores is given by Q1 = 5000 - 4 P1, where P1 is the price in $ per handbag and Q1 is the number
of handbags sold per quarter. The identical handbag is also sold through Type 2 stores that are
located in factory-outlet malls. These stores are visited by consumers who, on average, are
more price-sensitive than those who visit the Type 1 stores. The demand curve for handbags
sold through these types of stores is given by Q2 = 4000 –16 P2, where P2 is the price in $ per
handbag and Q2 is the number of handbags sold per quarter. The marginal cost is $200 per
handbag for both types of stores.

a) Suppose first that the monopolistic manufacturer wants to charge the same price in both
shops to avoid arbitrage by consumers. What is the profit-maximizing total quantity of
handbags sold in both outlets per quarter? What is the corresponding profit-maximizing price?
Q = ______________
P = ______________

Suppose for the rest of the exercise that it is highly unlikely that consumers who shop in one
type of store will shop in the other type, and thus the company can charge a different price for
the same handbag according to what store it is sold at.

b) What is the profit-maximizing quantity of handbags sold in each type of outlet per quarter?
What is the profit-maximizing price of handbags sold in each type of outlet?
Q1 = ______________
Q2 = ______________
P1 = ______________
P2 = ______________

c) Suppose that you find that the demand curve for the Type 1 stores given above is faulty. The
actual linear demand curve for the Type 1 stores is one-half as price elastic at the optimal price
and quantity (P1 and Q1) calculated in part (b). How does this affect the optimal price for Type
1 stores? (circle exactly one)

A. increases the price

B. decreases the price
C. does not affect the price
Question 13

The market for a generic drug is shared by two firms, Firm 1 and Firm 2. This drug is a
commodity, and statistical analysis has revealed that quantity competition captures well the
short-run competition between the two firms. It has further been determined that the demand
is given by P = 200 – 2Q, where Q = Q1 + Q2 is total output, P is the price (in dollars per ton),
and Q1 is the quantity (in tons) supplied by Firm 1. Similarly, Q2 is the quantity (in tons)
supplied by Firm 2. Firms have identical constant marginal cost of $20 per ton. There are no
fixed costs.

Throughout the exercise, we assume that firms choose quantities.

a. Assume that firms choose Q1 and Q2 simultaneously and independently, once and for all.
What is Firm 1’s reaction function?

Firm 1’s reaction function is _________________________________

b. Assume that firms choose Q1 and Q2 simultaneously and independently, once and for all.
What is the Cournot equilibrium in this market?

Cournot equilibrium output of Firm 1 is ______________________

Cournot equilibrium output of Firm 2 is ______________________

c. Consider the baseline situation described above where two firms with identical marginal
costs choose output simultaneously. Let’s now compare the outcome in this baseline case to
the outcome in a situation in which firms continue to act as quantity setters but some
economic fundamentals have changed. Each of the following scenarios should be considered
independently. For each scenario circle exactly one answer. No written explanations
necessary.

Suppose that Firm 1 has a lower marginal cost than the baseline case but firm 2’s marginal cost
has not changed. As compared to the baseline case:

A. Firm 1 produces more output and firm 2 produces more output.

B. Firm 1 produces more output and firm 2 produces less output.
C. Firm 1 produces less output and firm 2 produces more output.
D. Firm 1 produces less output and firm 2 produces less output.

Suppose we observe that, relative to the baseline case, both Firm 1 and Firm 2 are producing
more output. We also observe that, relative to the baseline case, the market price has risen.
Which of the following explanations is consistent with this fact pattern?

A. Firm 1 and Firm 2 have both experienced a reduction in marginal cost, with the position
of the market demand curve remaining the same.
B. Firm 1 and Firm 2 have both experienced an increase in marginal cost, with the position
of the market demand curve remaining the same.
C. The marginal costs of Firm 1 and Firm 2 have remained the same, but the market
demand curve has shifted rightward.
D. The marginal costs of Firm 1 and Firm 2 have remained the same, but the market
demand curve has shifted leftward.

The managers responsible for choosing quantities in Firms 1 and 2 have been ordered to
maximize total revenue rather than total profit. As compared to the baseline case:

A. Firm 1 produces more output and Firm 2 produces more output.

B. Firm 1 produces less output and Firm 2 produces less output.
C. The market price goes down.
D. The market price goes up.
E. Both A and C.
F. Both B and D.
Answer Sheet

A B C D

Question 1

Question 2

Question 3

Question 4

Question 5

Question 6

Question 7

Question 8

Question 9

Question 10