Regulation and Antitrust Policy (Econ 180) Drake University, Spring 2009 William M. Boal

Review: Cost, Profit, and Social Welfare

### Version A

I. Problems

(1) [Short-run cost curves: 12 pts]

1. SAVC = \$20, \$15, \$30;
2. SAFC = \$30, \$15, \$10;
3. SATC = \$50, \$30, \$40;
4. SMC = \$20, \$10, \$60.

(2) [Short-run cost curves and supply: 18 pts]

1. \$11;
2. \$8;
3. \$4;
4. 1700 doorknobs;
5. profit, because price > breakeven price;
6. 1300 doorknobs;
7. loss, because price < breakeven price;
8. 0 doorknobs, because price is less than shutdown price;
9. loss, equal to SFC.

(3) [Producer surplus: 20 pts]

1. \$5;
2. \$10;
3. \$25;
4. 8 million;
5. \$120 million;
6. worse off;
7. \$40 million;
8. 16 million;
9. better off;
10. \$120 million.

(4) [Demand, consumer surplus: 20 pts]

1. \$50;
2. \$35;
3. \$15;
4. 14 million;
5. \$210 million;
6. worse off;
7. \$245 million;
8. 10 million;
9. worse off;
10. \$120 million.

(5) [Welfare effects of price controls: 12 pts]

1. 8 million;
2. increase;
3. \$15 million;
4. decrease;
5. \$18 million;
6. \$3 million.

II. True/False/Explain

(1) FALSE. The statement suggests that the profit-maximizing firm should set output at the lowest level of average cost. But to maximize profit, the firm should not consider cost alone. Instead, the firm should set an output level that depends on price as well. The correct rule for maximizing profit is to set output at the level where price equals marginal cost (unless price is below minimum average cost, in which case the firm should shut down). If the firm follows this rule, in general it will not set output at the lowest level of average cost. [Full credit requires a graph showing how to apply the "price=MC" rule to choose the right level of output.]

(2) FALSE. The change in consumer surplus is the area between the demand curve, the price axis, and the two horizontal lines at P=\$4.00 and P=\$1.50. We cannot compute this area from the information given in the problem, but we can easily show that this area is greater than \$100. If demand were vertical (perfectly inelastic) then this area would be a rectangle with height=\$2.50, base=40, and area=\$100. But demand slopes down (by the Law of Demand) so change in consumer surplus must be greater than \$100. [Full credit requires a graph showing the change in consumer surplus as a trapezoid larger than the rectangle whose area is \$100.]

(3) FALSE. A price floor raises the price of the equilibrium price. This increases quantity supplied but decreases quantity demanded below the equilibrium quantity. Because buyers cannot be compelled to purchase more than the quantity they demand, the actual quantity traded in the market must decrease. [Full credit requires a graph showing a horizontal line at the price floor, the new quantity traded, and the original equilibrium quantity.]

### Version B

I. Problems

(1) [Short-run cost curves: 12 pts]

1. SAVC = \$4, \$3, \$5;
2. SAFC = \$12, \$6, \$4;
3. SATC = \$16, \$9, \$9;
4. SMC = \$4, \$2, \$9.

(2) [Short-run cost curves and supply: 18 pts]

1. \$5;
2. \$10;
3. \$4;
4. 0 doorknobs, because price is less than shutdown price;
5. loss, equal to SFC;
6. 1100 doorknobs;
7. loss, because price < breakeven price;
8. 1300 doorknobs;
9. profit, because price > breakeven price.

(3) [Producer surplus: 20 pts]

1. \$10;
2. \$20;
3. \$50;
4. 12 million;
5. \$480 million;
6. worse off;
7. \$180 million;
8. 16 million;
9. better off;
10. \$140 million.

(4) [Demand, consumer surplus: 20 pts]

1. \$100;
2. \$70;
3. \$30;
4. 16 million;
5. \$320 million;
6. worse off;
7. \$640 million;
8. 12 million;
9. worse off;
10. \$280 million.

(5) [Welfare effects of price controls: 12 pts]

1. 8 million;
2. decrease;
3. \$9 million;
4. increase;
5. \$6 million;
6. \$3 million.

II. True/False/Explain

Same as version A.