ECON 002 - Principles of Microeconomics Drake University, Spring 2014 William M. Boal Course page: www.cbpa.drake.edu/econ/boal/002 Blackboard: bb.drake.edu william.boal@drake.edu

### Version A

I. Multiple choice

(1)f. (2)a. (3)b. (4)a. (5)b. (6)a. (7)b.

II. Problems

(1) [Economy-wide efficiency: 12 pts]

1. \$12 (= marginal cost).
2. \$5 (= marginal cost).
3. Firm B (because it has lower marginal cost).
4. 8 million, so that marginal costs are equal.
5. 12 million, so that marginal costs are equal.
6. \$7, because each firm will then maximize its own profit by choosing its output level so that its marginal cost equals this price.

(2) [Economy-wide efficiency: 20 pts]

1. 1/3 garments.
2. 3 pounds of food.
3. \$2, because in competitive equilibrium, price equals marginal cost.
4. \$6, because in competitive equilibrium, prices reflect the slope of the production possibility curve for the economy as a whole: if the opportunity cost of a unit of clothing is 3 units of food, then a unit of clothing must be 3 times as expensive as a unit of food.
5. \$6, because in competitive equilibrium, price equals marginal cost.
6. Ashley's budget line should have intercept at 30 on food axis and intercept of 10 on clothing axis.
7. -3.
8. 3 pounds of food.
9. 1/3 garments.
10. 3, because Ashley's preferred bundle is at a tangency between her budget line and the highest indifference curve she can reach, and at a tangency the slope of the indifference curve must equal the slope of the budget line.

(3) [Monopoly, price discrimination: 22 pts]

1. Since demand curve is linear, MR curve must have same intercept and twice the slope. So MR curve should have intercept at \$13 on price axis, and slope = -1/1 thousand.
2. 6 thousand, where MR=MC.
3. \$10, on demand curve.
4. \$36 thousand = Rev - TC = price × quantity - AC × quantity.
5. \$9 thousand.
6. \$3 thousand.
7. 8 thousand, because anyone willing to pay at least the marginal cost will be served.
8. \$88 thousand, because with every customer paying a different price, revenue = area of the trapezoid under demand curve down to horizontal axis.
9. \$48 thousand = Rev - TC = Rev - AC × quantity.
10. \$0, because consumer surplus is defined as willingness-to-pay minus price, but with perfect price discrimination willingness-to-pay equals price for every customer.
11. \$0, because with perfect price discrimination, everyone willing to pay the marginal cost is served.

(4) [Competition versus collusion: 16 pts]

1. 12 billion.
2. \$7 (= marginal cost).
3. \$7.
4. Since demand curve is linear, MR curve must have same intercept and twice the slope. So MR curve should have intercept at \$13 on price axis, and slope = -1/1 billion.
5. 8 billion, where MR = MC.
6. \$5 (= marginal cost).
7. \$9, on demand curve.
8. \$8 billion.

(5) [Monopolistic competition: 12 pts]

1. Al's demand equation is
PA = PB + 1 - (QA/1000) = 2.00 + 1 - (QA/1000) = 3 - (QA/1000).
Al's marginal revenue curve must have same intercept and twice slope:
MR = 3 - 2(QA/1000).
2. Set MR = MC = \$2 and solve to get 500 gallons.
3. Insert 500 gallons into demand equation to get \$2.50.
4. Now Al's demand equation is
PA = PB + 1 - (QA/1000) = 3.50 + 1 - (QA/1000) = 4.50 - (QA/1000).
Al's marginal revenue curve must have same intercept and twice slope:
MR = 4.50 - 2(QA/1000).
5. Set MR = MC = \$2 and solve to get 1250 gallons.
6. Insert 1250 gallons into demand equation to get \$3.25.
• Two points extra credit: Given Al's price PA and Bob's price PB, which customers will choose to buy from Al's Store? To find the dividing point  x,  set the perceived total prices equal:
PA* = PB*
PA + 0.25 x = PB + 0.25 (4-x).
Solving for x gives    x = 2 (PB - PA + 1).
Now 500 customers per mile live along this road, so the number of customers choosing to buy one gallon of milk from Al's Store is
QA = 500 x = 1000 (PB - PA + 1).

