Microeconomics Final Exam

Name:

10 Open Questions

1.

P Q TR MR TC ATC MC
20 0 3
18 1 4
16 2 6
14 3 10
12 4 16
10 5 26

The above table shows the market demand schedule and the cost structure.
a. Fill in all the columns for TR, MR, ATC and MC.
b. If the market were a monopoly, what would be the profit-maximizing output and price?
How much would be the economic profit?
c. If the market were purely competitive, what would be the equilibrium price and output?
d. If the market were a monopoly and it practiced perfect price discrimination. What would
be the highest and the lowest prices it can charge?
e. Suppose the same situation as in d. but the monopoly can only sell the goods one by one
unit (for instance, you cannot sell a car in half).
How much would be the total economic profit? How much extra profit it can earn by perfect
price discrimination than by a single price? A)

P Q TR MR TC ATC MC
20 0 0 0 3 nan nan
18 1 18 18 4 4.0 4
16 2 32 14 6 3.0 2
14 3 42 10 10 3.3 4
12 4 48 6 16 4.0 6
10 5 50 2 26 5.2 10

b) MR=MC, Q=4, P=1

c) A perfectly competitive firm is a price taker, in equilibrium P=MC=10 (allocative efficiency) , Q=5

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d) Perfect price discrimination.

Attention !!!! Producer surplus trapezoid (not a triangle) !!!!!!

PS=(20+10)/2*5=75 (not 50)

PS with unprefect discrimination=18+16+14+12+10=70

During the class I badly draw the graph on the board and confused with calculation of the area, I
dropped the bar since it was incomplete but in fact, we have quite a few….

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 2. The following table is the demand schedule. We assume the marginal cost is 0 at any level of
output.

Q P
4 24
5 21
6 18
7 15
8 12
9 9

a. If the market were a monopoly, what would be the profit-maximizing price and output?
b. From now on, suppose there are two firms in the market and still their marginal cost is 0.
Denote the output of Firm 1 as q1 and the output of Firm 2 as q2. It is illegal to collude.
i. When q1 = 3 and q2 = 3, how much is the economic profit each firm can earn?
ii. When q1 = 3 and q2 = 4, how much is the economic profit each firm can earn?
iii. When q1 = 4 and q2 = 4, how much is the economic profit each firm can earn?
c. Are there any dominant strategies for each firm according to what you got in i. to iii.? What
is the equilibrium outcome in this duopoly market?
d. Considering the price and output COLLECTIVELY in the duopoly market, what can you
conclude by the comparison with the monopoly outcome?

Q P TR MR
4 24 96
5 21 105 9
6 18 108 3
7 15 105 -3
8 12 96 -9
9 9 81 -15

a) MR=MC, since a monopoly can sell a half unit, it will chose Q so that MR is closest to MC, Q=6

b) q1=q2=3

Economic profit for each firm (half of the monopoly profit)= 18*6=54

q1=3, q2=4

Economic profit of firm1 (q=3)=15*3=45

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Economic profit of firm2 (q=4)=15*4=60

q1=4, q2=4

Economic profit of firm (q=4)=8*12/2=48

q1=5 q2=4

Economic profit of firm (q1=5)=9*5=45

Economic profit of firm (q1=4)=9*4=36

c) Dominant strategy for each firm to produce q=4, because in this case a firm can earns higher profit (60
versus 54). However, since both firms choose to produce 4 units, the equilibrium outcome is (4.4)
implying that each firm earns 48. It is not profitable to deviate further because a deviator will earn lower
profit (if a firm choose to produce 5, it will earn only 45)

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3. The following table illustrates the average total cost (ATC) for a representative firm in different
market structures: pure competition and natural monopoly. Suppose the demand is the same in
all market structures and we know the quantity demanded would be 10,000 if price were $10.

a. Identify the respective market structure represented by column A and B. Explain your
reason.
b. What is the MES (minimum efficient scale) in market structure A and B?
c. What is the maximum number of firms possibly in each market structure?

Q Long Run Average Total Cost (LATC)

(quantity)
A B C
500 20 20 10
2500 16 12 12
5000 14 10 14
7500 12 12 16
10000 10 15 18
12500 8.5 18 20

Downward sloping ATC implies increasing return to scale which is a feature of the natural
monopoly.
ATC is U shape in case B, can be monopolistic competition or oligopoly. (for PC, MES happens at
very low level of outcome, implying a huge amount of small producers).

Minimum efficient scale, case A: Q=12500 at which ATC reaches its minimum
Minimum efficient scale, case B: Q=500 at which ATC reaches its minimum

Minimum efficient scale, case C: Q=5000 at which ATC reaches its minimum

A: Nmb of firms =Q(market)/Qmes=10000/12500 ≈ 1 monopoly

B: Nmb of firms=10000/5000=2 duopoly

C: Nmb of firms=10000/500=20 duopoly

4. The below figure shows the market demand and the cost structure. Suppose presently the
market is in long-run equilibrium. Denote the long-run equilibrium price under perfect
competition (PC) as Ppc, and output as Qpc. Also denote the profit-maximizing prices and
outputs under monopoly (M) as Pm and Qm.

a. Compare the long run price, Pm, Ppc. Also compare the economic profits in the long run.

