ECON 120  Regulation and Antitrust Policy
Drake University, Spring 2019
William M. Boal


EXAM 1 ANSWER KEY
Version A
I. Multiple choice
(1)d. (2)a. (3)c. (4)b. (5)e. (6)b. (7)c. (8)d. (9)b. (10)a.
(11)b. (12)a. (13)a. (14)b. (15)a. (16)b. (17)e. (18)b. (19)d. (20)b.
(21)c. (22)c. (23)a. (24)d. (25)c. (26)b. (27)b. (28)c. (29)b. (30)c.
(31)e. (32)b. (33)b. (34)b.
II. Problems
(1) [Using price elasticity of demand: 10 pts]
 inelastic.
 increase.
 5 percent.
 increase.
 2 percent.
(2) [Profit maximization: 10 pts]
 MR = dTR/dq = 5.
 Firm DOES take price as given because marginal revenue is constantit does not depend on the firm's own output level q.
 MC = dTC/dq = 0.02 q + 1.
 Set MR=MC and solve to get q*=200.
 Profit = TR  TC = 5(200)  (0.01 200^{2} + 200) = $400.
(3) [Shortrun cost curves and supply: 24 pts]
 $180 thousand = SATC × 20 thousand, because SATC is defined as STC divided by output.
 $120 thousand = SAVC × 20 thousand, because SAVC is defined as SVC divided by output.
 $60 thousand, because STC = SVC + SFC.
 $2 = MC(2 thousand), since marginal cost is defined as the change in total cost caused by a oneunit change in output.
 $8 = minimum SATC.
 $4 = minimum SAVC.
 17 thousand (using rule P=MC).
 profit because price > breakeven price.
 14 thousand (using rule P=MC).
 loss because price < breakeven price.
 zero because price < shutdown price.
 loss because price < breakeven price. (Loss = SFC.)
(4) [Longrun cost and supply: 10 pts]
 MC(q) = dTC/dq = 0.03 q^{2}  2.4 q + 56.
 AC(q) = TC/q = 0.01 q^{2}  1.2 q + 56.
 Efficient scale is value of q that minimizes AC(q). So set derivative of AC equal to zero and solve to get q_{ES}=60.
 Breakeven price = minimum AC = AC(q_{ES}) = $20.
 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) [Welfare analysis of price controls: 18 pts]
 $4.
 8 thousand.
 excess demand.
 5 thousand.
 decrease.
 $10 thousand.
 remain constant. (In this problem, the gain to consumers from a lower price is exactly equal to the loss to consumers from fewer units purchased.)
 $0 thousand.
 $10 thousand.
III. Critical thinking [4 pts]
(1) We are given that marginal revenue is $20 and marginal cost is $30. Since marginal revenue is less than marginal cost, you should downsize (mow fewer lawns). By mowing one less lawn, for example, your profit will increase by $30$20=$10.
(2) We are given that the change in price is 10 percent and the change in spending is 6 percent.
 Demand for gasoline is inelastic. When price falls, spending (or revenue) increases if demand is elastic and decreases if demand is inelastic.
 We can compute the price elasticity of demand in two steps. First, we know that percent change in spending (or revenue, from the seller's viewpoint) equals approximately the percent change in price plus the percent change in quantity. So 6 percent = 10 percent + percent change in quantity. Thus the percent change in quantity must be approximately positive 4 percent. Second, the price elasticity of demand is, by definition, percent change in quantity divided by percent change in price, so here the elasticity must be (+4 percent/10 percent) or 0.4.
Version B
I. Multiple choice
(1)a. (2)b. (3)c. (4)b. (5)e. (6)d. (7)a. (8)a. (9)a. (10)b.
(11)a. (12)b. (13)b. (14)d. (15)c. (16)a. (17)e. (18)c. (19)a. (20)d.
(21)a. (22)b. (23)b. (24)b. (25)c. (26)d. (27)e. (28)d. (29)a. (30)c.
(31)d. (32)a. (33)d. (34)d.
II. Problems
(1) [Using price elasticity of demand: 10 pts]
 elastic.
 increase.
 5 percent.
 decrease.
 1 percent.
(2) [Profit maximization: 10 pts]
 MR = dTR/dq = 4.
 Firm DOES take price as given because marginal revenue is constantit does not depend on the firm's own output level q.
 MC = dTC/dq = 0.02 q + 2.
 Set MR=MC and solve to get q*=100.
 Profit = TR  TC = 4(100)  (0.01 100^{2} + 2 100) = $100.
(3) [Shortrun cost curves and supply: 24 pts]
 $150 thousand = SATC × 15 thousand, because SATC is defined as STC divided by output.
 $120 thousand = SAVC × 15 thousand, because SAVC is defined as SVC divided by output.
 $30 thousand, because STC = SVC + SFC.
 $6 = MC(2 thousand), since marginal cost is defined as the change in total cost caused by a oneunit change in output.
 $8 = minimum SATC.
 $5 = minimum SAVC.
 zero because price < shutdown price.
 loss because price < breakeven price. (Loss = SFC.)
 12 thousand (using rule P=MC).
 profit because price > breakeven price.
 9 thousand (using rule P=MC).
 loss because price < breakeven price.
(4) [Longrun cost and supply: 10 pts]
 MC(q) = dTC/dq = 0.03 q^{2}  1.6 q + 28.
 AC(q) = TC/q = 0.01 q^{2}  0.8 q + 56.
 Efficient scale is value of q that minimizes AC(q). So set derivative of AC equal to zero and solve to get q_{ES}=40.
 Breakeven price = minimum AC = AC(q_{ES}) = $12.
 Existing firms will try to ENTER the industry in search profit opportunities. We know that existing firms are enjoying positive economic profits because the market price > breakeven price found in part (d).
(5) [Welfare analysis of price controls: 18 pts]
 $4.
 4 thousand.
 excess supply.
 6 thousand.
 increase.
 $7 thousand.
 decrease.
 $10 thousand.
 $3 thousand.
III. Critical thinking [4 pts]
Same as Version A.
[end of answer key]