ECON 002 - Principles of Microeconomics Drake University, Fall 2015 William M. Boal Course page: faculty.cbpa.drake.edu/econ/boal/002 Blackboard: drake.blackboard.com william.boal@drake.edu

### Version A

I. Multiple choice

(1)c. (2)b. (3)e. (4)a. (5)d. (6)a. (7)d. (8)c. (9)b. (10)a.

II. Problems

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

1. \$15 (= marginal cost).
2. \$5 (= marginal cost).
3. Firm Y (because it has lower marginal cost).
4. 6 thousand, so that marginal costs are equal.
5. 14 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. 2 servings French fries.
2. 1/2 hamburger.
3. \$6, 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 hamburger is 2 servings of French fries, then a hamburger must be 2 times as expensive as a serving of French fries.
5. \$3, because in competitive equilibrium, price equals marginal cost.
6. Luke's budget line should have intercept at 20 on French fries axis and intercept of 10 on hamburger axis.
7. -2, same as slope of country's production possibility curve.
8. 2 servings of French fries.
9. 1/2 hamburgers.
10. 2, because Luke's preferred bundle is at a tangency between his budget line and the highest indifference curve he can reach, and at a tangency the slope of the indifference curve must equal the slope of the budget line.

(3) [Monopoly, price discrimination: 20 pts] 2 pts for each part, except 1 pt each for parts j and k.

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 = -2/1 thousand.
2. 4 thousand, where MR=MC.
3. \$9, on demand curve.
4. \$24 thousand = Rev - TC = (price × quantity) - (AC × quantity).
5. \$8 thousand.
6. \$4 thousand.
7. 6 thousand, where the demand curve intersects the marginal cost curve, because anyone willing to pay at least the marginal cost will be served.
8. \$60 thousand, because with every customer paying a different price, revenue = area of the trapezoid under demand curve down to horizontal axis.
9. \$36 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) [Monopoly price discrimination: 4 pts]

1. \$4.50 (= MC / (1 + (1/ε)).
2. \$12.00 (same formula).

(5) [Competition versus collusion: 16 pts]

1. 12 million.
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 million.
5. 8 million, where MR = MC.
6. \$5 (= marginal cost).
7. \$9, on demand curve.
8. \$8 million.

(6) [Monopolistic competition: 16 pts]

1. differentiated products.
2. Since demand curve is linear, MR curve must have same intercept and twice the slope. So MR curve should have intercept at \$9 on price axis, and slope = -1/10.
3. \$5, the tangency between AC curve and long-run demand curve.
4. 80 ice-cream, directly below the tangency, and also where MR=MC.
5. \$5, directly above Kelsey's quantity.
6. \$1, directly above Kelsey's quantity.
7. The most plausible explanation is that free entry has driven economic profit to zero. If Kelsey had been making economic profits earlier, this would have attracted new ice cream stands to open, pushing Kelsey's demand curve toward the origin. New stands would stop opening only when profits fell to zero.

III. Critical thinking [4 pts]

(1) Microsoft is more likely to price its product above marginal cost because it is a monopoly. Microsoft enjoys patent protection for its Windows operating system and for its Office software, for which there are no close substitutes, so it has market power. As a monopoly, Microsoft faces a downward-sloping demand curve, and thus its marginal revenue is less than its price. It maximizes profit by choosing its output where marginal revenue equals marginal cost, so its marginal cost must be less than its price.
Dell Computer's products, by contrast, compete with essentially perfect substitutes made by HP, Gateway, Lenovo, Acer, etc., so Dell has no market power and must match the prices of other companies. As a perfectly-competitive firm, Dell perceives its own demand curve to be horizontal, with marginal revenue equal to its price. It maximizes profit by choosing its output where marginal revenue equals marginal cost, so its marginal cost must equal its price.

(2) (Competition versus cooperation)

1. One should disagree with this statement. If producers set prices cooperatively, as in a cartel, then producers benefit. However, consumers lose more than producers gain. The cartel would set prices above the competitive level (that is, above marginal cost) to a level similar to the monopoly price. Some consumers willing to pay the marginal cost will not be served and deadweight loss would therefore result. Society would be worse off, not better off, if producers set prices cooperatively.
2. Full credit requires a supply-and demand graph showing the deadweight loss triangle from price above marginal cost.

### Version B

I. Multiple choice

(1)a. (2)a. (3)d. (4)b. (5)c. (6)b. (7)a. (8)a. (9)c. (10)b.

