ECON 002 - Principles of Microeconomics Drake University, Fall 2018 William M. Boal

### Version A

I. Multiple choice

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

II. Problems

(1) [Efficiency of competition: 12 pts]

1. \$20, because the height of the demand curve = marginal willingness-to-pay.
2. \$8, because the height of the supply curve = marginal cost.
3. \$12, because the increase in total surplus = willingness-to-pay minus marginal cost.
4. \$14, because the height of the demand curve = marginal willingness-to-pay.
5. \$14, because the height of the supply curve = marginal cost.
6. \$0, roughly, because the increase in total surplus = willingness-to-pay minus marginal cost.

(2) [Economy-wide efficiency: 14 pts]

1. 1/3 units of clothing.
2. 3 units of food.
3. \$15, because in competitive equilibrium, prices reflect opportunity costs for the economy as a whole: if the opportunity cost of a unit of clothing is 3 units of food, then the price of a unit of clothing must be 3 times the price of a unit of food.
4. Ariana's budget line should have intercepts at 60/5=12 units of food and 60/15=4 units of clothing.
5. 1/3 units of clothing, same as PP curve.
6. 3 units of food, same as PP curve.
7. -1/3, because Ariana'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: 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 = TR - 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 from zero to 8 thousand.
9. \$48 thousand = TR - TC = \$88 thousand - (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. \$18 = MC / (1 + (1/ε)), where ε = elasticity for children.
2. \$30, using same formula, where ε = elasticity for adults.

(5) [Competition versus collusion: 16 pts]

1. 10 million.
2. \$5 = marginal cost = height of supply curve.
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 = -2/1 million.
5. 6 million, where MR = MC.
6. \$3 = marginal cost = height of supply curve.
7. \$9, on demand curve.
8. \$12 million, the area of a triangle

(6) [Monopolistic competition: 16 pts]

1. differentiated products.
2. 80 sandwiches.
3. loss, since P < average cost.
4. \$160, since profit = TR - TC = (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 = -2/10.
6. 40 sandwiches, where MR=MC.
7. \$7, on demand curve.
8. \$3 on marginal cost curve.
9. \$7, on average cost curve.
10. The most plausible explanation is that free entry has driven economic profit to zero. If Ben had been making economic profits earlier, this would have attracted food trucks to enter the market, pushing Ben'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) There are many possible answers--only three are needed.

• A price floor causes the consumers' price to be greater than marginal cost, so too little is produced compared to the efficient outcome.
• A quota on sellers causes the consumers' price to be greater than marginal cost, so too little is produced compared to the efficient outcome.
• A tax causes the consumers' price to be greater than marginal cost, so too little is produced compared to the efficient outcome.
• A subsidy causes the consumers' price to be less than marginal cost, so too much is produced compared to the efficient outcome.
• A monopoly causes the consumers' price to be greater than marginal cost, so too little is produced compared to the efficient outcome.
• A cartel or an oligopoly causes the consumers' price to be greater than marginal cost, so too little is produced compared to the efficient outcome.
• Monopolistic competition causes the consumers' price to be greater than marginal cost, so too little is produced compared to the efficient outcome.

(2) A grocery store in a small town is more likely to have market power, because it is larger relative to its market. A grocery store in a big city, even if the store is large, most likely faces many nearby competitors, but a grocery store in a small town may have few or none. Note that it is not the absolute size of the store that matters, but the size of the store relative to its market.

### Version B

I. Multiple choice

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

II. Problems

(1) [Efficiency of competition: 12 pts]

1. \$14, because the height of the demand curve = marginal willingness-to-pay.
2. \$10, because the height of the supply curve = marginal cost.
3. \$4, because the increase in total surplus = willingness-to-pay minus marginal cost.
4. \$12, because the height of the demand curve = marginal willingness-to-pay.
5. \$12, because the height of the supply curve = marginal cost.
6. \$0, roughly, because the increase in total surplus = willingness-to-pay minus marginal cost.

(2) [Economy-wide efficiency: 14 pts]

1. 1/4 units of clothing.
2. 4 units of food.
3. \$5, because in competitive equilibrium, prices reflect opportunity costs for the economy as a whole: if the opportunity cost of a unit of clothing is 4 units of food, then the price of a unit of clothing must be 4 times the price of a unit of food.
4. Ariana's budget line should have intercepts at 80/5=16 units of food and 80/20=4 units of clothing.
5. 1/4 units of clothing, same as PP curve.
6. 4 units of food, same as PP curve.
7. -1/4, because Ariana'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: 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. 8 thousand, where MR=MC.
3. \$9, on demand curve.
4. \$48 thousand = TR - 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. \$120 thousand, because with every customer paying a different price, revenue = area of the trapezoid under demand curve from zero to 12 thousand.
9. \$72 thousand = TR - TC = \$120 thousand - (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. \$14 = MC / (1 + (1/ε)), where ε = elasticity for children.
2. \$36, using same formula, where ε = elasticity for adults.

(5) [Competition versus collusion: 16 pts]

1. 9 million.
2. \$4 = marginal cost = height of supply curve.
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 = -2/1 million.
5. 5 million, where MR = MC.
6. \$3 = marginal cost = height of supply curve.
7. \$8, on demand curve.
8. \$10 million, the area of a triangle

(6) [Monopolistic competition: 16 pts]

1. differentiated products.
2. 90 sandwiches.
3. loss, since P < average cost.
4. \$90, since profit = TR - TC = (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 \$14 on price axis, and slope = -2/10.
6. 60 sandwiches, where MR=MC.
7. \$8, on demand curve.
8. \$2 on marginal cost curve.
9. \$8, on average cost curve.
10. The most plausible explanation is that free entry has driven economic profit to zero. If Ben had been making economic profits earlier, this would have attracted food trucks to enter the market, pushing Ben'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.