ECON 002 - Principles of Microeconomics Drake University, Fall 2023 William M. Boal

### Version A

I. Multiple choice

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

II. Problems

(1) [Efficiency of competition: 16 pts]

1. \$9, the height of the demand curve.
2. \$3, the height of the supply curve.
3. increase.
4. by \$6 = \$19 - \$3.
5. \$3, the height of the demand curve.
6. \$6, the height of the supply curve.
7. increase.
8. by \$3 = \$6 - \$3.

(2) [Economy-wide efficiency: 16 pts]

1. 2 units of clothing.
2. 1/2 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 1/2 units of food, then the price of a unit of clothing must be 1/2 times the price of a unit of food.
4. Caitlin's budget line should have intercepts at 50/10=5 units of food and 50/5=10 units of clothing.
5. 2 units of clothing, same as country's PP curve.
6. 1/2 units of food, same as country's PP curve.
7. 3 units of food, at tangency between budget line and highest indifference curve that Caitlin can reach.
8. 2, because at the tangency, the |slope| of her indifference curve (MRS) must equal the slope of her budget line.

(3) [Monopoly: 12 pts]

1. Since demand curve is linear, MR curve must also be linear and have same intercept and twice the slope as demand. So MR curve should have intercept = \$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 = area of triangle between monopoly price (\$9), demand curve, and vertical axis.
6. \$8 thousand = area of triangle between demand curve, MC curve, and vertical line at monopoly quantity (8 thousand).

(4) [Monopoly price discrimination: 6 pts]

1. Children should get the lower price because their demand is more elastic.
2. \$14 = MC / (1 + (1/ε)), where ε = elasticity for children.
3. \$18, using same formula, where ε = elasticity for adults.

(5) [Competition versus collusion: 16 pts]

1. 9 million.
2. \$5 = marginal cost = height of supply curve.
3. \$5. Note that perfect competition yields marginal-cost pricing.
4. Since demand curve is linear, MR curve must also be linear and have same intercept and twice the slope as demand. So MR curve should have intercept = \$14 on price axis, and slope = -2/1 million.
5. 5 million, where MR = MC.
6. \$5 = marginal cost = height of supply curve.
7. \$9, on demand curve.
8. \$10 million, the area of a triangle between demand curve, joint MC curve, and vertical line at cartel quantity (5 million).

(6) [Monopolistic competition: 16 pts]

1. differentiated products.
2. 20 ice cream cones, from demand curve.
3. loss, since P < average cost at that quantity.
4. \$40, since profit = TR - TC = (price × quantity) - (AC × quantity).
5. Since demand curve is linear, MR curve must also be linear and have same intercept and twice the slope as demand. So MR curve should have intercept = \$10 on price axis, and slope = -2/10.
6. 40 ice cream cones, where MR=MC.
7. \$6, on demand curve.
8. \$2, on marginal cost curve.
9. \$0, since profit = TR - TC = (price × quantity) - (AC × quantity). Note that whenever price = AC, profit is zero.

III. Critical thinking [4 pts]

(1) The Christmas tree stand in this question gains \$49 in revenue on the twenty-first tree. But it has to cut price by one dollar on the prior twenty trees sold, a loss of \$20. So marginal revenue of the twenty-first tree equals \$49 minus \$20 or \$29.

(2) Microsoft is more likely to price its product above marginal cost because it has a monopoly. Microsoft enjoys patent protection for its Windows operating system and for its Office software, for which there are no close substitutes, so it has market power. As a monopoly, Microsoft faces a downward-sloping demand curve, and thus its marginal revenue is less than its price. It maximizes profit by choosing its output where marginal revenue equals marginal cost, so its marginal cost must be less than its price.
Dell Computer's products, by contrast, compete with essentially perfect substitutes made by HP, Lenovo, Acer, Asus, etc., so Dell has no market power and must match the prices of other companies. As a perfectly-competitive firm, Dell perceives its own demand curve to be horizontal, with marginal revenue equal to its price. It maximizes profit by choosing its output where price equals marginal cost.

### Version B

I. Multiple choice

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

II. Problems

(1) [Efficiency of competition: 16 pts]

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

(2) [Economy-wide efficiency: 16 pts]

1. 1/3 units of clothing.
2. 3 units of food.
3. \$6, 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. Caitlin's budget line should have intercepts at 30/2=10 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. 3 units of food, at tangency between budget line and highest indifference curve that Caitlin can reach.
8. 1/3, because at the tangency, the |slope| of her indifference curve (MRS) must equal the slope of her budget line.

(3) [Monopoly: 12 pts]

1. Since demand curve is linear, MR curve must also be linear and have same intercept and twice the slope as demand. So MR curve should have intercept = \$14 on price axis, and slope = -1/1 thousand.
2. 4 thousand, where MR=MC.
3. \$10, on demand curve.
4. \$24 thousand = TR - TC = (price × quantity) - (AC × quantity).
5. \$8 thousand = area of triangle between monopoly price (\$10), demand curve, and vertical axis.
6. \$4 thousand = area of triangle between demand curve, MC curve, and vertical line at monopoly quantity (4 thousand).

(4) [Monopoly price discrimination: 6 pts]

1. Children should get the lower price because their demand is more elastic.
2. \$14 = MC / (1 + (1/ε)), where ε = elasticity for children.
3. \$18, 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. Note that perfect competition yields marginal-cost pricing.
4. Since demand curve is linear, MR curve must also be linear and have same intercept and twice the slope as demand. So MR curve should have intercept = \$12 on price axis, and slope = -1/1 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 between demand curve, joint MC curve, and vertical line at cartel quantity (5 million).

(6) [Monopolistic competition: 16 pts]

1. differentiated products.
2. 80 ice cream cones, from demand curve.
3. loss, since P < average cost at that quantity.
4. \$80, since profit = TR - TC = (price × quantity) - (AC × quantity).
5. Since demand curve is linear, MR curve must also be linear and have same intercept and twice the slope as demand. So MR curve should have intercept = \$12 on price axis, and slope = -2/10.
6. 50 ice cream cones, where MR=MC.
7. \$7, on demand curve.
8. \$2, on marginal cost curve.
9. \$0, since profit = TR - TC = (price × quantity) - (AC × quantity). Note that whenever price = AC, profit is zero.

III. Critical thinking

Same as Version A.