EXAM 1 ANSWER KEY
ECON 120 - Regulation and Antitrust Policy
Drake University, Spring 2018
William M. Boal
I. Multiple choice
(1)b. (2)b. (3)a. (4)a. (5)b. (6)b. (7)a. (8)b. (9)b. (10)b.
(1) [Using price elasticity of demand: 10 pts]
- 5 percent.
- 1 percent.
(2) [Profit maximization: 10 pts]
- MR = dTR/dq = 8.
- Firm DOES take price as given because marginal revenue is constant--it does not depend on the firm's own output level q.
- MC = dTC/dq = 2 + (q/50).
- Set MR=MC and solve to get q*=300.
- Profit = TR - TC = 8(300) - (2(300) + 3002/100) = $900.
(3) [Short-run cost curves and supply: 24 pts]
- $220 thousand = SATC × 20 thousand, because SATC is defined as STC divided by output.
- $180 thousand = SAVC × 20 thousand, because SAVC is defined as SVC divided by output.
- $40 thousand, because STC = SVC + SFC.
- $8 = MC(2 thousand), since marginal cost is defined as the change in total cost caused by a one-unit change in output.
- $8 = minimum SATC.
- $5 = minimum SAVC.
- 14 thousand (using rule P=MC).
- profit because price > breakeven price.
- zero because price < shutdown price.
- loss because price < breakeven price. (Loss = SFC.)
- 13 thousand (using rule P=MC).
- loss because price < breakeven price.
(4) [Long-run cost and supply: 10 pts]
- MC(q) = dTC/dq = 0.03 q2 - 2 q + 35.
- AC(q) = TC/q = 0.01 q2 - q + 35.
- Efficient scale is value of q that minimizes AC(q). So set derivative of AC equal to zero and solve to get qES=50.
- Breakeven price = minimum AC = AC(qES) = $10.
- Existing firms will try to EXIT the industry because they are making losses. We know they are making losses because the market price < breakeven price found in part (d).
(5) [Consumer surplus, producer surplus: 12 pts]
- $13 = height of demand curve.
- $7 = height of demand curve - price.
- $4 = height of supply curve.
- $2 = price - height of supply curve.
- $50 million = area of triangle bounded by demand curve, vertical axis, and price.
- $25 million = area of triangle bounded by supply curve, vertical axis, and price.
(6) [Welfare analysis of price controls: 18 pts]
- 6 million pounds.
- excess supply.
- 6 million pounds.
- $11 million.
- $14 million.
- $3 million.
III. Critical thinking [4 pts]
- If the price elasticity of demand is -0.5, then demand is price-inelastic. Whenever the price elasticity of demand is less than one in absolute value, the percent change in output must be smaller in absolute value (but opposite in sign) than the percent change in price. So if output increases, price must decrease by a larger percent change. Now firms' total revenue (TR) equals price (P) times quantity (Q), so the percent change in total revenue is given approximately by
Percent chg TR = percent chg P + percent chg Q.
So even though the percent change in Q is given as positive, the percent change in P is negative and larger in absolute value, so the percent change in TR must be negative. Firms' total revenue must DECREASE.
- A firm that likely takes price as given is one that has small market share and produces a product that is a perfect substitute for its competitors' products in the eyes of buyers. Most farmers fit this description. Makers of Windows computers also fit this description, especially if they have very small market share.
A firm that likely does NOT take price as given is one that produces a unique product, perhaps protected by patents or trade secrets. Makers of patented pharmaceutical drugs fit this description, if there are no other drugs available which work just as well. Apple Corporation probably also fits this description, to the extent that its computers, phones, and other devices are not viewed by consumers as perfect substitutes for other companies's devices.
[end of answer key]