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We
can
solve
this
for
E2
as
E2=4.
Plugging
into
the
marginal
benefit
curve
for
E2
yields
that
MB2=MB1=tax=2.
Question
3
A
competitive
firm
is
facing
a
price
of
P=10.
The
firm
has
two
factories
to
produce
the
same
output
with
the
following
marginal
cost
functions:
Factory
1:
MC1=2Q1
Factory
2:
MC2=1+Q2
How
much
output
is
the
firm
going
to
produce
if
it
maximizes
profits
as
a
price
taker?
a. 5
b. 6
c. 9
d. 10
e. 14
Solution:
e)
Remarks:
In
either
factory
price
has
to
be
equal
to
marginal
cost.
Hence
10 = 2! ! = 5
10 = 1 + ! ! = 9
Consequently,
total
output
is
Q=14.
Question
4
A
monopolist
has
set
her
level
of
output
to
maximise
profit.
The
firm's
marginal
cost
is
20,
and
the
price
elasticity
of
demand
is
-5.0.
The
firm's
profit
maximising
price
is
approximately:
a)
0
b)
25
c)
40
d)
10
e)
there
is
not
enough
information
to
answer
this
question
Solution:
b)
Use
the
markup
pricing
formula
Question
5
A
competitive
market
is
characterised
by
the
demand
function
P=450-0.5Q
and
the
supply
function
P=2Q.
Production
of
good
Q
leads
to
pollution
costs
(PC)
of
the
form
= 10 .
What
is
the
socially
efficient
total
amount
of
Q?
a.
b.
c.
d.
e.
176
50
100
60
450
Solution:
a)
We
have
to
add
the
marginal
costs
of
pollution
to
the
supply
function.
If
total
pollution
costs
are
PC=10Q
then
marginal
costs
are
10.
Hence
the
socially
optimal
amount
of
output
is
determined
by
10+2Q=450-0.5Q
Solving
for
Q
yields
Q=(450-10)/2.5=176
Question
6
The
orange
juice
industry
is
perfectly
competitive.
Each
producer
has
the
long-
run
total
cost
function
= 31 6! + ! /3
where
q
is
the
output
of
an
individual
producer.
The
market
demand
curve
for
orange
juice
is
= 3100
100.
What
will
be
the
output
of
an
individual
producer
in
the
long
run
competitive
equilibrium?
a. 9
b. 4
c. 3
d. 2
e. 1
Solution:
a)
We
know
that
in
the
long
run
equilibrium
MC=AC;
i.e.
in
this
case
!
31 12 + ! = 31 6 +
3
which
we
can
re-write
as
12 + = 6 +
3
and
easily
solve
for
q
as
q=9
Question
7
Suppose
a
monopoly
is
serving
a
market
with
the
demand
curve
P=100-Q
Also
assume
that
production
costs
are
0.
What
is
the
elasticity
of
demand
in
the
market
equilibrium?
a. 0
b. -0.5
c. -1
d. -2
e. -4
Solution:
c.
Note
that
a
monopoly
will
always
produce
in
a
point
where
the
elasticity
is
smaller
than
-1.
This
is
because
of
what
we
discussed
in
the
first
lecture:
if
demand
is
inelastic
(i.e.
between
-1
and
0)
a
firm
can
increase
its
revenue
by
increasing
prices.
Moreover,
because
they
sell
less
their
costs
go
down
too
when
reducing
output
so
profits
must
increase.
Hence,
as
a
consequence
the
monopolist
would
increase
price
until
the
elasticity
turns
elastic
(note
that
for
instance
with
the
linear
demand
curve
the
elasticity
goes
to
infinity
if
you
increase
the
price
high
enough.)
Of
course
you
might
have
a
demand
function
whose
elasticity
never
turns
elastic.
That
would
in
principle
imply
that
the
monopolist
would
sell
a
very
small
amount
(0
in
the
limit)
for
an
infinitely
high
price.
However,
this
is
not
something
we
see
in
actual
markets
(although
some
prices
particular
house
prices
in
London
might
seem
virtually
equal
to
infinity
to
many
of
us)
so
those
kind
of
demand
functions
are
not
very
realistic
(at
least
for
a
monopoly,
take
into
account
that
this
would
mean
that
profits
would
be
infite
as
well.
But
if
profits
are
infinite
its
likely
that
other
firms
will
enter
the
market
and
so
we
dont
have
a
monopoly
any
more).
Question
8
Which
of
the
following
is
a
correct
definition
of
the
concept
of
market
failure?
a. A
situation
where
no
sales
are
undertaken
on
a
market
b. When
there
is
excess
demand;
i.e.
not
all
buyers
will
be
served
by
the
sellers
in
the
market
c. When
there
is
excess
supply;
i.e.
not
sellers
can
find
customers
for
their
goods.
d. A
situation
where
no
market
equilibrium
can
be
reached
e. When
the
market
equilibrium
is
inefficient.
Solution:
e)
Question
9
Suppose
a
market
is
characterised
by
the
following
demand
and
supply
curves:
P=100-QD
P=100+QS
c. 3
d. 4
e. 5
Question
10
The
demand
curve
for
a
product
is
given
by:
P
=
28
-
0.005Q
The
supply
curve
of
the
product
is
given
by:
P
=
10
+
0.004Q
What
is
the
price
elasticity
of
demand
in
the
market
equilibrium?
a.
1
b.
-0.5
c.
-1
d.
-1.8
e.
-2
Solution:
d)
Remarks:
We
first
have
to
figure
out
the
market
equilibrium
by
equating
supply
and
demand:
28 0.005 = 10 + 0.004
18 = 0.009 = 2000 = 18
Note
that
the
demand
function
(inverse
of
the
inverse)
is
= 5600 200
Hence,
using
the
elasticity
formula
we
find
18
=
= 200
= 1.8
2000
Question
11
Antigone
is
a
producer
in
a
monopoly
industry.
Her
demand
curve,
and
total
cost
curve
are
given
as
follows:
P=160-4Q
TC=4Q
If
she
is
to
maximize
profit,
how
much
profit
will
she
make?
a.
72
b.
22
c.
1521
d.
1296
e.
1300
Solution:
c)
Remarks:
We
can
use
MR=MC;
i.e.
160-8Q=4
so
that
Q=19.5
and
P=82
Hence
profits
become
(82-4)x19.5=1521
Question
12
Tony
and
Jim
are
two
consumers
that
have
arranged
their
consumption
for
two
periods
in
an
optimal
way.
Tony
consumes
more
than
his
income
today
and
compensates
by
consuming
less
of
his
income
tomorrow.
For
Jim
it
is
the
other
way
round.
Unexpectedly
the
interest
rate
declines
compared
to
the
rate
they
used
for
their
calculations.
Which
of
the
following
statements
is
correct?
a. Both
are
worse
off
b. Tony
is
better
off
and
Jim
is
worse
off
c. Jim
is
better
off
and
Tony
is
worse
off
d. They
are
both
better
off.
e. Tony
is
worse
off
and
Jim
might
be
better
or
worse
off
Solution:
b)
Remarks:
Tony
is
a
borrower
and
Jim
a
saver.
So
when
the
interest
rate
drops
that
is
good
for
Tony
but
bad
for
Jim.