ECON 002 - Principles of Microeconomics Drake University, Spring 2024 William M. Boal

### Version A

I. Multiple choice

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

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. \$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: 16 pts]

1. 1/2 units of clothing.
2. 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 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. Carmen's budget line should have intercepts at 40/8=5 units of clothing and 40/4=10 units of food.
5. 1/2 units of clothing, same as country's PP curve.
6. 2 units of food, same as country's PP curve.
7. 3 units of clothing, at tangency between budget line and highest indifference curve that Carmen can reach.
8. 1/2, 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 = \$12 on price axis, and slope = -2/1 thousand.
2. 4 thousand, where MR=MC.
3. \$8, on demand curve.
4. \$24 thousand = TR - TC = (price × quantity) - (AC × quantity).
5. \$8 thousand = area of triangle between monopoly price (\$8), 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. \$20 = MC / (1 + (1/ε)), where ε = elasticity for children.
3. \$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. 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 = \$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, cartel MC curve, and vertical line at cartel quantity (5 million).

(6) [Monopolistic competition: 16 pts]

1. differentiated products.
2. 40 sandwiches, 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 = \$13 on price axis, and slope = -2/10.
6. 60 sandwiches, where MR=MC.
7. \$7, on demand curve.
8. \$1, 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) This question refers to economy-wide efficiency.

1. If both markets are competitive, the economy locates at point C. This is because competitive markets result in an efficient output mix, putting the economy on the tangency between the production possibility curve and the highest attainable indifference curve.
2. If the market for food is competitive and the market for energy is a monopoly, the economy locates at point B. This is because monopoly in the energy industry raises the price and reduces the quantity sold compared to the competitive quantity.

(2) The Arts Festival is an example of monopolistic competition.

1. Craft artists produce differentiated products, not perfect substitutes, because each artist's style is unique--at least in the minds of buyers.
2. Price is greater than marginal cost. Each artist faces downward-sloping demand because their work has a unique style.
3. Price equals average cost in the long run. There are no barriers to entry. If craft artists at the Festival are enjoying positive economic profits, more artists will come to the Festival, until prices are driven down to average cost. There are zero economic profits in the long run, which means that artists are making as much money creating and selling crafts as they could make doing something else.

### Version B

I. Multiple choice

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

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. \$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: 16 pts]

1. 3 units of clothing.
2. 1/3 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 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. Carmen's budget line should have intercepts at 45/5=9 units of clothing and 45/5=9 units of food.
5. 3 units of clothing, same as country's PP curve.
6. 1/3 units of food, same as country's PP curve.
7. 2 units of clothing, at tangency between budget line and highest indifference curve that Carmen can reach.
8. 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. 8 thousand, where MR=MC.
3. \$10, 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 (8 thousand).

(4) [Monopoly price discrimination: 6 pts]

1. Adults should get the higher price because their demand is less elastic.
2. \$16 = MC / (1 + (1/ε)), where ε = elasticity for children.
3. \$21, 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. 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 = \$10 on price axis, and slope = -1/1 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 between demand curve, cartel MC curve, and vertical line at cartel quantity (4 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. \$160, 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 sandwiches, 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

Same as Version A.