Intermediate Microeconomics - Topics in Price Theory

ECMC02H Intermediate Microeconomics - Topics in Price Theory

Term Test – October 15, 2004 Time: 100 minutes Professor Gordon Cleveland

______Your name (Print clearly and underline your last name) Your student number

1. ______6. ______11. ______

2. ______7. ______12. ______

3. ______8. ______13. ______

4. ______9. ______14. ______

5. ______10. ______15. ______

This exam consists of TWO PARTS, both of which are to be answered in this exam booklet. For the first part, there are 15 multiple choice questions, each worth 4 marks, which are to be answered on this front sheet of the exam. Each question should be answered by indicating with a BLOCK CAPITAL LETTER the alternative which is correct (if you feel that a question is ambiguous or that no one answer is entirely correct, pick the answer which you believe to be the "best" answer). You will receive 3 marks for each correct answer, 0 for each wrong or blank response (thus you will not be penalized for wrong guesses). For the second part, there are five short answer and graphical problems. You should answer four of these questions; they are worth a total of 40 marks. These problems are provided at the end of the multiple choice questions, and you are to answer them in the space provided. If you make mistakes and need to redo the question, you can use the back of the pages, but clearly indicate that you are doing this below the question. 2

The exam is out of 100. Your exam consists of 14 pages. FILL IN YOUR NAME NOW. 3

PART I - 15 Multiple Choice Questions - 60 marks

1-5. A monopoly producer of diamonds sells these diamonds in the United States and in Brazil. Strict trade laws prevent consumers from re-selling their diamonds from one market to another. You are given the following demand curves per year for these distinct markets:

United States: Q1 = 1000 - P1 Brazil: Q2 = 425 – 0.25P2 where P refers to prices charged in each market and Q refers to quantities demanded in each market. The variable cost of producing diamonds is uniform at $100 per diamond. In addition there are fixed costs of $10,000 per year. Questions 1 through 5 concern this case.

1. If the producer of diamonds can price discriminate by charging different prices in each market, the profit-maximizing price charged in Market #1 (United States) will be:

A) $0 B) $5 C) $10 D) $20 E) $40 F) $50.00 G) $55.00 H) $70.00 I) $100 J) $125.00 K) $160.00 L) $200.00 M) $270.00 N) $300.00 O) $380.00 P) $400.00 Q) $450.00 R) $490.00 S) $550.00 T) $620.00 U) $740.00 V) $860.00 W) $900.00 X) $960.00 Y) $1000 Z) none of the above

2. If the producer of diamonds can price discriminate by charging different prices in each market, the profit-maximizing price charged in Market #2 (Brazil) will be:

A) $0 B) $5 C) $10 D) $20 E) $40 F) $50.00 G) $55.00 H) $70.00 I) $100 J) $125.00 K) $160.00 L) $200.00 M) $270.00 N) $300.00 O) $380.00 P) $400.00 Q) $450.00 R) $490.00 S) $550.00 T) $620.00 U) $740.00 V) $860.00 W) $900.00 X) $960.00 Y) $1000 Z) none of the above

3. Assume now that the producer of diamonds is unable to discriminate between markets but must sell at a uniform price. By how much will profits fall as a result of this? A) $0 B) $50 C) $1000 D) $2000 E) $4000 F) $5000 G) $5500 H) $9000 I) $10000 J) $12500 K) $14500 L) $23500 M) $24500 N) $30000 O) $43000 P) $53250 Q) $62000 R) $75000 S) $84000 T) $88000 U) $90000 V) $96000 W) $100000 X) $124000 Y) $144000 Z) none of the above 4

4. For the consumers in market #1 (United States), by how much has consumer surplus fallen (-) or risen (+) in moving from the price discrimination situation to the normal monopoly situation with no price discrimination? A) -$29,050 B) -$19,050 C) -$16,400 D) -$14,800 E) -$12,600 F) $0 G) +$500 H) +$10,000 I) +$12,500 J) +$15,000 K) +$22,250 L) +$36,800 M) +$40,500 N) +$43,500 O) +$47,700 P) +$48,000 Q) +$50,400 R) +$54,200 S) +$60,700 T) +$65,800 U) +$79,800 V) +$86,000 W) +$96,500 X) +$98,200 Y) +$100,000 Z) none of the above

