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Question 4 (10%)
In a monopolistically competitive market, a firm has market power because it produces a
differentiated product. This means that the firm earns positive economic profits in the long-run.
Please use an appropriate diagram to further illustrate your answer (required).
Question 5 (10%)
In a recent publication displayed on a famous news website a journalist argued that in 2000 an
average 401k account earned a negative rate of return. Assuming that the typical 401k account
earned minus 5% would you as an economist agree with the journalist who argued that the loss to
the typical account holder was 5% of the amount kept in the account.
Question 1 (5%)
Recently there have been rumors of a possible recession. In order for you to find out more about
whether you might lose your job or not if recession comes, which elasticity of demand parameter
would you look at and why?
Question 2 (5%)
Explain why a profit-maximizing monopolist would not choose to operate in the inelastic portion
of the demand curve.
Question I
Who do you think pays corporate income tax, explain your answer in terms of demand supply
frameworks.
Question II
What determines the market value? Why do doctors get paid more than MBA graduates, and
economists ‘don’t get hired at all’?
Question III
What do you think will happen to the production process if due to government regulations the
wage rate in the economy increases? Contrast between short-run and long-run, and between fixed
proportions and variable proportions functions. What will the impact on average and marginal
productivity of labor and capital be? For simplicity assume that there is only one homogeneous
capital and only one homogeneous type of labor.
Question IV
How long is the short-run framework? (as defined in economics)
Question V
What do you think is the shape of the MC curve (function) for Microsoft corporation in the
production of Windows 2000, should we expect it to be different from the Marginal cost of GM
corporation, or MC of GSU (MC to GSU is the cost for providing training to additional student)?
What do your answers imply about the average variable costs in each of these cases?
Problem 1 (18%, each subpart is 3%)
Imagine that you are a consultant with a degree in economics. You are asked to analyze the
following situation and make your recommendations as to how the firm should attempt to
maximize its’ profits. The firm is selling its’ output in two geographically different markets
(Atlanta GA, Birmingham AL). The firm has only one production facility, which is located in
Atlanta and has a fixed cost of $10,000/month (this includes their utility bills, maintenance costs
associated with the building, county and state fees and other fixed expanses). This firm hires
labor for $10/hr, and each worker produces 2 units of output in an hour. This productivity of labor
stays constant independent of the level of output. For simplicity you can assume that there are no
shipping costs associated with transporting the output to Birmingham. After an extensive and
long econometric research you were able to estimate the following demand curves and marginal
revenue curves for each market:
Atlanta:
demand:
Q = 10000 – 2000 P + 3000 Pc + 0.1 IA
where Pc is the price of our local competitor (presently set at $8/unit), IA is the average
income level in the area, which presently is at $60,000.
marginal revenue:
MR = 20 – Q/1000
Birmingham:
demand:
Q = 14000-3000 P +0.15 IB
Note that in this market the firm has no competition at present. IB represents the average
income level in this area and it is $40,000
marginal revenue:
MR = 6.667 – (2Q)/3000
a)
b)
c)
d)
e)
What is the profit maximizing level of output, how many units should be sold in each
market and at what prices?
If the economy of Alabama enters into a recession and the average income level in
that area drops to $35,000, what will the answer to part (a) be in that case? Note that
in the new MR function for Birmingham is MR= 6.42- Q/1500
If our competitor in Atlanta increases their price to $10/unit, what price should we
charge in Atlanta then? Note that the new marginal revenue function for the Atlanta
market in this case is MR = 23 – Q/1000
What are the values of the marginal product of labor?
Is this firm engaged in dumping in any of the two markets?
Problem 2
Assume that the demand function has the following form:
Q = 100,000 - 500 P + 100 Pc – 0.1 I
Where I stands for the average income in the geographical market area and Pc is the price
charged by the firm’s competitor. If we assume that I = 100,000, and Pc = 100, then the marginal
revenue can be given by the following expression:
MR = 200 – Q/250
Assume that marginal cost is constant regardless of the level of output and is equal to 50. Also
assume that there are fixed costs of 10,000.
a)
If the goal is sales revenue maximization, what level of output should be produces
and what price should be charged?
b)
If the goal is to maximize profits, what level of output should be produced and what
price should be charged?
c)
What is the point elasticity of demand at the profit maximizing level of output?
d)
What is the cross-price elasticity of demand?
e)
Would a recession adversely affect this firm? Why or why not?
Problem 3
Demand is represented by the following expression:
Q = 1000 – 10 P
Supply is represented by:
Q = 20 P – 200
a)
What is the market equilibrium (price and quantity)?
b)
If a sales tax of 10 per unit is introduced, what is the equilibrium then?
c)
If a sales tax of 10% is introduced, what is the equilibrium then?
Problem 4
Assume that the demand function is given by the following equation:
Q  15000  5P  2P  3P  0.001I
x
x
y
z
Also assume that currently I=20000, the price of Y is 150 and the price of Z is 100.
a)
b)
Which of the goods Y and Z is(are) complement(s) to X?
What is the revenue-maximizing price?
Problem 5
Assume that the supply function is given by the following equation:
Q x  5Px  Py  Pz  500
a)
Which of the goods y and z is (are) complements in production to x?
Possible Solution to Problem 1
Selling in multiple markets / producing using more than one plant
Qa = 40000 – 2000 Pa
MRa = 20 –Qa / 1000
Qb = 20000 – 3000 Pb
MRb = 20/3 – Qb / 1500
MC = 5
First, at what level of output does the firm enter the B market?
MRb (0) = MRa (Q*)
20/3 = 20 – Q*/1000
-> Q* = 13333.3(3)
Horizontal summation of MR functions:
Rewrite each of MR functions in the form of Q = f( MR)
Qa = 20000 – 1000 MRa
Qb = 10000 – 1500 MRb
A profit maximizing firm would choose to produce at the point where MR a = MRb = MR
Total output produced (horizontal summation) is:
Q = Qa + Qb = 20000 – 1000 MR + 10000 – 1500 MR = 30000 –2500 MR =>
=>
MR = 12 – Q / 2500,
profit maximization also requires that MR of the firm be equal to MC,
hence:
12 – Q / 2500 = 5 =>
Q = 17500
thus MR = MC = MRa = MRb
Qa = 20000 – 1000 * 5 =15000
Qb = 10000 – 1500 * 5 = 2500
Simillar approach is used when multi-plant production takes place. Assume that we have two plants with
different marginal cost curves:
MCa = 15 + Q /1000
and
MCb = 10 + Q / 100
Assume that the demand is given by: Q = 100000 – 1000 P, and MR = 100 – Q / 500
First, at which level of output does the plant with higher starting marginal cost start to operate?
= 10 + Q* / 100 => Q* = 500, since MCa (0) = 15
Horizontal summation:
Rewrite each MC function for Q:
Qa = 1000 MCa – 15000
Qb = 100 MCb – 1000
Again, note that profit maximization requires that MCa = MCb = MC. Thus:
Q = Qa + Qb = 1000 MC – 15000 + 100 MC – 1000 = 1100 MC – 16000
Profit maximization also requires that MC = MR => MC = (Q – 16000) / 1100 = 100 – Q/500
Q = 29375
MR = 41.25 = MC
MCa (0)