APPLIED ECONOMIC

BEEB 2033
GROUP ASSIGNMENT 2
Group B

Prepared by: Mohammad Fauzan Bin Azhar (238473)

Nur Athikah Binti Anuar (248262)
Prepared for : Madam Munzarina Bt Ahmad Samidi

QUESTION 1

1. There is one art museum on the island of Watsonia. The museum's demand and cost
curves are shown in the graph below. The museum currently relies on an admission charge
for some of its funding. Its directors are debating about how to set the admission charge.
a) Using the labelling of the graph above, identify the price and quantity associated
with the following objectives.
i.
The museum maximizes its profit.
ii.
The museum maximizes its total revenue.
iii.
The museum maximizes the sum of consumer and producer surplus.
iv. The museum maximizes its attendance, as long as it breaks even.
b) When the attendance is Q1, is the demand price elastic, inelastic, or unit elastic?
Explain
c) Assume that the price is set at P2. Assuming the existence of an opportunity
cost, indicate whether the museum's accounting profits would be positive, negative, or zero.
Explain why.
d) Assume that the government decides the museum should charge no admission
and agrees to subsidize the museum for any losses.
i.

Using the labelling in the graph, identify the museums attendance under that

ii.

circumstance.
Would the outcome be allocatively efficient? Explain.

ANSWERS :
1 a)

i) P5, Q2
ii) P3, Q4
iii) P4, Q3 (MC = D)
iv ) P2, Q5 (ATC = D)

b) Elastic. At Q1 MR>0or Q1 is less than the Revenue Maximizing attendance of Q4.

c) Positive. At P2, attendance would be Q5 and P = ATC, so economic costs are zero. With
the existence of an opportunity cost, accounting profits must be positive, because economic
profits = accounting profits minus opportunity costs.
d) i) Q7
ii) No. Price < Marginal cost

QUESTION 2

Assume that Clark Electronic has a monopoly in the production and sale of new device for
detecting and destroying a computer virus. Clark Electronics currently incurs short run losses,
but it continues to operate.
a) What must be true for Clark to continue to operate in the short run?
b) Draw a correctly labelled graph, and show each of the following for Clark.
i.
The profit maximizing price and output
ii.
Area of loss
c) Assume Clark is maximizing profit. What will happen to its total revenue if Clark
raises it price? Explain.
d) If demand for the new devices increases, explain what will happen to each of the
following in the short run.
i.
ii.

Profit maximizing output

Total cost

ANSWERS :
a) If the firms average variable cost are less than its marginal revenue at the profit
maximizing level of output , the firm will not shut down in the short-run. The firm is
better off continuing its operation because it can cover its variable costs and use any
remaining revenue to pay off some of its fixed costs. The fact that the firm can pay its
variable costs is all that matter because in the short-run, the firms fixed costs are
sunk, the firm must pay its fixed costs regardless of whether or not it decided to shut
down.

b)

c) If the firm raise its price, the firm total revenue would go to zero because, in a PCM,
Firms demand curve are perfectly elastic and therefore an increse in price would cause the
firm to sell nothing.
d) i)

QUESTION 3

(a) Draw a correctly labelled graph showing a typical monopoly that is maximizing
profit and indicate each of the following
(i) Price
(ii) Quantity of output
(iii)Profit
(b) Describe and explain the relationship between the monopolist's demand curve and
marginal revenue curve.
(c) Label each of the following on your graph in part (a):
(i) Consumer surplus
(ii) Deadweight loss

ANSWERS :

a)

Profits

b) For monopolist, both marginal revenue and demand are downward- slopping
curves marginal revenue will always be less than demand for a given quantity. This is
due to monopolist demand curve, is the same as its average revenue curve and for a
monopolist, either marginal revenue will decrease or quantity increase.
c) i) ii) Refer the answer a.

QUESTION 4

1. Market structures differ from one another in many respects. Consider two profitmaximizing firms that earn short-run economic profits. One is a perfectly competitive firm
and the other is a monopoly.
(a) For each firm, draw a correctly labelled graph showing the following:
i.
ii.
iii.

Price
Quantity of output
Area of economic profits

(b) For each firm, explain the relationship between price and marginal revenue.
(c) For each firm, explain how economic profits would most likely change in the long run.
(d) Label the area that represents the deadweight loss on the graph for the monopoly firm
drawn in (a). Explain what deadweight loss represents.
ANSWERS :
a)

Perfectly Competitive firm: Correct labels, horizontal D=P=MR curve, upward sloping
swoosh MC curve intersecting both D=P=MR line above u-shaped ATC curve at its
minimum; Q where MR=MC; economic profits shaded as Q * (P ATC).

Monopoly: Correct labels, downward sloping D curve, MR curve below D curve with
steeper slope; upward sloping swoosh MC curve; Q where MR=MC, P following vertical Q
line to its intersection with D curve; profits in the area Q * (P ATC).
b) For a perfectly competitive firm, marginal revenue is equal to price (P = MR) because it is
a price taker. It can sell as much of the good as it wants at the market price, so it does not
have to lower price to sell additional output. For a monopoly, marginal revenue is less than
price because the firm must lower price to sell additional output, but it must lower price on all
units, not just the additional unit in order to sell an additional unit, so it loses revenue on units
at had been selling at the old price. This means that marginal revenue will be less than price
for the monopoly and price lies along the demand curve, which is always above MR.

c) If a Perfectly Competitive firm earns economic profits in the short run, new competitors
enter the industry, increasing industry supply, reducing prices and eliminating economic
profits. Monopolies have barriers to entry so, absent government regulation, economic
profits can exist in the long run.

d)

Deadweight loss represents the consumer surplus and producer surplus lost due to the
monopoly producing less than the efficient quantity (where P = MC).