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Intermediate Microeconomic Analysis (Econ 173) Signature: Drake University, Fall 2004 William M. Boal Printed name:
MIDTERM EXAMINATION #4 VERSION A
“General Equilibrium and Market Power”
December 2, 2004
INSTRUCTIONS: This exam is closed-book, closed-notes. Simple calculators are permitted, but not graphing calculators or calculators with alphabetical keyboards. Point values for each question are noted in brackets. I. MULTIPLE CHOICE: Circle the one best answer to each question. Feel free to use margins for scratch work [2 pts each—54 pts total] The next three questions refer to the following Edgeworth box diagram. The solid curves are Caitlin's indifference curves. The dashed curves are Derek's indifference curves. (1) From allocation A, both people can be made better off if a. Caitlin gives Derek some food, and Derek gives Caitlin some clothing. b. Caitlin gives Derek some clothing, and Derek gives Caitlin some food. c. Either (a) or (b). d. No trade can make both people better off. (2) From allocation B, both people can be made better off if a. Caitlin gives Derek some food, and Derek gives Caitlin some clothing. b. Caitlin gives Derek some clothing, and Derek gives Caitlin some food. c. Either (a) or (b). d. No trade can make both people better off. (3) Caitlin and Derek have identical marginal rates of substitution in consumption at a. allocation A only. b. allocation B only. c. allocation C only. d. allocations A, B, and C. e. allocations B and C, but not A. (4) The contract curve for this Edgeworth box diagram would not pass through a. Allocation A. b. Allocation B. c. Allocation C. d. Allocation D. e. The contract curve passes through all four allocations. f. The contract curve does not pass through any of these four allocations. The next three questions refer to the following graph of an economy's production-possibility curve. Assume this economy is in general Caitlin Derek Clothing Food
A
B
C
D
Drake University, Fall 2004 Page 2 of 11 competitive equilibrium at point A, where the slope of the production-possibility curve is 4 (in absolute value). (5) If this economy were to produce two more units of food, it would have to reduce production of other goods by about a. one unit. b. two units. c. four units. d. six units. e. eight units. (6) If the price of food in this economy is $ per unit, then the price of other goods must be a. $1. b. $2. c. $4. d. $6. e. $8. (7) Throughout the economy, the slope of every consumer's budget line, with food on the horizontal axis and other goods on the vertical axis, is a. one. b. two. c. four. d. six. e. eight. (8) A firm than enjoys a natural monopoly a. was the first producer of the good. b. owns a patent on the good. c. has a downward-sloping average cost curve. d. owns all of some key natural resource necessary to produce the good. e. any of the above. (9) If marginal revenue is greater than marginal cost at the current level of output, the firm can increase its profit by a. increasing output. b. decreasing output. c. either increasing or decreasing output. d. neither—the firm cannot increase its profit by making small changes in output. e. Cannot be determined from information given. (10) If the demand curve for a firm's product slopes downward, and the firm must charge all customers the same price, then the firm's price a. less than marginal revenue. b. greater than marginal revenue. c. equal to marginal revenue. d. zero. e. cannot be determined without knowing the elasticity of demand. (11) Suppose a hotdog vendor with market power is now selling ten hotdogs per hour at a price of $2. If he cuts the price to $1.90, he can sell one more hotdog per hour (that is, a total of eleven hotdogs per hour). The vendor's marginal revenue for the eleventh hotdog is therefore a. $0.10 per hotdog. b. $0.90 per hotdog. c. $1.00 per hotdog. d. $1.90 per hotdog. e. $2.00 per hotdog. (12) Suppose the demand for a monopolist's product has an elasticity of -6, and the monopolist's marginal cost is $10. Then the profit-maximizing price is a. $6.. b. $10.. c. $12.. d. $15.. e. $16.. Other goods Food
A
Drake University, Fall 2004 Page 4 of 11 c. q 1 = 15 and q 2 = 15. d. q 1 = 20 and q 2 = 10. e. q 1 = 30 qnd q 2 = 0. (17) If all firms in an industry are colluding to maximize their total profit, then each firm's marginal cost is a. greater than the price. b. equal to the price. c. less than the price. d. Cannot be determined from information given. (18) According to the model of symmetric Cournot oligopoly, the markup of price over marginal cost will be larger, a. the less elastic is demand. b. the fewer firms are in the industry. c. both (a) and (b). d. neither (a) nor (b). (19) Suppose two profit-maximizing firms, with identical and constant marginal cost equal to $2, serve a single market. If each firm sets its price while taking