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Microeconomics: Kinked Demand, Advertising, and Monopolistic Competition, Assignments of Microeconomics

Problem sets for chapters 10 and 11 of a microeconomics textbook. The problems cover topics such as kinked demand curves in oligopolies, advertising strategies in duopolies, and the behavior of monopolistically competitive firms. Students are asked to analyze graphs, calculate profits, and determine optimal strategies.

Typology: Assignments

Pre 2010

Uploaded on 08/19/2009

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PROBLEM SET 6
Problems for Chapters 10 and 11
1. a. Explain the meaning of a “kinked demand curve” and under what circumstances a firm
operating in an oligopoly would have one.
b. On the graph below draw a case in which marginal cost changes, but a firm with a
kinked demand curve DOES NOT change the price it charges.
P
P1 A MC
D
MR
Q1Q
c. On the graph below draw a case in which marginal cost changes, and a firm with a
kinked demand curve DOES change the price it charges.
P
P1 A MC
D
MR
Q1Q
pf3
pf4
pf5
pf8

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PROBLEM SET 6

Problems for Chapters 10 and 11

  1. a. Explain the meaning of a “ kinked demand curve” and under what circumstances a firm operating in an oligopoly would have one. b. On the graph below draw a case in which marginal cost changes , but a firm with a kinked demand curve DOES NOT change the price it charges. P P 1 A MC D MR Q 1 Q c. On the graph below draw a case in which marginal cost changes , and a firm with a kinked demand curve DOES change the price it charges. P P 1 A MC D MR Q 1 Q
  1. Suppose that two rival firms (Firm A and Firm B) are considering whether or not to allocate lots of resources to advertising their product (“HIGH ADVERTISING BUDGET”) or just a small share of resources (“LOW ADVERTISING BUDGET”). The success of each strategy in generating profits for each firm depends on the advertising strategy the rival firm follows. a. Using the pay-off matrix below, indicate which strategy is optimal for the two firms combined (“the group”). PAY-OFF MATRIX FIRM B’S ACTIONS High Advertising Budget Low Advertising Budget High Advertising Budget A: profit = +10, B: profit = +10, A: profit = +50, B: profit = +7, FIRM A’S ACTIONS Low Advertising Budget A: profit = +7, B: profit = +50, A: profit = +30, B: profit = +30, b. Figure out which advertising strategy is in each individual firm’s best interest by filling out the chart below. FIRM A’S BEST STRATEGY FIRM B’S BEST STRATEGY If Firm B implements high advertising budget If Firm A implements high advertising budget If Firm B implements low advertising budget If Firm A implements low advertising budget c. Which advertising strategy will more likely be implemented by the two firms in the industry if they cannot credibly collude with each other? Explain.
  1. Use the diagram of a monopolistically competitive firm below to help you answer the questions. $ MC ATC P 4 AVC P 3 P 2 P 1 D=P MR 0 Q 1 Q 2 Q 3 Q a. Where does a monopolistically competitive firm get its “market power”? b. What “rule” do you use to find the monopolistically competitive firm’s profit- maximizing level of output? c. According to the diagram, what is the firm’s profit-maximizing level of output? d. What price will the firm charge? e. Does the diagram show a long-run or short-run situation? How can you tell? f. FILL IN THE BLANKS: In long-run equilibrium, the average total cost curve will be tangent to the _______________ curve and the economic profits will be _____.
  1. Suppose that, as a by product of production, the widget industry releases pollutants into the air, leading to sickness and missed days of work for people living downwind of a widget factory. Below is a diagram of the typical widget firm which operates in a perfectly competitive industry.

Market for Widgets

0 25 50 75 100 125 150 175 200 225 250 275 300 325 350 375 0 5 10 15 20 25 30 35 40 Quantity of Widgets (Q) Price and Marginal Costs D = P Marginal Private Cost Marginal Social Cost a. What level of output will the typical widget firm produce if left unregulated? Why is this level of output “too high”? b. What is the dollar value of the external costs of the air pollution? c. What is the optimal level of output for society? TEXT, P21: #2 a,b, c. P25: #3 a, b. P26: 6 a, b, c (For #6, calculate the MCs of Pollution Abatement for each firm)

  1. a. The industry as a whole (the two firms combined) will earn higher profits if the two rivals each implement a low advertising budget (In the other outcomes, the industry as whole makes lower total profits than if they both implement a low advertising budget and at least one firm makes lower profits than if they both implement a low advertising budget). b. FIRM A’S BEST STRATEGY FIRM B’S BEST STRATEGY If Firm B implements high advertising budget High advertising budget If Firm A implements high advertising budget High advertising budget If Firm B implements low advertising budget High advertising budget If Firm A implements low advertising budget High advertising budget c. They will each implement the strategy that is in their individual best interest, i.e. each will implement a high advertising budget. The waste of money implies that the two firms combined are worse off than if they both pursued a low advertising budget.
  2. a. The industry as a whole (the two airlines combined) will earn higher profits if the two rivals each do not offer a frequent flyer program (In the other outcomes, the industry as a whole makes lower profits than if they both decline to offer a frequent flyer program, and at least one of the airlines earns lower profits than if they both decline to offer a frequent flyer program). b. AMERICAN’S BEST STRATEGY UNITED’S BEST STRATEGY If United offers program Offer frequent flyer program If American offers program Offer frequent flyer program If United does not offer program Offer frequent flyer program If American does not offer program Offer frequent flyer program c. They will each implement the strategy that is in their individual best interest, i.e. each will offer a frequent flyer program. The waste of money implies that the two firms combined are worse off than if they both chosen not to implement the program.
  3. a. From differentiated product based on customer loyalty. b. MR = MC. c. Q 1 where MR = MC. d. Short-run because there is both an ATC curve and an AVC curve, implying fixed costs. e. demand, zero.
  4. a. The widget firm will maximize profits and produce 20 units of output where price (marginal revenue) = marginal private cost. 20 units of output is too high because it does not take into account the costs the associated pollution imposes on society (external costs) b. The external costs are $75.

c. The optimal level of output for society is 5 widgets where price (marginal revenue) equals social marginal cost. The amount of pollution released when 5 widgets are produced is the optimal level of pollution. TEXT, P 21:

  1. a. $12 b. 6 c. TR = $12 x 6 = $72. TC = ATC x Q = $8.33 (approx.) x 6 = $49.  Total Profit = $72 - $49.98 = $22.02. TEXT, P 25:
  2. a. 20 pounds per week. b. 14 pounds per week. TEXT, P 26: Marginal Costs of Pollution Abatement Emissions Reduction Firm A Firm B Firm C 1 $ 50 $ 60 $ 40 2 55 80 110 3 70 90 150 4 125 120 200
  3. a. $50 (A) + $60 (B) + $40 (C) = $ b. $40 (C) + $50 (A) + $55 (A) = $ c. Assuming the government initially handed out 1 “permit” to each of the firms (requiring that the holder cut back pollution by 1 unit), Firm B would be willing to pay up to $ to avoid having to pay $60 to reduce pollution by 1 unit. It will offer to pay someone, say $58, to cut back pollution. Firm C won’t accept because it would have to cut back pollution by a second unit which would cost it $110. However, Firm A will accept because it would receive $58 from Firm B and would only have to pay $55 to cut back pollution by a second unit, making a profit of $3. The cost of a “permit” would be between $55, Firm A’s cost of cutting back pollution by a second unit, and $60, Firm B’s cost of cutting back pollution by one unit.