ECON 002 - Principles of Microeconomics
Drake University, Fall 2019
William M. Boal

EXAM 4 ANSWER KEY

Version A

I. Multiple choice

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

II. Problems

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

  1. $5 (= marginal cost).
  2. $10 (= marginal cost).
  3. Firm A (because it has lower marginal cost).
  4. 8 thousand, so that marginal costs are equal.
  5. 4 thousand, 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: 14 pts]

  1. 1/3 units of clothing.
  2. 3 units of food.
  3. $2, because in competitive equilibrium, prices reflect opportunity costs for the economy as a whole: if the opportunity cost of a unit of food is 1/3 units of clothing, then the price of a unit of food must be 1/3 times the price of a unit of clothing.
  4. Alan's budget line should have intercepts at 30/2=15 units of food and 30/6=5 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 at a tangency the slope of his indifference curve must equal the slope of his 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 = -1/1 thousand.
  2. 6 thousand, where MR=MC.
  3. $11, 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. $96 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. $10 = MC / (1 + (1/ε)), where ε = elasticity for children.
  2. $12, using same formula, where ε = elasticity for adults.

(5) [Competition versus collusion: 16 pts]

  1. 9 million.
  2. $3 = marginal cost = height of supply curve.
  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 = height of supply curve.
  7. $97, on demand curve.
  8. $10 million, the area of a triangle

(6) [Monopolistic competition: 16 pts]

  1. differentiated products.
  2. 20 cones.
  3. loss, since P < average cost.
  4. $40, 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 $10 on price axis, and slope = -2/10.
  6. 40 cones, 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 Bessie had been making economic profits earlier, this would have attracted ice cream stands to enter the market, pushing Bessie's demand curve toward the origin. New ice cream stands would stop entering the market only when profits fell to zero (P=AC).

III. Critical thinking [4 pts]

(1) If all markets are competitive, then prices reflect opportunity costs--not only for each individual consumer along their budget line, but also for the economy as a whole along the economy's production-possibility curve. Since the price of pens is given as five times the price of pencils, the opportunity cost of a pen is five pencils. If pencils are on the vertical axis and pens are on the horizontal axis, then the slope of the production-possibility curve must equal the opportunity cost of pens--that is, five. (Actually, since the production-possibility curve slopes down, the slope is minus five.) (Full credit requires a graph of the production-possibility curve with pencils on the vertical axis and pens on the horizontal axis.)

(2) Generic ice cream does not have a distinctive flavor. Therefore producers of generic ice cream is more likely to take price as given, and perceive that they face perfectly elastic (horizontal) demand, because consumers are likely to view them as perfect substitutes for each other. By contrast, each gourmet brand of ice cream has or claims to have, a unique taste due to special ingredients or a unique recipe. Therefore, producers of gourmet ice cream are likely to enjoy market power because consumers perceive their products as differentiated. So producers of gourmet ice cream are likely to enjoy downward-sloping demand.

Version B

I. Multiple choice

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

II. Problems

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

  1. $10 (= marginal cost).
  2. $5 (= marginal cost).
  3. Firm B (because it has lower marginal cost).
  4. 3 thousand, so that marginal costs are equal.
  5. 7 thousand, 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: 14 pts]

  1. 1/2 units of clothing.
  2. 2 units of food.
  3. $3, because in competitive equilibrium, prices reflect opportunity costs for the economy as a whole: if the opportunity cost of a unit of food is 1/2 units of clothing, then the price of a unit of food must be 1/2 times the price of a unit of clothing.
  4. Alan's budget line should have intercepts at 30/3=10 units of food and 30/6=5 units of clothing.
  5. 1/2 units of clothing, same as PP curve.
  6. 2 units of food, same as PP curve.
  7. -1/2, because at a tangency the slope of his indifference curve must equal the slope of his 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 = -1/1 thousand.
  2. 8 thousand, where MR=MC.
  3. $10, 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. $132 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 = $132 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. $12 = MC / (1 + (1/ε)), where ε = elasticity for children.
  2. $20, using same formula, where ε = elasticity for adults.

(5) [Competition versus collusion: 16 pts]

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

(6) [Monopolistic competition: 16 pts]

  1. differentiated products.
  2. 90 cones.
  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 $13 on price axis, and slope = -2/10.
  6. 60 cones, where MR=MC.
  7. $7, on demand curve.
  8. $1 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 Bessie had been making economic profits earlier, this would have attracted ice cream stands to enter the market, pushing Bessie's demand curve toward the origin. New ice cream stands would stop entering the market only when profits fell to zero (P=AC).

III. Critical thinking

Same as Version A.

[end of answer key]