Download Fall 2010, Econ 002, Section 001 Study Guide for the Final The final

Fall 2010,
Econ 002, Section 001
Study Guide for the Final
1. The final is comprehensive. Most weight (16 points out of 40) will be put on material covered
after exam 2 (units 9,10,11,12).
2. You will have 45 minutes for Part 1 and 2 hours for Part 2.
3. Make sure that you go over all homework answer keys and compare them with your
submissions. Spot the points you got wrong. If you feel that you do not understand the right
answer, consult your instructor for clarification.
4. Study the practice questions posted.
5. Make sure you know how to solve the following types of questions. Note that these are not the
only questions that can come up but they cover the basic concepts thought in this class.
i.
Given demand curve and marginal cost, find the profit maximizing price and
quantity for a monopolist, as well as the profit level.
ii.
Finding the price a monopolist would charge using a diagram of demand,
marginal revenue and marginal cost.
iii.
Calculating the deadweight loss created by a monopolist and by an excise tax
iv.
Finding comparative advantage using the production levels of two countries for
two goods.
v.
Given supply and demand curves, find equilibrium price and quantity.
vi.
Identify whether dominant strategies exist in payoff matrix of a simultaneous
game.
vii.
Finding max-min strategies in a payoff matrix.
viii.
Transforming a simultaneous game to a sequential game by drawing and
labeling a game tree.
ix.
Identify efficient, inefficient, feasible and infeasible points in a diagram of the
PPF.
x.
Calculate the HHI given information on market shares of firms in an industry.
xi.
Calculate price elasticity of demand using two points on the demand curve.
6. Here are some typical questions from past quizzes and their answers.

given a level of marginal cost and a demand curve, how to find the quantity produced by
a competitive curve: we know that P=MC for a competitive firm, use this in the demand
curve, P = a – b*Q => insert P, solve for Q.

characteristics of a perfectly competitive market: There are many firms, each too small
to influence the market price. Firms produce identical (homogeneous) products.
Households have perfect information about qualities and prices in the market. Firms
have perfect information about technologies and input costs. There are no barriers to
entry.

the concept of being a ‘price taker’: the firm's demand curve is horizontal at the
competitive price, the firm sees a price in the market that it cannot affect. If the firm
charges a price slightly above that market price, it will not sell any product.

identifying the graph of a demand curve faced by a price taker: in the figure below, this
is depicted by graph 2. The demand faced by this firm is perfectly elastic.

the market demand curve in a perfectly competitive industry is downward sloping: note
the difference between the demand curve faced by a firm vs. the market demand curve
under perfect competition. The latter is downward sloping, the former is flat.

A perfectly competitive firm produce a positive quantity if at the market price, marginal
cost curve is above the average variable cost curve. For instance, in the graph below, if
P=4, a competitive firm produces 8 units (although MC < ATC. Note that ATC matters for
the long-run. In the short-run, the firm will produce as long as P=MC > AVC). If P=1, it
does not produce since P=MC < AVC there.

In the figure below, the left hand side graph represents a perfectly competitive industry
and the right hand side graph represents a perfectly competitive firm. Note that at the
equilibrium price (P=5), the firm is making zero economic profits (because P=ATC).

Reading marginal revenue from price & quantity table. Suppose a monopolist faces the
following demand curve: What is the marginal revenue of the 5th unit of output?
Price
Quanity
$90
0
$80
1
$70
2
$60
3
$50
4
$40
5
$30
6
$20
7
In this question, first find total revenues for the 4th and 5th units: for 4 units, total
revenue is $50*4 = $200. For 5 units, it is $40*5 = $200. For both 4 and 5 units, the firms
earns $200. So, the 5th unit does not bring in additional revenue, its marginal revenue is
zero!

The concept of Pareto efficiency: If in a situation, some economic agent can be made
better off without making any other economic agent worse off, that situation is NOT
Pareto efficient. Consider splitting $100 between two people. Any division that does not
leave any money in the table is Pareto efficient (why?). Any division where there is
money left on the table, is NOT Pareto efficient.

Marginal revenue product of labor (MRPL) is the additional revenue contributed by the
last worker employed. As more and more labor is added, MRPL falls (because of
diminishing returns) The firm hires labor until MRPL = wage.