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 b. Discuss the reasons that make the monopolistic equilibrium M (Qm,Pm) and the competitive
equilibrium C (Qpc, Ppc) different.

Pm

Ppc

Qpc
Qm

A monopoly face downward sloping demand curve, it tries to optimize output so that its
economic profit maximizes (MR=MC) and sets price Pm (on demand curve).
A perefectly competitive frim is price taker, it cannot change the market price, it produces
MC=D (where MC is supply curve of a perfectly competitve firm) which is also Qmes (minimum
efficient scale).

5. Barbara left a $25,000 job as an architect to run a catering business. She invested $100,000 of
her own money to purchase a building for the business. The interest rate that Barbara typically
earns on her investments is 10%, while real estate is not appreciating in Barbara's
neighborhood. Barbara spends $150,000 per year on employee salaries, supplies, etc. What is
the economic cost of Barbara's catering business?

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Total costs=explicit costs +implicit costs=(150,000+100000)+ (10%*250,000+25000)

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6. Let the demand curve in some market be given by: Market Demand: P = 12 – 2Q. Suppose
presently there are 100 competitive firms in the market and they are identical (that is, they have
the same cost function). The marginal cost function of a representative firm is: MC = 200Q
a. Find market supply curve
b. What would be the equilibrium price and quantity if the market were purely competitive?
c. Suppose that a single company buys all 100 firms and becomes a monopoly in this market.
The technology does not change but only does the ownership.
d. What is the profit-maximizing output and price for the single-price monopoly?
e. Draw the demand, MR and MC curves, show the equilibrium price and quantity for the
purely competitive market, and the profit-maximizing output and price for a single price
monopoly.
f. What is your conclusion from this comparison?
g. You can imagine that there is a welfare loss due to the monopolization. Compute the
deadweight loss.

a) P=MC ( P>=ATC) for a representative firm

P=200Q Q=1/200*P
Q=100*(1/200P) Q=0.5P P=2Q (market supply)

b) 12-2Q=P(market demand)
P=2Q (market supply)

4Q=12 Q=3

c) Here we assume that MS represents the cost structure of a monopolist

MC=2Q
MR=12-4Q
6Q=12
Q=2

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 P MS
d)-g)

12

MD

2 6 Q
3

7. Two cigarette manufacturers (Firm A and Firm B) are faced with lawsuits from states to recover
the health care related expenses associated with cigarette smoking. Both cigarette firms have
evidence that indicates that cigarette smoke causes lung cancer (and other related illness). State
prosecutors do not have access to the same data used by cigarette manufacturers and thus will
have difficulty recovering full costs without the help of at least one cigarette firm study. Each
firm has been presented with an opportunity to lower their liability in the suit if they cooperate
with attorneys representing the states.

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 Firm B

Concede that Argue that there is no

cigarette smoke evidence that smoke
causes lung cancer causes cancer

Concede that Firm A profit = $–20 Firm A profit = $–50 b

cigarette smoke b Firm B profit = $–5 b
causes lung cancer Firm B profit = $–15
b
Firm A
Argue that there is Firm A profit = $–5 Firm A profit = $–10 b
no evidence that b Firm B profit = $–10 b
smoke causes Firm B profit = $–50
cancer b

When this game reaches a Nash equilibrium, profits for firm A and firm B will be

$–10 b and $–10 b, respectively.

8. Each year the United States considers renewal of Most Favored Nation (MFN) trading status
with China. Historically, legislators have made threats of not renewing MFN status because of
human rights abuses in China. The non renewal of MFN trading status is likely to involve some
retaliatory measures by China. The Game below reflects the potential economic gains associated
with a two-outcome game in which China may impose trade sanctions against U.S. firms and the
United States may not renew MFN status with China. The following table contains the dollar
value of all trade flow benefits to the United States and China under two trade-relationship
scenarios.

China

Impose trade sanctions Do not impose trade

against U.S. firms sanctions against U.S.
firms

Don't renew U.S. trade value = $65 U.S. trade value = $140 b
MFN status with b China trade value = $5 b
Unite China China trade value =
d $75 b
State
s Renew MFN U.S. trade value = $35 U.S. trade value = $130 b
status with China b China trade value = $275
China trade value = b
$285 b

When this game reaches a Nash equilibrium, the value of trade flow benefits will be

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 United States $65 b and China $75 b.

9. In the following normal-form game, what strategies survive iterated elimination of strictly
dominated strategies ? What are the Nash equilibria ?

Player 2

L C R

T (5,5) (-2,6) (1,3)

Player 1 M (7,2) (3,3) (3,1)

B (6,0) (0,0) (-1,-1)

Solutions

For player 1, strategy B is strictly dominated by M. Likewise, for player 2, strategy is strictly
dominated by both strategy L and C. We end up with the following reduced normal-form game.

Player 2

L C

T (5,5) (-2,6)

Player 1 M (7,2) (3,3)

Note that now for player 1, strategy T is strictly dominated by strategy M. Likewise, for player 2,
strategy L is strictly dominated by strategy C. By eliminating those two strategies, we end up
with only two remaining strategies, one for each player, such that the Nash equilibrium is (M,C)
and the associated payoff is (3,3)

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