Version A

I. Multiple choice [2 pts each: 20 pts total]

(1)a. (2)d. (3)c. (4)c. (5)a. (6)d. (7)c. (8)b. (9)c. (10)a.

II. Problems

(1) [Theories of regulation: 6 pts]

1. Stigler-Peltzman theory.
2. capture theory.
3. Becker theory.

(2) [Pricing with economies of scale: 30 pts]

1. $3.
2. loss (because price is less than average cost).
3. $30 million.
4. $0 million (there is never deadweight loss if P=MC for all customers).
5. $9.
6. neither.
7. $0 million.
8. $3 million (computed as the area of the triangle bounded by the demand curve, the MC curve, and a vertical line at 5 million).
9. $3.
10. $15 (computed by subtracting total cost from revenue received from the per-unit price, and then dividing by the number of customers).

(3) [Multipart tariffs: 39 pts]

	(i)Two-part tariff	(ii) Declining-block tariff
a. How much would a typical big customer buy?	100 units	100 units
b. How much would a typical small customer buy?	0 units	10 units
c. Compute the firm's total revenue.	$600 million	$620 million.
d. Compute the firm's total cost (including the "fixed" cost).	$600 million	$620 million.
e. Does the firm make a profit, a loss, or just break even?	break even	break even
f. Compute the deadweight loss from this pricing policy.	$45 million	$20 million
g. Which of these tariffs do you favor? Why?	Favor tariff (ii) "Declining-block." Both tariffs ensure that the regulated firm breaks even, but the declining-block tariff causes less deadweight loss.

III. Challenge question

"Ramsey pricing" implies that price-cost margins (or "markups") are inversely proportional to price elasticities of demand. Let M_i denote the price-cost margin for product i, which by definition equals (P_i-MC_i)/P_i. Let ε_i denote the price elasticity of demand for product i. Then Ramsey pricing implies that M_i/M_j = ε_j/ε_i.

From the data given in the problem,
M_A/M_B = 3 = ε_B/ε_A,
M_B/M_C = 5/6 ≠ ε_C/ε_B = 2/3,
M_C/M_A = 2/5 ≠ ε_A/ε_C = 1/2.
Therefore products A and B, considered alone, have "Ramsey prices." However, when product C is included, one cannot claim that all three products have "Ramsey prices."

Version B

I. Multiple choice [2 pts each: 20 pts total]

(1)c. (2)a. (3)b. (4)b. (5)b. (6)c. (7)b. (8)d. (9)d. (10)a.

II. Problems

(1) [Theories of regulation: 6 pts]

1. Becker theory.
2. Stigler-Peltzman theory.
3. Normative analysis as positive theory.

(2) [Pricing with economies of scale: 30 pts]

1. $2.
2. loss (because price is less than average cost).
3. $60 million.
4. $0 million (there is never deadweight loss if P=MC for all customers).
5. $8.
6. neither.
7. $0 million.
8. $6 million (computed as the area of the triangle bounded by the demand curve, the MC curve, and a vertical line at 10 million).
9. $2.
10. $30 (computed by subtracting total cost from revenue received from the per-unit price, and then dividing by the number of customers).

(3) [Multipart tariffs: 39 pts]

	(i)Two-part tariff	(ii) Declining-block tariff
a. How much would a typical big customer buy?	60 units	70 units
b. How much would a typical small customer buy?	0 units	10 units
c. Compute the firm's total revenue.	$620 million	$590 million.
d. Compute the firm's total cost (including the "fixed" cost).	$500 million	$590 million.
e. Does the firm make a profit, a loss, or just break even?	profit	break even
f. Compute the deadweight loss from this pricing policy.	$55 million	$20 million
g. Which of these tariffs do you favor? Why?	Favor tariff (ii) "Declining-block." Both tariffs ensure that the regulated firm at least breaks even, but the declining-block tariff causes less deadweight loss.

III. Challenge question

Same as Version A.

[end of answer key]