5. For the consumers in market #2 (Brazil), by how much has consumer surplus fallen (-) or risen (+) in moving from the price discrimination situation to the normal monopoly situation with no price discrimination? A) -$29,050 B) -$19,050 C) -$16,400 D) -$14,800 E) -$12,600 F) $0 G) +$500 H) +$10,000 I) +$12,500 J) +$15,000 K) +$22,250 L) +$36,800 M) +$40,500 N) +$43,500 O) +$47,700 P) +$48,000 Q) +$50,400 R) +$54,200 S) +$60,700 T) +$65,800 U) +$79,800 V) +$86,000 W) +$96,500 X) +$98,200 Y) +$100,000 Z) none of the above

6.10. A small country called YesICan has no international trade in running shoes, but it does produce and consume these shoes domestically. The monthly domestic demand for running shoes is given by P = 60 – 0.005Q, where P is measured in dollars and Q is the number of pairs of shoes per month. The domestic supply of running shoes (these shoes are sold in a perfectly competitive market) is given by P = 0.0025Q. This information can be used in answering questions 6-10.

6. What is the equilibrium quantity of running shoes traded in YesICan? A) 0 B) 100 C) 200 D) 300 E) 400 F) 500 G) 700 H) 900 I) 1000 J) 1200 K) 1400 L) 1600 M) 1800 N) 2000 O) 2400 P) 3000 Q) 4000 R) 5000 S) 6000 T) 7000 U) 8000 V) 8500 W) 9000 X) 10000 Y)11000 Z) none of the above

7. Now, the consumers in YesICan lobby vigorously and are successful in opening up the markets of YesICan to international trade. Running shoes are available on the international market at a uniform price of $5. Now, what quantity of running shoes will be imported into YesICan? A) 0 B) 100 C) 200 D) 300 E) 400 F) 500 G) 700 H) 900 I) 1000 J) 1200 K) 1400 L) 1600 M) 1800 N) 2000 O) 2400 P) 3000 Q) 4000 R) 5000 S) 6000 T) 7500 U) 8000 V) 8500 W) 9000 X) 10000 Y)11000 Z) none of the above 5

8. Now, the domestic producers of running shoes in YesICan lobby vigorously and are successful in getting the government to put a tax of 100% on each pair of running shoes imported into YesICan. By how much do imports fall as a result of this tariff? A) 0 B) 100 C) 200 D) 300 E) 400 F) 500 G) 700 H) 900 I) 1000 J) 1200 K) 1400 L) 1600 M) 1800 N) 2000 O) 2400 P) 2600 Q) 3000 R) 3200 S) 3600 T) 4000 U) 4800 V) 5000 W) 6000 X) 8000 Y) more information is needed to answer Z) none of the above

9. How much consumer surplus per month did consumers in YesICan lose as a result of this tariff? A) $0 B) $5000 C) $7500 D) $20000 E) $40000 F) $50000 G) $52500 H) $55000 I) $57500 J) $62500 K) $77500 L) $80000 M) $82500 N) $90000 O) $120000 P) $125000 Q) $200000 R) $250000 S) $275000 T) $300000 U) $302500 V) $325000 W) $330000 X) $350000 Y) $375000 Z) none of the above

10. What is the amount of the deadweight loss per month as a result of the tariff? A) $0 B) $5000 C) $7500 D) $20000 E) $40000 F) $50000 G) $52500 H) $55000 I) $57500 J) $62500 K) $77500 L) $80000 M) $82500 N) $90000 O) $120000 P) $125000 Q) $200000 R) $250000 S) $275000 T) $300000 U) $302500 V) $325000 W) $330000 X) $350000 Y) $375000 Z) none of the above

11-14. An industry consists of two mineral springs, each of which have variable costs of $20 per unit of water produced and no fixed costs. The industry demand curve is: P = 596 - 4Q. Questions 11 through 14 concern this industry.

