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					Principles of Microeconomics (Econ 002)             Signature:
Drake University, Spring 2009
William M. Boal                                 Printed name:

                                 MIDTERM EXAMINATION #4 VERSION A
                                    “Perfect and Imperfect Competition”
                                                May 5, 2009

INSTRUCTIONS: This exam is closed-book, closed-notes. Simple calculators are permitted, but graphing calculators or
calculators with alphabetical keyboards are NOT permitted. Numerical answers, if rounded, must be correct to at least 3
significant digits, but fractions are always acceptable answers. Point values for each question are noted in brackets.
Maximum total points are 100.


I. MULTIPLE CHOICE: Circle the one best answer to each question. [1 pt each, 8 pts total]

(1) In a perfectly-competitive industry, firms' economic         (5) A "natural monopoly" is a firm that enjoys
profits are driven down to zero in the long run because          a. a downward-sloping average cost curve.
a. costs eventually rise because of inflation.                   b. patent protection.
b. firms enter the industry seeking profit, but                  c. an exclusive government franchise allowing it alone
     unintentionally shift short-run supply to the right.             to sell the product.
c. taxes automatically rise to soak up any profits.              d. exclusive ownership of a natural resource essential
d. demand eventually shifts left, lowering the                        for producing the product.
     equilibrium price.
e. entering firms deliberately try to drive prices down.         (6) Suppose a coffee stand sells 20 lattes per hour if the
                                                                 price is $3, and sells 21 lattes if the price is lowered to
(2) If firms' costs are not affected by the size of the          $2.95. The vendor's marginal revenue of the 21st latte is
industry or the number of firms in the industry, then the        therefore
long-run supply curve                                            a. $0.05.
a. is horizontal.                                                b. $0.95.
b. slopes down.                                                  c. $1.00.
c. slopes up.                                                    d. $1.45.
d. is shaped like a U.                                           e. $1.95.
e. is shaped like an inverted U.                                 f. $2.95.
                                                                 g. $3.00.
(3) Efficiency in consumption requires that all consumers
a. choose identical combinations, or bundles, of goods.          (7) After a cartel agreement is reached, each cartel
b. have the same budget lines.                                   member has an incentive to cheat by
c. have equal marginal rates of substitution.                    a. producing less than its quota of output.
d. have equal incomes.                                           b. raising its price higher than the cartel's agreed price.
e. All of the above.                                             c. shutting down all production.
                                                                 d. producing more than its quota of output.
(4) Suppose the price of a computer is $500 and the price
of a microwave oven is $100. If the economy is perfectly         (8) The Cournot model of oligopoly predicts that the
competitive, then these prices indicate that the economy's       fewer firms there are in the industry, the
opportunity cost of a computer is                                a. higher the equilibrium price.
a. 1/5 of a microwave oven.                                      b. closer the equilibrium price is to marginal cost.
b. 1 microwave oven.                                             c. lower the market demand curve.
c. 5 microwave ovens.                                            d. lower the total profits of all firms.
d. 100 microwave ovens.
e. 500 microwave ovens.
Principles of Microeconomics (Econ 002)                                                       Midterm Examination #4 Version A
Drake University, Spring 2009                                                                                      Page 2 of 7

II. PROBLEMS: Insert your answer to each question in the box provided. Feel free to use the margins and graphs for
scratch workonly the answers in the boxes will be graded. Work carefullypartial credit is not normally given for
questions in this section.


(1) [Long-run competitive equilibrium: 24 pts] The graph below shows the market for eucalyptus-scented soap, which is
competitive. Assume all producers and potential producers have the same costs as each other.

            $12
            $11
            $10
             $9
             $8                                                                                           Old demand
             $7
                                                                                                          New demand
    Price




             $6
                                                                                                          Short-run supply
             $5
             $4                                                                                           Long-run supply
             $3
             $2
             $1
             $0
                  0   1   2   3   4   5   6    7   8   9 10 11 12 13 14 15 16 17 18

                                           Quantity (thousands)


Initially the market is in long-run equilibrium, with the demand curve given by ―old demand‖ and the short-run supply curve
given by ―short-run supply‖ as shown in the graph.
a. What is the initial equilibrium price?                                                 $
b. What is the initial equilibrium quantity?                                                                      thousand
c. What is the average cost of production for firms in this industry?                          $
Suddenly, eucalyptus-scented soap becomes popular, and the demand shifts right to ―new demand.‖ Consider the short-run
market response to this demand shift.
d. What is the new equilibrium price in the short run?                                 $
e. What is the new equilibrium quantity in the short run?                                                         thousand
f. Are producers making economic profits, losses, or just breaking even?

