Planning time—10 minutes
Writing time—50 minutes
Directions: You have 10 minutes to read all of the questions in this booklet, to sketch graphs, to make notes, and to plan your answers. You will then have 50 minutes to answer all three of the following questions. It is suggested that you spend approximately half your time on the first question and divide the remaining time equally between the next two questions. In answering the questions, you should emphasize the line of reasoning that generated your results; it is not enough to list the results of your analysis. Include correctly labeled diagrams, if useful or required, in explaining your answers. A correctly labeled diagram must have all axes and curves clearly labeled and must show directional changes. Use a pen with black or dark blue ink.
1. The graph below illustrates the demand, marginal revenue (MR), marginal cost (MC), and average total cost(ATC) curves for a profit-maximizing monopolist.
(a) Assume that the profit-maximizing monopolist is unregulated. Using the labeling in the graph, identify each of the following.
(i) The monopolist’s quantity of output
(ii) The monopolist’s price
(iii) The profit earned by the monopolist
(iv) The deadweight loss
(b) Now assume that the monopolist can perfectly price discriminate. Using the labeling of the graph, identify each of the following.
(i) The quantity produced
(ii) The total revenue received by the monopolist
(c) Instead, assume the monopolist charges a single price and is regulated to produce the socially efficient quantity. Using the labeling of the graph, identify each of the following.
(i) The socially efficient quantity
(ii) The consumer surplus at the socially efficient quantity
(d) Is the monopolist facing the regulation in part (c) earning a positive economic profit, earning zero economic profit, or incurring a loss? Explain.
(e) Is point f in the elastic, inelastic, or unit elastic portion of the demand curve? Explain.
2. There are two pizza restaurants in College Town, PieCrust and LaPizza. Each company must decide whether to advertise or to not advertise. In the payoff matrix below, the first entry in each cell indicates PieCrust’s daily profit, and the second entry indicates LaPizza’s daily profit. Both firms have complete information.
(a) What strategy should PieCrust choose if LaPizza chooses to advertise? Explain using the dollar values in the payoff matrix.
(b) What is the dominant strategy, if any, for LaPizza? Explain using the dollar values in the payoff matrix.
(c) In the Nash equilibrium, determine each of the following.
(i) PieCrust’s daily profit
(ii) LaPizza’s daily profit
(d) Suppose that advertising costs increase by $60 per day. Redraw the payoff matrix to reflect the effect of the higher advertising costs.
3. For special occasions some people purchase and set off fireworks in their backyards. Assume the market for fireworks is perfectly competitive.
(a) Draw a correctly labeled graph of the market for fireworks and show the market equilibrium price and quantity, labeled PE and QE.
(b) Assume that the noise from the fireworks disturbs all of the neighbors. On your graph in part (a), show each of the following.
(i) The marginal social cost curve, labeled MSC
(ii) The marginal social benefit curve, labeled MSB
(iii) The deadweight loss, if any, shaded completely
(c) Now instead assume that all of the neighbors enjoy watching the fireworks.
(i) In this case, is the market equilibrium quantity of fireworks greater than, less than, or equal to the socially optimal quantity? Explain.
(ii) In this case, if the government bans fireworks, will the deadweight loss increase, decrease, or remain unchanged?