11. If the firms collude and agree to split the total profits in the industry, then the price that will result is:

A) $0 B) $20 C) $44 D) $60 E) $72 F) $84 G) $96 H) $124 I) $144 J) $164 K) $176 L) $186 M) $200 N) $212 O) $236 P) $272 Q) $298 R) $308 S) $312 T) $326 U) $376 V) $380 W) $384 X) $390 Y) more information is needed to answer Z) none of the above 6

12. If the firms compete under the Cournot assumptions (that is, each firm assumes that the other firm will not change its output), then the price that will result in the Nash equilibrium is:

A) $0 B) $20 C) $44 D) $60 E) $72 F) $84 G) $96 H) $124 I) $144 J) $164 K) $176 L) $186 M) $200 N) $212 O) $236 P) $272 Q) $298 R) $308 S) $312 T) $326 U) $376 V) $380 W) $384 X) $390 Y) more information is needed to answer Z) none of the above

13. Now suppose that one firm is a Stackelberg leader while other firm is a follower. Assume, as usual, that the follower behaves like a Cournot duopolist (that is, assumes that the leader's output is fixed). Then the price that will result is:

A) $0 B) $20 C) $44 D) $60 E) $72 F) $84 G) $96 H) $124 I) $144 J) $164 K) $176 L) $186 M) $200 N) $212 O) $236 P) $272 Q) $298 R) $308 S) $312 T) $326 U) $376 V) $380 W) $384 X) $390 Y) more information is needed to answer Z) none of the above

14. If we move from the Cournot equilibrium obtained in question 12 to the Stackelberg leader-follower equilibrium obtained in question 13, then the deadweight loss rises (+) or falls (-) by:

A) $0 B) +$8 C) -$8 D) +$20 E) -$20 F) +$32 G) -$32 H) +$64 I) -$64 J) +$96 K) -$96 L) +$108 M) -$108 N) +$126 O) -$126 P) +$164 Q) -$164 R) +$212 S) -$212 T) +$288 U) -$288 V) +$2016 W) -$2016 X) -$2592 Y) -$4608 Z) none of the above

15. If a monopolist is in profit-maximizing equilibrium producing 12 units of output, its marginal and average cost is constant at $3.00, and it earns $48 of profit in the short run, then we can say that the elasticity of demand is: A) 0 B) -0.1 C) -0.2 D) -0.25 E) -0.3 F) -0.33 G) -0.4 H) -0.5 I) -0.5714 J) -0.67 K) -0.7 L) -0.75 M) -0.8 N) -0.9 O) -1.2 P) -1.4 Q) –1.6 R) –1.75 S) –2.3 T) –4.0 U) –6.4 V) –7.0 W) none of the above 7

PART II - Graphical and Short Answer Questions - 40 marks (There are five questions in this section; you are to answer any four of these questions.

16. A monopoly producer of arthritis medication has demand for the product given by P = 100 – Q. The total costs of the monopolist are given by TC = 1.5Q2. The initial equilibrium is at P = $80, Q = 20. There is now a tax of $50 per unit placed on the monopolist. Label the diagram below, put numbers on the axes, and show the demand, marginal revenue and marginal cost curves for this arthritis medication. Show the effects of the tax on these curves and show the new equilibrium price and quantity on the graph. 8

16. (continued) Calculate and write down the following: (a) the sellers’ share of the tax,

(b) ignoring the effects of the tax for the moment, calculate the amount of deadweight loss due to monopolization of this industry (relative to the competitive, or quasi-competitive, solution),

(c) the amount of deadweight loss added by the tax. 9

17. “Number 4 Northern” is a type of wheat that shows great promise for disease-resistance without genetic modification. The Canadian government is anxious to ensure that farmers who produce this type of wheat are able to survive. The Canadian government is considering alternative ways of supporting these farmers. The demand for “Number 4 Northern” is given by: P = 10 – 0.001Q, where P is the price of a bushel of wheat and Q is the quantity of bushels of wheat traded per day. The supply curve of “Number 4 Northern” is given by: P = 1 + 0.0005Q. This gives an equilibrium price of $4.00 and quantity of 6,000 bushels per day traded in this perfectly competitive market for wheat. (a) On the graph below, draw the demand and supply curves for “Number 4 Northern” and show the effects on this market if the Canadian government passes and enforces a law that makes $8.00 the minimum price that can be charged. Assume sellers reduce their output in response to this policy. In particular, (i) shade in the area showing the amount of efficiency loss due to this policy. (ii) Below the diagram, calculate and write down the amount of this efficiency loss in dollars per day. (iii) Also, below the diagram, calculate and write down the amount of consumer surplus per day given up by consumers as a result of this policy. 10