Now, consider the long-run market response to this demand shift.
g. Given your answer to (f) above, will existing firms try to exit the industry or will new
   firms try to enter the industry?
h. What is the new equilibrium price in the long run?                                          $
i. What is the new equilibrium quantity in the long run?                                                          thousand
j. What is the new long-run average cost of production for firms in this industry?             $
k. Has the number of firms in this industry increased, decreased, or remained constant?
l. Should this industry be called a constant-cost industry, an increasing-cost industry, or
   a decreasing-cost industry?
Principles of Microeconomics (Econ 002)                                                         Midterm Examination #4 Version A
Drake University, Spring 2009                                                                                        Page 3 of 7

(2) [Economy-wide efficiency: 12 pts] Suppose there are two firms in the industry producing thumb drives, with the
marginal cost curves shown in the graph below.

                                   $15
  Marginal cost and average cost




                                   $14
                                   $13
                                   $12
                                   $11
                                   $10                                                                Marginal cost for Firm A
                                    $9
                                    $8                                                                Average cost for firm A
                                    $7                                                                Marginal cost for Firm B
                                    $6
                                                                                                      Average cost for firm B
                                    $5
                                    $4
                                    $3
                                    $2
                                    $1
                                    $0
                                         0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

                                                         Quantity (millions)

a. Suppose Firm A is currently producing 10 million thumb drives. If Firm A                       $
  increases production by one unit, by how much will its total costs increase? (Give an
  answer to the nearest whole dollar.)
b. Suppose Firm B is currently producing 10 million thumb drives. If Firm B                       $
  increases production by one unit, by how much will its total costs increase? (Give an
  answer to the nearest whole dollar.)

First assume the firms' output levels must be set by a government planner. The planner wants the firms to produce a total of
20 million thumb drives, but total industry cost (that is, the combined costs for both firms) must be as low as possible.
 c. Which firm should be instructed to produce more output—Firm A or Firm B, or
   should they produce an equal amount of output to make total industry cost as low as
   possible?
 d. How much output should Firm A produce?                                                                           million
e. How much output should Firm B produce?                                                                               million
Alternatively assume there is no government planner. Assume instead that the two firms are competitive and that they each
maximize their own profit taking price as given.
 f. What price for thumb drives will motivate the two firms to produce a total of 20     $
    million thumb drives at lowest total industry cost?
Principles of Microeconomics (Econ 002)                                                    Midterm Examination #4 Version A
Drake University, Spring 2009                                                                                   Page 4 of 7

(3) [Economy-wide efficiency, PP curves: 10 pts] The graph below shows the production possibility (PP) curve for an
economy. Suppose the economy is at point A and the slope of the PP curve at that point is -3 .




                                                                 A



                                      Other goods




                                                                              Energy


a. Starting from point A, if this economy were to produce 60 more units of energy, it                             units of
   would have to reduce production of other goods. By how many units?                                         other goods
b. Starting from point A, if this economy were to produce 60 more units of other goods,                           units of
   it would have to reduce production of energy. By how many units?                                                energy

Assume all markets are in competitive equilibrium.
c. What is the slope of every consumer's budget line, with energy on the horizontal axis
   and other goods on the vertical axis? (Give a number.)
d. What must be the marginal rate of substitution of energy for other goods for every
   consumer in this economy? (The marginal rate of substitution equals the |slope| of
   the consumer's indifference curve at the chosen bundle, with energy on the horizontal
   axis and other goods on the vertical axis.)
e. If the price of other goods is $2 in this economy, what must be the price of energy?     $
   [Hint: the |slope| of the consumer's budget line, with energy on the horizontal axis
   and other goods on the vertical axis, equals the price of energy divided by the price
   of other goods.]
Principles of Microeconomics (Econ 002)                                              Midterm Examination #4 Version A
Drake University, Spring 2009                                                                             Page 5 of 7

(4) [Monopoly, perfect price discrimination: 22 pts] Suppose Acme Pharmaceutical Company has a patent for a particular
pharmaceutical drug. Its demand, marginal revenue, and marginal cost curves are shown below. Assume for simplicity that
marginal cost equals average cost.
   $12
                                                                                             Demand
   $11
   $10
                                                                                             Marginal revenue
    $9
    $8                                                                                       Marginal cost and
    $7                                                                                       average cost
    $6
    $5
    $4
    $3
    $2
    $1
    $0
         0   1    2   3     4   5   6   7   8    9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
                                                   Quantity (millions)

