Boal's Econ

ECON 120 - Regulation and Antitrust Policy
Drake University, Spring 2026
William M. Boal

EXAM 1 ANSWER KEY

Version A

I. Multiple choice

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

II. Problems

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

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

(2) [Profit maximization: 10 pts]

MR = dTR/dq = 5.
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 = (1/50) q + 1.
Set MR=MC and solve to get q*=200.
Profit = TR - TC = 5(200) - ((1/100) 200² + 200) = $400.

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

$6 thousand = SATC × 500, because SATC is defined as STC divided by output.
$2 thousand = SAVC × 500 thousand, because SAVC is defined as SVC divided by output.
$4 thousand, because STC = SVC + SFC.
$3 = MC at 500, since marginal cost is defined as the change in total cost caused by a one-unit change in output.
$7 = minimum SATC.
$3 = minimum SAVC.
zero because price < shutdown price.
loss because price < breakeven price. (Loss = SFC.)
1100 (using rule P=MC).
loss because price < breakeven price.
13 thousand (using rule P=MC).
profit because price < breakeven price.

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

MC(q) = dTC/dq = 0.03 q² - 1.6 q + 26.
AC(q) = TC/q = 0.01 q² - 0.8 q + 26.
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) = $10.
If the market price is $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]

$5.
5 million gallons.
excess demand.
3 million gallons.
producer surplus decreases.
by $6 million, the area of the trapezoid bounded by horizontal lines at the new and old price, the vertical axis, and the supply curve.
consumer surplus increases.
by $3 million, the area of the lower rectangle minus the area of the upper triangle.
deadweight loss = $3 million.

III. Critical thinking [4 pts]

(1) If the elasticity of demand is -2, then percent changes in quantity are greater (in absolute value) than percent changes in price by a factor of 2. So an increase in price would cause an even larger decrease in quantity demanded, resulting in a decrease in revenue. So Consultant 1 is incorrect. By the same reasoning, a decrease in price would cause an even larger increase in quantity demanded, resulting in an increase in revenue. So Consultant 2 is correct. If you want to increase revenue, you must lower price, because demand is elastic.

(2) One should disagree with this statement. To maximize profit, produce output up to the point where marginal cost equals price, provided price is greater than or equal to average cost. If price is less than average cost, shut down. In almost all cases, this rule implies producing an output level different from the minimum point on the average cost curve. (Full credit requires a graph showing the firm's average cost and marginal cost curves, and dotted lines demonstrating how to choose output using the rule "price = marginal cost.")

[The above answer assumes a long-run time horizon for the firm and uses long-run cost concepts. You could instead answer the question using a short-run time horizon, using short-run cost concepts, as follows.]

To maximize profit in the short run, produce output up to the point where short-run marginal cost equals price, provided price is greater than or equal to short-run average variable cost (SAVC). If price is less than SAVC, shut down. In almost all cases, this rule implies producing an output level different the minimum point on the SAVC curve, and different from the minimum point on the short-run total cost (SATC) curve. (Full credit requires a graph showing the firm's SAVC, SATC, and SMC curves, and dotted lines demonstrating how to choose output using the rule "price = SMC.")

Version B