(b) An alternative policy available to the Canadian government is to purchase sufficient amounts of “Number 4 Northern” that the price rises to $8.00 per bushel. On the diagram below, draw the demand and supply curves for Number 4 Northern, and show the effects on these curves of the policy described. In addition, (i) shade in the area showing the amount of efficiency loss due to this policy. (ii) Below the diagram, calculate and write down the amount of this efficiency loss in dollars per day. (iii) Also, below the diagram, calculate and write down the amount of consumer surplus given up by consumers as a result of this policy. (iv) how many bushels per day will the government have to buy? 11

18. There are two types of consumers in the market for digital books: Type A consumers are wary and uncertain, Type B consumers are enthusiastic. The demand per week by each Type A consumer is given by P = 20 - 10Q. The demand per week by each Type B consumer is given by P = 40 – 5Q. You can assume that the cost of producing digital books is zero. The monopoly producer of digital books is trying to figure out how to price digital books so that each type of consumer will pay a different price, so that the monopolist can price discriminate. Since the consumers are not distinguished by any obvious characteristic, the monopolist will have to design different price-quantity packages that encourage consumers to self-select into the two types. For the purposes of this question, you can assume that there is only one Type A consumer and one Type B consumer. (a) Label the graph below and show the demand curves of the two types of consumers. Assume that the monopolist designs price-quantity packages with Q = 2 per week for Type A consumers and Q = 8 per week for Type B consumers. (i) What prices will the monopolist charge for the Type A package and the Type B package if she wants consumers to self-select into purchasing the appropriate packages? (ii) on the graph, show the amount of consumer surplus that the Type B consumer will get when he purchases the appropriate package. Below the graph, calculate the amount of this consumer surplus. 12

a. Now assume that the monopolist is trying to work out an even better arrangement for price discrimination. The monopolist decides to offer a different set of price-quantity packages to the consumers. She offers packages with Q=1, intended to attract Type A consumers, and Q=8, intended to attract Type B consumers. (i) how much will the monopolist now be able to charge Type A consumers for the first package?

(ii) how much will the monopolist be able to charge Type B consumers for the second package?

(iii) does this new price discrimination arrangement increase the profits of the monopolist? By how much?

19. Consider the following economics poem about the cost of raising pigs, the 13

cost of buying corn (which pigs eat), and the price of farming land upon which the corn is grown:

The cost of pig Is something big Because its corn you'll understand Is high priced too: Because it grew Upon the high priced farming land. If you'd know why Consider this: the price is big Because it pays Thereon to raise The costly corn, the high priced pig.

Note that the line “If you’d know why….” should be understood to mean “if you would like to know why the price of farming land is high…”

What determines the amount of producer surplus in a competitive market in the long run, and how is this related to the poem? (be brief) 14

20. An industry consists of 6 firms. Five of these firms are small firms that constitute the "competitive fringe" of the market. These small firms all take as given the price established by the single large firm in the industry. These 5 small price takers are then free to supply whatever output they choose. The remaining firm (i.e., the sixth firm) firm is the large dominant firm in the industry. This large firm sets the price for the industry. Each of the 5 small firms has a supply curve given by the equation P = .05qi for i running from 1 to 5; the dominant firm has fixed marginal and average costs MC = AC = 20. Total market demand for the good can be expressed as: P = 60 - .005QT.

(a) Label the graph below, put numbers on the axes and draw in the demand curve for the output of the dominant firm, its marginal revenue curve, and show the equilibrium output of the dominant firm (QDF), the equilibrium price (P*) and the equilibrium output of the competitive fringe (QCF) of firms. Write the amount of these equilibrium outputs down below the graph. 15

(b) How much profit does the dominant firm earn? Would it be reasonable to interpret a large part of this profit as really being “economic rent”? Why or why not? (be brief)