the other firm's price as given, then the Nash equilibrium of this game will result in a price a. greater than $2. b. less than $2. c. equal to $2. d. Cannot be determined from information given. (20) Suppose two profit-maximizing firms, with identical and constant marginal cost equal to $2, serve a single market. If each firm chooses its quantity of output while taking the other firm's quantity of output as given, then the Nash equilibrium of this game will result in a price a. greater than $2. b. less than $2. c. equal to $2. d. Cannot be determined from information given. (21) Each firm in an industry faces downward- sloping demand if a. their products as perfect substitutes. b. their products are differentiated. c. no individual firm has market power. d. All of the above. e. None of the above. (22) Free entry ensures that price equals average cost in the long run, under the model of a. perfect competition. b. monopolistic competition. c. Both of the above. d. None of the above. The next five questions refer to the following game. Two firms are making a new wireless product according one of two possible technical standards (#1 and #2). Each firm favors a different standard. However, both products will sell better if they are compatible—that is, use the same standard. Firm B Technical standard
Technical standard
Firm A Tech- nical standard
A gets $ million. B gets $ million. A gets $ million. B gets $ million. Tech- nical standard
A gets $ million. B gets $ million. A gets $ million. B gets $ million. (23) How many Pareto-optimal outcomes are there in this game? a. Zero. b. One. c. Two. d. Three e. Four. (24) What is Firm A's dominant strategy? a. Technical standard #1.
Drake University, Fall 2004 Page 5 of 11 b. Technical standard #2. c. Both (a) and (b). d. Firm A has no dominant strategy. (25) What is Firm B's best reply if Firm A chooses technical standard #1? a. Technical standard #1. b. Technical standard #2. c. Both (a) and (b). d. Firm A has no best reply. (26) What is the dominant-strategy equilibrium of this game? a. Firm A chooses technical standard #1, Firm B chooses technical standard #1. b. Firm A chooses technical standard #2, Firm B chooses technical standard #2. c. Firm A chooses technical standard #1, Firm B chooses technical standard #2. d. Firm A chooses technical standard #2, Firm B chooses technical standard #1. e. There is no dominant-strategy equilibrium in this game. (27) How many Nash equilibria are there in this game? a. Zero. b. One. c. Two. d. Three. e. Four. II. PROBLEMS: Please write your answers in the boxes on this question sheet. Show your work and circle your final answers.
Drake University, Fall 2004 Page 7 of 11 (2) [Monopoly, price discrimination: 16 pts] Suppose a monopolist faces the following demand curve: P = 8 - (Q/20). Further suppose that the monopolist's marginal cost and average cost are constant and equal to $2. Assume initially that the monopolist must charge the same price for all units sold—that is, price discrimination is impossible. Circle your final answers. Use the space on the next page for scratch work. Note: question continues on next page. a. Find the monopolist's marginal revenue function MR(Q). b. Compute the monopolist's profit-maximizing quantity of output. c. Compute the monopolist's profit-maximizing price. d. Compute monopoly profit at this price. e. Compute social deadweight loss at this price.
Drake University, Fall 2004 Page 8 of 11 Alternatively, assume that perfect price discrimination is possible. Each unit of output may be sold at a different price, equal to the maximum amount the buyer is willing to pay for that unit. f. Compute the monopolist's profit-maximizing quantity of output with perfect price discrimination. g. Compute monopoly profit with perfect price discrimination. h. Compute social deadweight loss with perfect price discrimination. Quantity Price
Drake University, Fall 2004 Page 10 of 11 e. Compute total market quantity Q* and the equilibrium price P*. f. Compute the total profit of both firms. g. Compute the social deadweight loss. Quantity Price
Drake University, Fall 2004 Page 11 of 11 III. CRITICAL THINKING: Write a one-paragraph essay answering one question below (your choice). Full credit requires correct economic reasoning, legible writing, good grammar including complete sentences, and accurate spelling. [4 pts] (1) Collusion in setting prices is beneficial to firms but harmful to consumers. For society as a whole, is collusion beneficial or harmful? Justify your answer. (2) Fair outcomes are different from efficient outcomes. Suppose four pairs of shoes must be divided between two people. Give an example of an allocation that is efficient but not fair. Give an example of an allocation that is fair but not efficient. Which question are you answering, (1) or (2)? _________. Please write your answer below. [end of exam]