II. Problems

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

1. \$4 (= marginal cost).
2. \$10 (= marginal cost).
3. Firm X (because it has lower marginal cost).
4. 12 thousand, so that marginal costs are equal.
5. 8 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. 3/2 servings French fries.
2. 2/3 hamburger.
3. \$6, 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 hamburger is 3/2 servings of French fries, then a hamburger must be 3/2 times as expensive as a serving of French fries.
5. \$4, because in competitive equilibrium, price equals marginal cost.
6. Luke's budget line should have intercept at 30 on French fries axis and intercept of 20 on hamburger axis.
7. -3/2, same as slope of country's production possibility curve.
8. 3/2 servings of French fries.
9. 2/3 hamburgers.
10. 3/2, because Luke's preferred bundle is at a tangency between his budget line and the highest indifference curve he can reach, and at a tangency the slope of the indifference curve must equal the slope of the budget line.

(3) [Monopoly, price discrimination: 20 pts] 2 pts for each part, except 1 pt each for parts j and k.

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 = -1/1 thousand.
2. 8 thousand, where MR=MC.
3. \$10, on demand curve.
4. \$48 thousand = Rev - TC = (price × quantity) - (AC × quantity).
5. \$16 thousand.
6. \$8 thousand.
7. 12 thousand, where the demand curve intersects the marginal cost curve, because anyone willing to pay at least the marginal cost will be served.
8. \$132 thousand, because with every customer paying a different price, revenue = area of the trapezoid under demand curve down to horizontal axis.
9. \$72 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) [Monopoly price discrimination: 4 pts]

1. \$7.50 (= MC / (1 + (1/ε)).
2. \$10.00 (same formula).

(5) [Competition versus collusion: 16 pts]

1. 18 million.
2. \$4 (= marginal cost).
3. \$4.
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 million.
5. 10 million, where MR = MC.
6. \$3 (= marginal cost).
7. \$8, on demand curve.
8. \$20 million.

(6) [Monopolistic competition: 16 pts]

1. differentiated products.
2. Since demand curve is linear, MR curve must have same intercept and twice the slope. So MR curve should have intercept at \$9 on price axis, and slope = -1/10.
3. \$6, the tangency between AC curve and long-run demand curve.
4. 60 ice-cream, directly below the tangency, and also where MR=MC.
5. \$6, directly above Kelsey's quantity.
6. \$3, directly above Kelsey's quantity.
7. The most plausible explanation is that free entry has driven economic profit to zero. If Kelsey had been making economic profits earlier, this would have attracted new ice cream stands to open, pushing Kelsey's demand curve toward the origin. New stands would stop opening only when profits fell to zero.

III. Critical thinking

Same as Version A.

### Version C

I. Multiple choice

(1)b. (2)c. (3)a. (4)c. (5)b. (6)c. (7)b. (8)b. (9)a. (10)c.

II. Problems

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

1. \$5 (= marginal cost).
2. \$12 (= marginal cost).
3. Firm X (because it has lower marginal cost).
4. 14 thousand, 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. 3 servings French fries.
2. 1/3 hamburger.
3. \$6, because in competitive equilibrium, price equals marginal cost.
4. \$2, 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 hamburger is 3 servings of French fries, then a hamburger must be 3 times as expensive as a serving of French fries.
5. \$2, because in competitive equilibrium, price equals marginal cost.
6. Luke's budget line should have intercept at 30 on French fries axis and intercept of 10 on hamburger axis.
7. -3, same as slope of country's production possibility curve.
8. 3 servings of French fries.
9. 1/3 hamburgers.
10. 3, because Luke's preferred bundle is at a tangency between his budget line and the highest indifference curve he can reach, and at a tangency the slope of the indifference curve must equal the slope of the budget line.

(3) [Monopoly, price discrimination: 20 pts] 2 pts for each part, except 1 pt each for parts j and k.

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 = -1/1 thousand.
2. 6 thousand, where MR=MC.
3. \$11, on demand curve.
4. \$36 thousand = Rev - TC = (price × quantity) - (AC × quantity).
5. \$9 thousand.
6. \$3 thousand.
7. 8 thousand, where the demand curve intersects the marginal cost curve, because anyone willing to pay at least the marginal cost will be served.
8. \$96 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) [Monopoly price discrimination: 4 pts]

1. \$5 (= MC / (1 + (1/ε)).
2. \$8 (same formula).

(5) [Competition versus collusion: 16 pts]

1. 9 million.
2. \$3 (= marginal cost).
3. \$3.
4. 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 = -2/1 million.
5. 5 million, where MR = MC.
6. \$2 (= marginal cost).
7. \$7, on demand curve.
8. \$10 million.

(6) [Monopolistic competition: 16 pts]

1. differentiated products.
2. 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 = -1/10.
3. \$7, the tangency between AC curve and long-run demand curve.
4. 100 ice-cream, directly below the tangency, and also where MR=MC.
5. \$7, directly above Kelsey's quantity.
6. \$2, directly above Kelsey's quantity.
7. The most plausible explanation is that free entry has driven economic profit to zero. If Kelsey had been making economic profits earlier, this would have attracted new ice cream stands to open, pushing Kelsey's demand curve toward the origin. New stands would stop opening only when profits fell to zero.

III. Critical thinking

Same as Version A.