First, assume Acme must charge the same price to all its customers.
 a. Suppose Acme were producing 6 million units of the drug, for some unknown            $
   reason. If Acme produced one more unit, by how much would its total cost increase?
   That is, what would be the change in total cost as Acme increased output from
   6,000,000 to 6,000,001 units? (Give an answer to the nearest whole dollar.)
 b. Again suppose Acme were producing 6 million units. If Acme produced one more         $
   unit, by how much would its total revenue increase? That is, what would be the
   change in total revenue as Acme increased output from 6,000,000 to 6,000,001 units?
   (Give an answer to the nearest whole dollar.)
 c. What quantity should Acme produce to maximize profits?                                                   million
d. What price should Acme charge?                                                        $
e. Compute Acme's profit.                                                                $                   million
f. Compute the deadweight loss from single-price monopoly.                               $                   million
Now assume that Acme can charge a different price to each customer, based on what that customer is willing to pay. In
other words, the monopolist can engage in perfect price discrimination.
 g. What is the highest price Acme will charge any customer? (Give an answer to the     $
    nearest whole dollar.)
 h. What is the lowest price Acme will charge any customer? (Give an answer to the      $
    nearest whole dollar.)
 i. What quantity will Acme produce to maximize profit?                                                         million
j. Compute Acme's profit.                                                                $                   million
k. Compute the deadweight loss from monopoly with perfect price discrimination.          $                   million
Principles of Microeconomics (Econ 002)                                                   Midterm Examination #4 Version A
Drake University, Spring 2009                                                                                  Page 6 of 7

(5) [Monopoly price discrimination: 8 pts] Suppose an opera company believes that the elasticity of demand for tickets by
students is –11, and the elasticity of demand by the general public is –1.5 .
 a. If the price is decreased by 2%, what will be the approximate increase in the number                                %
   of tickets sold to students?
 b. If the price is decreased by 2%, what will be the approximate increase in the number                                %
   of tickets sold to the general public?

Assume this opera company has a marginal cost of $20 per seat.
 c. Compute the opera's profit-maximizing ticket price for students.                         $
d. Compute the opera's profit-maximizing ticket price for the general public.                $

(6) [Competition versus collusion: 12 pts] Suppose a group of firms produce an electronic part. The graph below shows the
demand curve for the part, and the joint marginal cost or supply curve of the four firms.
          $16
          $15                                                                                    Joint marginal cost
          $14                                                                                    or supply
          $13
          $12                                                                                    Demand
          $11
          $10
           $9
  Price




           $8
           $7
           $6
           $5
           $4
           $3
           $2
           $1
           $0
                0 1 2       3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
                                                      Quantity (thousands)

First, assume the firms compete with each other, each maximizing its own profit while taking the market price as given.
 a. What will be the equilibrium market quantity?                                                              thousand
b. What will be the equilibrium market price?                                                $
Now assume the firms collude with each other, setting price jointly as a cartel to maximize the sum of their profits.
 c. Using a straightedge, draw and label the colluding firms' marginal revenue curve.

d. What total quantity will the firms produce?                                                                    thousand
e. What price will the firms jointly set?                                                    $
f. Compute the deadweight loss from collusion.                                               $                   thousand
Principles of Microeconomics (Econ 002)                                                Midterm Examination #4 Version A
Drake University, Spring 2009                                                                               Page 7 of 7

III. CRITICAL THINKING: Write a one-paragraph essay answering one question below (your choice). [4 pts]

(1) Why do software producers like Adobe and Microsoft offer big discounts to students (often more than 50%) but
    hardware manufacturers like Dell, HP, and Gateway do not? Explain your reasoning.

(2) Consider the following statement. "Perfect competition is the law of the jungle. Unregulated competition drives profit
    to zero in a race to the bottom. If the government would allow firms to set prices cooperatively, everyone would
    benefit and society would be better off." Do you agree or disagree? Explain your reasoning using a demand-and-
    supply graph.

Please circle the question you are answering. Write your answer below. Full credit requires correct economic reasoning,
legible writing, good grammar including complete sentences, and accurate spelling.




[end of exam]

				
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