(6) [Monopoly price discrimation: 8 pts]

1. 25 percent.
2. 15 percent.
3. \$15.
4. \$18.

III. Critical thinking [3 pts]

Fredonia's economy is at point B on the production-possibility curve. If all markets were competitive, Fredonia would be at the efficient outcome, point C--that is, at the tangency between the production possibility curve and the highest attainable indifference curve of the representative consumer. However, the market for energy is a monopoly, so the quantity of energy is reduced. Therefore Fredonia is at point B.

### Version B

I. Multiple choice

(1)e. (2)b. (3)c. (4)b. (5)d. (6)c. (7)c.

II. Problems

(1) [Economy-wide efficiency: 12 pts]

1. \$6 (= marginal cost).
2. \$15 (= marginal cost).
3. Firm A (because it has lower marginal cost).
4. 10 million, so that marginal costs are equal.
5. 6 million, so that marginal costs are equal.
6. \$8, because each firm will then maximize its own profit by choosing its output level so that its marginal cost equals this price.

(2) [Economy-wide efficiency: 20 pts]

1. 1/2 garments.
2. 2 pounds of food.
3. \$2, because in competitive equilibrium, price equals marginal cost.
4. \$4, because in competitive equilibrium, prices reflect the slope of the production possibility curve for the economy as a whole: if the opportunity cost of a unit of clothing is 2 units of food, then a unit of clothing must be 2 times as expensive as a unit of food.
5. \$4, because in competitive equilibrium, price equals marginal cost.
6. Ashley's budget line should have intercept at 30 on food axis and intercept of 15 on clothing axis.
7. -2.
8. 2 pounds of food.
9. 1/2 garments.
10. 2, because Ashley's preferred bundle is at a tangency between her budget line and the highest indifference curve she can reach, and at a tangency the slope of the indifference curve must equal the slope of the budget line.

(3) [Monopoly, price discrimination: 22 pts]

1. Since demand curve is linear, MR curve must have same intercept and twice the slope. So MR curve should have intercept at \$14 on price axis, and slope = -2/1 thousand.
2. 3 thousand, where MR=MC.
3. \$11, on demand curve.
4. \$18 thousand = Rev - TC = price × quantity - AC × quantity.
5. \$4.5 thousand.
6. \$1.5 thousand.
7. 4 thousand, because anyone willing to pay at least the marginal cost will be served.
8. \$48 thousand, because with every customer paying a different price, revenue = area of the trapezoid under demand curve down to horizontal axis.
9. \$24 thousand = Rev - TC = Rev - AC × quantity.
10. \$0, because consumer surplus is defined as willingness-to-pay minus price, but with perfect price discrimination willingness-to-pay equals price for every customer.
11. \$0, because with perfect price discrimination, everyone willing to pay the marginal cost is served.

(4) [Competition versus collusion: 16 pts]

1. 10 billion.
2. \$6 (= marginal cost).
3. \$6.
4. Since demand curve is linear, MR curve must have same intercept and twice the slope. So MR curve should have intercept at \$16 on price axis, and slope = -2/1 billion.
5. 6 billion, where MR = MC.
6. \$4 (= marginal cost).
7. \$10, on demand curve.
8. \$12 billion.

(5) [Monopolistic competition: 12 pts]

1. Al's demand equation is
PA = PB + 1 - (QA/1000) = 2.50 + 1 - (QA/1000) = 3.50 - (QA/1000).
Al's marginal revenue curve must have same intercept and twice slope:
MR = 3.50 - 2(QA/1000).
2. Set MR = MC = \$2 and solve to get 750 gallons.
3. Insert 750 gallons into demand equation to get \$2.75.
4. Now Al's demand equation is
PA = PB + 1 - (QA/1000) = 4.00 + 1 - (QA/1000) = 5 - (QA/1000).
Al's marginal revenue curve must have same intercept and twice slope:
MR = 5 - 2(QA/1000).
5. Set MR = MC = \$2 and solve to get 1500 gallons.
6. Insert 1500 gallons into demand equation to get \$3.50.
• Two points extra credit: same as Version A.