Reading marginal product, marginal revenue product, and marginal profit from a table:

Effects of an increase in labor supply: An increase in labor supply will result in lower
wages, more people will be hired.

In the input markets, a perfectly competitive firm using multiple inputs maximizes profit
by hiring inputs until the marginal product per dollar is the same for all inputs. Then all
inputs contribute the same at the margin. If this was not correct (one input generates
more revenue at the margin) the firm could increase profits by using more of that input,
and less of some other inputs.

An example for the above: You own a bagel shop that uses capital and labor in its
production process. You recently realized that your marginal product per dollar
for capital is larger than your marginal product per dollar for labor. What should
you do to increase profit?
A.
B.
C.
D.
You should increase the amount of capital you are using
You should increase the amount of labor you are using
You are already maximizing profit so you should not make any changes
You should hire more capital and more labor to increase profit
The right answer is (A). You are using too little capital compared to labor. Because of
diminishing marginal returns, as you use more of an input, its marginal product revenue
decreases. If you realize that the MRP of an input X is below the MRP of another input Y,
this only happens because you have not used enough of input X.

Another similar question: Your bagel shop uses both capital and labor in the
production of bagels. In this production process capital and labor are substitutes.
If you install a new oven and the marginal product of capital (MPK) increases,
you will
A.
B.
C.
D.
reduce the number of workers you employ
increase the number of workers you employ
reduce the amount of capital you are using
not make any changes since you are already maximizing profit
You will reduce the number of workers. This way MPL will increase (more labor reduces
MPL, less labor increases MPL). You will fire workers until the value of MPL equals the
value of MPK.

The difference between accounting and economic profits: you can have positive
accounting profit and zero economic profit at the same time. The first one is simply
revenue minus direct expenses. The latter takes into account the opportunities you
could have exploited with your time and capital.

Price elasticity of demand: when you look at the demand curve at (P,Q) graph, elasticity
is about the slope of the line. If it is steep, it is inelastic. If it is flat, it is elastic
(remember, horizontal line is perfectly or infinitely elastic). In the below figure, (A) is the
least elastic, and (C) is the most elastic demand curve:

Compared to a perfectly competitive firm, the demand curve facing a
monopolistically competitive firm is
A.
B.
C.
D.
is more elastic.
less elastic.
perfectly elastic.
perfectly inelastic.
The correct answer is B. For a competitive firm, demand is infinitely elastic.

In a monopolistically competitive industry, in long run equilibrium
A.firms produce at minimum average total cost and make zero economic profit.
B.firms produce at minimum average total cost and make positive economic profit.
C.firms produce at greater than minimum average total cost and make positive
economic profit.
D.firms produce at greater than minimum average total cost and make zero economic
profit.
Correct answer is D. In the long run, the monopolistically competitive firm
produces at a level where demand curve is tangent to the ATC curve. At that
point, price is greater than minimum average total cost. Entry eliminates
economic profits.

For a monopolistically competitive firm,
A. price is equal to marginal revenue.
B. price is greater than marginal revenue.
C. price is less than marginal revenue.
D. price can be greater than or less than marginal revenue.
Correct answer is B. Note that this does NOT mean that MR is not equal to MC. This
condition still holds. However, price is greater than MC.

In long run equilibrium, a monopolistically competitive firm will produce a
quantity
A.
B.
C.
D.
where average total cost is at a minimum.
that is less than the quantity where average total cost is at a minimum.
that is more than the quantity where average total cost is at a minimum.
where marginal cost intersects average total cost.
Correct answer is B.

Suppose a monopolistically competitive firm in the short run is selling 100 units
of output at $10 each. At that level of output, MR = MC and marginal cost is
rising. Also, ATC = $15, AVC = $12 and AFC = $3. This firm should
A. continue to produce 100 units of output since MR = MC.
B. increase output to the point where price equals marginal cost.
C. decrease output to the point where marginal cost equals average total
cost.
D. shut down and produce 0 units of output.
Correct answer is B. Since MC is increasing, and price is already less than ATC, if the firm
increases production, MR will fall short of MC and the firm will make negative profits.