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

### Version A

I. Multiple choice

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

II. Problems

(1) [Efficiency of competition: 16 pts]

1. \$11, the height of the demand curve.
2. \$3, the height of the supply curve.
3. increase.
4. by \$8 = \$11 - \$3.
5. \$2, the height of the demand curve.
6. \$6, the height of the supply curve.
7. increase.
8. by \$4 = \$6 - \$2.

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

1. 1/2 units of clothing.
2. 2 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 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. Anna's budget line should have intercepts at 60/6=10 units of food and 60/12=5 units of clothing.
5. 1/2 units of clothing, same as PP curve.
6. 2 units of food, same as PP curve.
7. 3 units of clothing, at tangency between budget line and highest indifference curve that Anna can reach.
8. 1/2, because at a 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 have same intercept and twice the slope. So MR curve should have intercept at \$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. General public should get the higher price because their demand is less elastic.
2. \$15 = MC / (1 + (1/ε)), where ε = elasticity for students.
3. \$36, using same formula, where ε = elasticity for general public.

(5) [Competition versus collusion: 16 pts]

1. 10 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 have same intercept and twice the slope. So MR curve should have intercept at \$10 on price axis, and slope = -1/1 million.
5. 6 million, where MR = MC.
6. \$4 = marginal cost = height of supply curve.
7. \$7, on demand curve.
8. \$6 million, the area of a triangle between demand curve, joint MC curve, and vertical line at cartel quantity (6 million).

(6) [Monopolistic competition: 16 pts]

1. differentiated products.
2. 80 sandwiches, 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 have same intercept and twice the slope. So MR curve should have intercept at \$12 on price axis, and slope = -2/10.
6. 50 sandwiches, 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 [4 pts]

(1) A gas station in the city, with other gas stations nearby, is more likely to take price as given. If customers can easily switch to other gas stations, then this gas station must charge approximately the same price as other gas stations or it will lose all its customers. That is the situation of the city gas station. By contrast, the gas station is not likely to lose many customers if it raises price because no other gas stations are nearby, and people are unlikely to spend the time and money driving great distances to buy gas.

(2) If the government permitted automobile companies to set prices cooperatively, the companies would form a cartel to restrict output and raise price. [Compare with problem (5).]

1. The companies would gain from higher prices but automobile buyers would lose.
2. Society as a whole would lose. Some consumers willing to pay the marginal cost of a car would not buy a car at the higher price, resulting in a deadweight loss. Put differently, the gains to automobile companies would be less than the losses to automobile buyers.
3. The vertical axis should be labeled "price." The horizontal axis should be labeled "quantity." The demand curve should slope down. The supply curve (which becomes the joint marginal cost curve under the cartel) should slope up. The cartel quantity should be lower than the competitive quantity at the intersection of supply and demand. The cartel price should be higher than the competitive price at the intersection of supply and demand. The area representing deadweight loss is a triangle bounded by the demand curve, the supply curve, and a vertical line at cartel quantity.

### Version B

I. Multiple choice

(1)c. (2)d. (3)a. (4)a. (5)a. (6)b. (7)c. (8)d. (9)b. (10)a.
(11)c. (12)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. 3 units of clothing.
2. 1/3 units of food.
3. \$9, because in competitive equilibrium, prices reflect opportunity costs for the economy as a whole: if the opportunity cost of a unit of food is 3 units of clothing, then the price of a unit of food must be 3 times the price of a unit of clothing.
4. Anna's budget line should have intercepts at 60/6=10 units of food and 60/12=5 units of clothing.
5. 3 units of clothing, same as PP curve.
6. 1/3 units of food, same as PP curve.
7. 2 units of food, at tangency between budget line and highest indifference curve that Anna can reach.
8. 3, because at a 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 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 = area of triangle between monopoly price (\$10), demand curve, and vertical axis.
6. \$8 thousand = area of triangle between demand curve, MC curve, and vertical line at monopoly quantity (4 thousand).

(4) [Monopoly price discrimination: 6 pts]

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

(5) [Competition versus collusion: 16 pts]

1. 9 million.
2. \$3 = marginal cost = height of supply curve.
3. \$3. Note that perfect competition yields marginal-cost pricing.
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. \$7, 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 sandwiches, 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 have same intercept and twice the slope. So MR curve should have intercept at \$9 on price axis, and slope = -1/10.
6. 60 sandwiches, where MR=MC.
7. \$6, on demand curve.
8. \$3, 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.