ECON 002 - Principles of Microeconomics Drake University, Fall 2021 William M. Boal

EXAM 4 ANSWER KEY

### Version A

I. Multiple choice

(1)c. (2)b. (3)b. (4)b. (5)e. (6)a. (7)d. (8)d. (9)a. (10)b. (11)c. (12)d. (13)a. (14)b.

II. Problems

(1) [Efficiency of competition: 16 pts]

1. \$8, the height of the demand curve.
2. \$5, the height of the supply curve.
3. increase.
4. by \$3 = \$8 - \$5.
5. \$4, the height of the demand curve.
6. \$7, the height of the supply curve.
7. increase.
8. by \$3 = \$7 - \$4.

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

1. 2 units of clothing.
2. 1/2 units of food.
3. \$8, because in competitive equilibrium, prices reflect opportunity costs for the economy as a whole: if the opportunity cost of a unit of food is 2 units of clothing, then the price of a unit of food must be 2 times the price of a unit of clothing.
4. Ana's budget line should have intercepts at 40/8=5 units of food and 40/4=10 units of clothing.
5. 2 units of clothing, same as PP curve.
6. 1/2 units of food, same as PP curve.
7. -2, because at a tangency the slope of her indifference curve must equal the slope of her budget line.

(3) [Monopoly: 12 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 = -2/1 thousand.
2. 4 thousand, where MR=MC.
3. \$9, on demand curve.
4. \$24 thousand = TR - TC = (price × quantity) - (AC × quantity).
5. \$8 thousand.
6. \$4 thousand.

(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. 7 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 \$12 on price axis, and slope = -2/1 million.
5. 4 million, where MR = MC.
6. \$4 = marginal cost = height of supply curve.
7. \$8, on demand curve.
8. \$6 million, the area of a triangle

(6) [Monopolistic competition: 16 pts]

1. differentiated products.
2. 30 sandwiches.
3. loss, since P < average cost.
4. \$90, since profit = TR - TC = (price × quantity) - (AC × quantity).
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 Brian had been making economic profits earlier, this would have attracted more food trucks to enter the market, pushing Brian'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) The country of Fredonia is at point D. Too little energy is consumed and produced because it is overpriced. The energy monopoly raises its price above marginal cost.

(2)

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. Graph should show demand curve, supply (or joint marginal cost) curve, marginal revenue curve, profit-maximizing quantity, profit-maximizing price on demand curve above marginal cost, and deadweight loss triangle. The graph should resemble problem (5).

### Version B

I. Multiple choice

(1)a. (2)c. (3)d. (4)c. (5)d. (6)b. (7)a. (8)b. (9)b. (10)e. (11)a. (12)b. (13)d. (14)c.

II. Problems

(1) [Efficiency of competition: 16 pts]

1. \$10, the height of the demand curve.
2. \$4, the height of the supply curve.
3. increase.
4. by \$6 = \$10 - \$4.
5. \$2, the height of the demand curve.
6. \$8, the height of the supply curve.
7. increase.
8. by \$6 = \$8 - \$2.

(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. Ana'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 her indifference curve must equal the slope of her budget line.

(3) [Monopoly: 12 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.

(4) [Monopoly price discrimination: 4 pts]

1. \$20 = MC / (1 + (1/ε)), where ε = elasticity for children.
2. \$27, using same formula, where ε = elasticity for adults.

(5) [Competition versus collusion: 16 pts]

1. 12 million.
2. \$6 = marginal cost = height of supply curve.
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 \$12 on price axis, and slope = -1/1 million.
5. 8 million, where MR = MC.
6. \$4 = marginal cost = height of supply curve.
7. \$8, on demand curve.
8. \$8 million, the area of a triangle

(6) [Monopolistic competition: 16 pts]

1. differentiated products.
2. 60 sandwiches.
3. loss, since P < average cost.
4. \$180, since profit = TR - TC = (price × quantity) - (AC × quantity).
5. 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 = -4/10.
6. 30 sandwiches, where MR=MC.
7. \$10, on demand curve.
8. \$4, on marginal cost curve.
9. \$10, on average cost curve.
10. The most plausible explanation is that free entry has driven economic profit to zero. If Brian had been making economic profits earlier, this would have attracted more food trucks to enter the market, pushing Brian'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.

[end of answer key]