ECON 002 - Principles of Microeconomics Drake University, Fall 2016 William M. Boal

### Version A

I. Multiple choice

(1)c. (2)a. (3)b. (4)a. (5)d. (6)b. (7)b. (8)b. (9)d. (10)c. (11)c. (12)a.

II. Problems

(1) [Monopoly price discrimination: 8 pts]

1. 30 percent, because elasticity = percent chg Q / percent chg P.
2. 10 percent.
3. \$12 = MC / (1 + (1/ε)).
4. \$20 (same formula).

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

1. 3/2 units of other goods.
2. 2/3 gallons of gasoline.
3. \$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 gallon of gasoline is 3/2 units of other goods, then the price of a gallon of gasoline must be 3/2 times the price of other goods.
4. \$2, because in competitive equilibrium, price equals marginal cost.
5. \$3, because in competitive equilibrium, price equals marginal cost.
6. Amy's budget line should have intercepts at 30 units of other goods and 20 gallons of gasoline.
7. -3/2, same as slope of country's production possibility curve.
8. 3/2 units of other goods.
9. 2/3 gallons of gasoline.
10. 3/2, because Amy'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 her indifference curve must equal the slope of her budget line.

(3) [Monopoly, price discrimination: 20 pts] 2 pts for each part, except part (a) not scored.

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. 8 thousand, where MR=MC.
3. \$11, 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. \$144 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) [Competition versus collusion: 16 pts]

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

(5) [Monopolistic competition: 16 pts]

1. differentiated products.
2. 160 sandwiches.
3. loss, since P < average cost.
4. \$160, since profit = revenue - total cost = (P × Q) - (AC × Q).
5. Since demand curve is linear, MR curve must have same intercept and twice the slope. So MR curve should have intercept at \$11 on price axis, and slope = -1/10.
6. 100 sandwiches, where MR=MC.
7. \$6, on demand curve.
8. \$1 on marginal cost curve.
9. \$6, on average cost curve.
10. The most plausible explanation is that free entry has driven economic profit to zero. If Ryan had been making economic profits earlier, this would have attracted new food trucks to enter the market, pushing Ryan's demand curve toward the origin. New food trucks would stop entering the market only when profits fell to zero (P=AC).

III. Critical thinking [4 pts]

(1) Fredonia's economy is at point C. If both energy and food were competitive markets, Fredonia's economy would be at the tangency between its production-possibility curve and the representative consumer's highest attainable indifference curve, which is point B. However, Fredonia's energy market is a monopoly. Monopolies raise price and decrease the quantity produced and sold. So less energy is produced in Fredonia and its economy is at point C.

(2) If the government permitted airlines to set prices cooperatively, they would form a cartel, raising price above marginal cost like a monopoly.

1. The airlines would gain from higher prices and profits.
2. Consumers would lose from higher prices.
3. Society as a whole would lose. The gains to airlines 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 (4).)

### Version B

I. Multiple choice

(1)b. (2)d. (3)d. (4)e. (5)a. (6)b. (7)d. (8)c. (9)a. (10)b. (11)b. (12)c.

II. Problems

(1) [Monopoly price discrimination: 8 pts]

1. 33 percent, because elasticity = percent chg Q / percent chg P.
2. 9 percent.
3. \$22 = MC / (1 + (1/ε)).
4. \$30 (same formula).

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

1. 3 units of other goods.
2. 1/3 gallons of gasoline.
3. \$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 gallon of gasoline is 3 units of other goods, then the price of a gallon of gasoline must be 3 times the price of other goods.
4. \$2, because in competitive equilibrium, price equals marginal cost.
5. \$6, because in competitive equilibrium, price equals marginal cost.
6. Amy's budget line should have intercepts at 30 units of other goods and 10 gallons of gasoline.
7. -3, same as slope of country's production possibility curve.
8. 3 units of other goods.
9. 1/3 gallons of gasoline.
10. 3, because Amy'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 her indifference curve must equal the slope of her budget line.

(3) [Monopoly, price discrimination: 20 pts] 2 pts for each part, except part (a) not scored.

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, where the demand curve intersects the marginal cost curve, 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. 6 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 \$10 on price axis, and slope = -1/1 million.
5. 4 million, where MR = MC.
6. \$6 (= marginal cost).
7. \$8, on demand curve.
8. \$2 million.

(5) [Monopolistic competition: 16 pts]

1. differentiated products.
2. 40 sandwiches.
3. loss, since P < average cost.
4. \$80, since profit = revenue - total cost = (P × Q) - (AC × Q).
5. Since demand curve is linear, MR curve must have same intercept and twice the slope. So MR curve should have intercept at \$10 on price axis, and slope = -1/10.
6. 80 sandwiches, where MR=MC.
7. \$6, on demand curve.
8. \$2 on marginal cost curve.
9. \$6, on average cost curve.
10. The most plausible explanation is that free entry has driven economic profit to zero. If Ryan had been making economic profits earlier, this would have attracted new food trucks to enter the market, pushing Ryan's demand curve toward the origin. New food trucks would stop entering the market only when profits fell to zero (P=AC).

III. Critical thinking

Same as Version A.