(6) [Monopoly price discrimation: 8 pts]

1. 28 percent.
2. 6 percent.
3. \$14.
4. \$36.

III. Critical thinking

Same as Version A.

### Version C

I. Multiple choice

(1)e. (2)c. (3)d. (4)c. (5)c. (6)b. (7)d.

II. Problems

(1) [Economy-wide efficiency: 12 pts]

1. \$11 (= marginal cost).
2. \$3 (= marginal cost).
3. Firm B (because it has lower marginal cost).
4. 5 million, so that marginal costs are equal.
5. 9 million, so that marginal costs are equal.
6. \$6, because each firm will then maximize its own profit by choosing its output level so that its marginal cost equals this price.

(2) [Economy-wide efficiency: 20 pts]

1. 2/3 garments.
2. 1.5 pounds of food.
3. \$2, because in competitive equilibrium, price equals marginal cost.
4. \$3, because in competitive equilibrium, prices reflect the slope of the production possibility curve for the economy as a whole: if the opportunity cost of a unit of clothing is 1.5 units of food, then a unit of clothing must be 1.5 times as expensive as a unit of food.
5. \$3, because in competitive equilibrium, price equals marginal cost.
6. Ashley's budget line should have intercept at 30 on food axis and intercept of 20 on clothing axis.
7. -1.5.
8. 1.5 pounds of food.
9. 2/3 garments.
10. 1.5, because Ashley's preferred bundle is at a tangency between her budget line and the highest indifference curve she can reach, and at a tangency the slope of the indifference curve must equal the slope of the budget line.

(3) [Monopoly, price discrimination: 22 pts]

1. Since demand curve is linear, MR curve must have same intercept and twice the slope. So MR curve should have intercept at \$12 on price axis, and slope = -1/1 thousand.
2. 12 thousand, where MR=MC.
3. \$9, on demand curve.
4. \$72 thousand = Rev - TC = price × quantity - AC × quantity.
5. \$18 thousand.
6. \$6 thousand.
7. 16 thousand, because anyone willing to pay at least the marginal cost will be served.
8. \$160 thousand, because with every customer paying a different price, revenue = area of the trapezoid under demand curve down to horizontal axis.
9. \$96 thousand = Rev - TC = Rev - AC × quantity.
10. \$0, because consumer surplus is defined as willingness-to-pay minus price, but with perfect price discrimination willingness-to-pay equals price for every customer.
11. \$0, because with perfect price discrimination, everyone willing to pay the marginal cost is served.

(4) [Competition versus collusion: 16 pts]

1. 20 billion.
2. \$5 (= marginal cost).
3. \$5.
4. Since demand curve is linear, MR curve must have same intercept and twice the slope. So MR curve should have intercept at \$15 on price axis, and slope = -1/1 billion.
5. 12 billion, where MR = MC.
6. \$3 (= marginal cost).
7. \$9, on demand curve.
8. \$24 billion.

(5) [Monopolistic competition: 12 pts]

1. Al's demand equation is
PA = PB + 1 - (QA/1000) = 3.00 + 1 - (QA/1000) = 4 - (QA/1000).
Al's marginal revenue curve must have same intercept and twice slope:
MR = 4 - 2(QA/1000).
2. Set MR = MC = \$2 and solve to get 1000 gallons.
3. Insert 1000 gallons into demand equation to get \$3.00.
4. Now Al's demand equation is
PA = PB + 1 - (QA/1000) = 4.50 + 1 - (QA/1000) = 5.50 - (QA/1000).
Al's marginal revenue curve must have same intercept and twice slope:
MR = 5.50 - 2(QA/1000).
5. Set MR = MC = \$2 and solve to get 1750 gallons.
6. Insert 1750 gallons into demand equation to get \$3.75.
• Two points extra credit: same as Version A.

(6) [Monopoly price discrimation: 8 pts]

1. 24 percent.
2. 8 percent.
3. \$12.
4. \$20.

III. Critical thinking

Same as Version A.