ECON 120 - Regulation and Antitrust Policy
Drake University, Spring 2023
William M. Boal

EXAM 1 ANSWER KEY

Version A

I. Multiple choice

(1)a. (2)b. (3)c. (4)b. (5)c. (6)b. (7)b. (8)a. (9)b. (10)a. (11)a. (12)c. (13)d. (14)f. (15)e. (16)b. (17)b. (18)e. (19)b. (20)d. (21)b. (22)c. (23)c. (24)b.

II. Problems

(1) [Using price elasticity of demand: 10 pts]

  1. elastic, because the elasticity is greater than one in absolute value.
  2. increase, because quantity decreased.
  3. 5 percent, using formula: elasticity = percent change Q / percent change P.
  4. decrease, because the increase in price is less than the decrease in quantity.
  5. 1 percent, using formula: percent change revenue = percent change Q + percent change P.

(2) [Profit maximization: 10 pts]

  1. MR = dTR/dq = 4.
  2. Firm DOES take price as given because marginal revenue is constant--it does not depend on the firm's own output level q.
  3. MC = dTC/dq = (1/40) q + 2.
  4. Set MR=MC and solve to get q*=80.
  5. Profit = TR - TC = 4(80) - ((1/80) 802 + 2*80) = $80.

(3) [Short-run cost curves and supply: 24 pts]

  1. $80 thousand = SATC × 10 thousand, because SATC is defined as STC divided by output.
  2. $30 thousand = SAVC × 10 thousand, because SAVC is defined as SVC divided by output.
  3. $50 thousand, because STC = SVC + SFC.
  4. $2 = MC at 5 thousand, since marginal cost is defined as the change in total cost caused by a one-unit change in output.
  5. $7 = minimum SATC.
  6. $3 = minimum SAVC.
  7. 14 thousand (using rule P=MC).
  8. profit because price > breakeven price.
  9. zero because price < shutdown price.
  10. loss because price < breakeven price. (Loss = SFC.)
  11. 12 thousand (using rule P=MC).
  12. loss because price < breakeven price.

(4) [Long-run cost and supply: 10 pts]

  1. MC(q) = dTC/dq = 0.03 q2 - 2 q + 35.
  2. AC(q) = TC/q = 0.01 q2 - q + 35.
  3. Efficient scale is value of q that minimizes AC(q). So set derivative of AC equal to zero and solve to get qES=50.
  4. Breakeven price = minimum AC = AC(qES) = $10.
  5. 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]

  1. $6.
  2. 8 thousand.
  3. excess supply.
  4. 6 thousand.
  5. decrease.
  6. $18 thousand, the area of the trapezoid bounded by horizontal lines at the new and old price, the vertical axis, and the demand curve.
  7. increase.
  8. $15 thousand, the area of the upper rectangle minus the area of the lower triangle.
  9. $3 thousand.

III. Critical thinking [4 pts]

(1) Recommend the company decrease its output. Since MR < MC, a one-unit increase in output would increase revenue by MR and cost by MC, resulting in a profit decrease of MR-MC, or $3. Conversely, a one-unit decrease in output would result in cost savings (MC) that are greater than the lost revenue (MR) and so would increase profit.

(2) Collusion will push price and quantity up the demand curve. Revenue will increase by ($15 × 800 - $10 × 100) = $2000. Consumer surplus will decrease by the area of the trapezoid bounded by horizontal lines at the new and old prices, the vertical axis, and the demand curve. That area is
([800+100]/2 × (15-10) = $4500. [Full credit requires graph showing demand curve and horizontal lines at the new and old prices.]

Version B

I. Multiple choice

(1)b. (2)b. (3)a. (4)d. (5)d. (6)d. (7)a. (8)b. (9)a. (10)b. (11)d. (12)f. (13)c. (14)c. (15)b. (16)c. (17)c. (18)e. (19)c. (20)a. (21)a. (22)a. (23)c. (24)e.

II. Problems

(1) [Using price elasticity of demand: 10 pts]

  1. inelastic, because the elasticity is less than one in absolute value.
  2. decrease, because price increased.
  3. 2 percent, using formula: elasticity = percent change Q / percent change P.
  4. increase, because the increase in price is greater than the decrease in quantity.
  5. 3 percent, using formula: percent change revenue = percent change Q + percent change P.

(2) [Profit maximization: 10 pts]

  1. MR = dTR/dq = 6.
  2. Firm DOES take price as given because marginal revenue is constant--it does not depend on the firm's own output level q.
  3. MC = dTC/dq = (1/20) q + 1.
  4. Set MR=MC and solve to get q*=100.
  5. Profit = TR - TC = 6(100) - ((1/40) 1002 + 100) = $250.

(3) [Short-run cost curves and supply: 24 pts]

  1. $55 thousand = SATC × 5 thousand, because SATC is defined as STC divided by output.
  2. $25 thousand = SAVC × 5 thousand, because SAVC is defined as SVC divided by output.
  3. $30 thousand, because STC = SVC + SFC.
  4. $4 = MC at 3 thousand, since marginal cost is defined as the change in total cost caused by a one-unit change in output.
  5. $7 = minimum SATC.
  6. $4 = minimum SAVC.
  7. zero because price < shutdown price.
  8. loss because price < breakeven price. (Loss = SFC.)
  9. 10 thousand (using rule P=MC).
  10. loss because price < breakeven price.
  11. 13 thousand (using rule P=MC).
  12. profit because price > breakeven price.

(4) [Long-run cost and supply: 10 pts]

  1. MC(q) = dTC/dq = (3/100) q2 - 4 q + 140.
  2. AC(q) = TC/q = (1/100) q2 - 2 q + 140.
  3. Efficient scale is value of q that minimizes AC(q). So set derivative of AC equal to zero and solve to get qES=100.
  4. Breakeven price = minimum AC = AC(qES) = $40.
  5. 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]

  1. $6.
  2. 6 thousand.
  3. excess supply.
  4. 12 thousand.
  5. decrease.
  6. $32 thousand, the area of the trapezoid bounded by horizontal lines at the new and old price, the vertical axis, and the demand curve.
  7. increase.
  8. $20 thousand, the area of the upper rectangle minus the area of the lower triangle.
  9. $12 thousand.

III. Critical thinking [4 pts]

Same as Version A.

[end of answer key]