ECON 002 - Principles of Microeconomics Drake University, Spring 2015 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)b. (3)d. (4)e. (5)a. (6)b. (7)a. (8)c.

II. Problems

(1) [Perfect competition: 10 pts]

1. inelastic, because elasticity is less than 1 in absolute value.
2. 0.6 percent.
3. -12 (= market elasticity devided by market share).
4. elastic, because perceived elasticity is greater than 1 in abolute value.
5. 12 percent.

(2) [Monopoly price discrimination: 4 pts]

1. \$22 (= MC / (1 + (1/ε)).
2. \$60 (same formula).

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

1. 3/2 pounds of food.
2. 2/3 garments.
3. \$4, 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 1.5 pounds of food, then a unit of clothing must be 1.5 times as expensive as a pound of food.
5. \$6, because in competitive equilibrium, price equals marginal cost.
6. Adam's budget line should have intercept at 15 on food axis and intercept of 10 on clothing axis.
7. -3/2.
8. 3/2 pounds of food.
9. 2/3 garments.
10. 1.5, because Adam'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.

(4) [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 \$15 on price axis, and slope = -1/1 thousand.
2. 6 thousand, where MR=MC.
3. \$12, 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. \$104 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.

(5) [Competition versus collusion: 16 pts]

1. 16 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 \$15 on price axis, and slope = -1/1 million.
5. 10 million, where MR = MC.
6. \$5 (= marginal cost).
7. \$10, on demand curve.
8. \$15 million.

(6) [Monopolistic competition: 16 pts]

1. differentiated products.
2. demand curve (ii), because in long equilibrium, free entry drives profits to zero and price to average cost. The demand curve moves down until it is just tangent to the average cost curve.
3. \$5, the tangency between AC curve and long-run demand curve.
4. 90 sandwiches.
5. \$5, because price = AC in long-run equilibrium.
7. zero, because price = AC in long-run equilibrium.
8. about 123 sandwiches, where MC intersects demand.

III. Critical thinking [4 pts]

(1) If the government permitted firms in the milk industry to set prices cooperatively, those firms would form a cartel, raising price above marginal cost like a monopoly.

1. The firms would gain from higher prices and profits.
2. Consumers would lose from higher prices.
3. Society as a whole would lose. The gains to firms would be smaller than the losses to consumers, so there would be deadweight loss to society as a whole. (Full credit requires a graph similar to problem (5).)

(2) The Festival features many craft artists, each with a distinctive style (that some people like and others might not). At the same time, there are no barriers to entry, so this market is an example of monopolistic competition.

1. Their products are differentiated products because each craft artist has a distinctive style.
2. Marginal cost is less than price. Because their products are differentiated, each artist perceives downward-sloping demand so marginal revenue is less than price. To maximize profit, each artist chooses an output level where marginal cost equals marginal revenue.
3. Average cost is equal to price. Free entry (anyone can be a craft artist) drives economic profits to zero in the long run. Zero profit implies price equals average cost.

Version B

I. Multiple choice

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

II. Problems

(1) [Perfect competition: 10 pts]

1. elastic, because elasticity is greater than 1 in absolute value.
2. 2 percent.
3. -20 (= market elasticity devided by market share).
4. elastic, because perceived elasticity is greater than 1 in abolute value.
5. 20 percent.

(2) [Monopoly price discrimination: 4 pts]

1. \$24 (= MC / (1 + (1/ε)).
2. \$100 (same formula).

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

1. 3 pounds of food.
2. 1/3 garments.
3. \$4, because in competitive equilibrium, price equals marginal cost.
4. \$12, 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 pounds of food, then a unit of clothing must be 1.5 times as expensive as a pound of food.
5. \$12, because in competitive equilibrium, price equals marginal cost.
6. Adam's budget line should have intercept at 15 on food axis and intercept of 10 on clothing axis.
7. -3.
8. 3 pounds of food.
9. 1/3 garments.
10. 3, because Adam'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.

(4) [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.

(5) [Competition versus collusion: 16 pts]

1. 14 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 \$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. \$12 million.

(6) [Monopolistic competition: 16 pts]

1. differentiated products.
2. demand curve (ii), because in long equilibrium, free entry drives profits to zero and price to average cost. The demand curve moves down until it is just tangent to the average cost curve.
3. \$6, the tangency between AC curve and long-run demand curve.
4. 80 sandwiches.
5. \$6, because price = AC in long-run equilibrium.
6. \$2.
7. zero, because price = AC in long-run equilibrium.
8. about 98 sandwiches, where MC intersects demand.

III. Critical thinking

Same as Version A.

Version C

I. Multiple choice

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

II. Problems

(1) [Perfect competition: 10 pts]

1. elastic, because elasticity is greater than 1 in absolute value.
2. 1.5 percent.
3. -50 (= market elasticity devided by market share).
4. elastic, because perceived elasticity is greater than 1 in abolute value.
5. 50 percent.

(2) [Monopoly price discrimination: 4 pts]

1. \$25 (= MC / (1 + (1/ε)).
2. \$40 (same formula).

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

1. 2 pounds of food.
2. 1/2 garments.
3. \$4, because in competitive equilibrium, price equals marginal cost.
4. \$8, 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 pounds of food, then a unit of clothing must be 1.5 times as expensive as a pound of food.
5. \$8, because in competitive equilibrium, price equals marginal cost.
6. Adam's budget line should have intercept at 15 on food axis and intercept of 10 on clothing axis.
7. -2.
8. 2 pounds of food.
9. 1/2 garments.
10. 2, because Adam'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.

(4) [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.

(5) [Competition versus collusion: 16 pts]

1. 7 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 \$12 on price axis, and slope = -2/1 million.
5. 4 million, where MR = MC.
6. \$4 (= marginal cost).
7. \$8, on demand curve.
8. \$6 million.

(6) [Monopolistic competition: 16 pts]

1. differentiated products.
2. demand curve (ii), because in long equilibrium, free entry drives profits to zero and price to average cost. The demand curve moves down until it is just tangent to the average cost curve.
3. \$4, the tangency between AC curve and long-run demand curve.
4. 70 sandwiches.
5. \$4, because price = AC in long-run equilibrium.