Micro II Spring 2016

Final Exam Review Suggested Answers

Practice all problem sets, in-class assignments and quizzes as well.

1. Suppose demand for a monopolists product is given by P = 300 6Q while the monopolists
marginal cost is given by MC = 3Q. The profit-maximizing price for this monopolist is
a) 100
b) 180
c) 60
d) 150

2. Suppose that firms A and B are Cournot duopolists in the salt industry. The market demand curve
can be specified as P = 200 QA QB. The marginal cost to each firm is $40. Suppose that firm A
is producing 100 units. What is firm Bs profit-maximizing quantity?
a) 100
b) 60
c) 30
d) 20

3. Which of the following statements regarding a monopolys first-degree price discrimination is

correct?
a) With first-degree price discrimination, consumer surplus is small, yet still greater than zero.
b) With first-degree price discrimination, producer surplus is lower than with uniform pricing.
c) With first-degree price discrimination, deadweight loss is large.
d) With first-degree price discrimination, total surplus is greater than when the monopoly
charges a uniform price.

4. In a duopoly, a residual demand curve

a) Is the same as a market demand curve.
b) Represents the demand curve that one firm faces given the output choice of the other firm.
c) Is the same as a marginal revenue curve when determining output in the Cournot model.
d) Is steeper than the market demand curve.

5. Game X shows the payoff matrix in terms of profit (in millions of dollars) for two possible
strategies: advertise or do not advertise. If they legally could, why might the two companies agree
to not advertise?
a) Because advertising is ineffective.
b) Because advertising is too expensive
c) Because not advertising would lower the costs and therefore increase the profits to each firm.
d) Because not advertising would lower profits.
6. In Game 3 above,
a) Player A choosing A1 and Player B choosing B1 is a Nash equilibrium.
b) Player A choosing A1 and Player B choosing B3 is a Nash equilibrium.
c) Player A choosing A3 and Player B choosing B1 is a Nash equilibrium.
d) Player A choosing A3 and Player B choosing B3 is a Nash equilibrium.

7. A decision-maker is faced with a choice between a lottery with a 30% chance of a payoff of $30
and a 70% chance of a payoff of $80, and a guaranteed payoff of $65. If the decision makers
utility function is U = I1/2, what is the risk-premium associated with this choice?
a) $1.59
b) $2.52
c) $0
d) $4

8. Suppose a monopolist faces demand P = 225 Q and has marginal cost MC = 25 + 3Q. Complete
the following table identifying consumer surplus, producer surplus, total surplus, and deadweight
loss for two situations: (1) the monopoly charges a uniform price and (2) the monopoly engages
in first degree price discrimination.
With uniform pricing the monopoly charges $185 for each unit and sells 40 units. With first-
degree price discrimination, the last unit is sold for $175 and the monopoly sells 50 units. Here is
the completed table.
9. Consider a simple bundling problem in which a producer sells two products to three potential
customers. The customers reservation prices for the two products and the firms marginal costs
are given in the following table.

a) If the firm does not bundle the products, what price should it charge for Product A and for
Product B to maximize profit? How much profit will the firm expect to earn?
If the firm does not bundle the products, then for Product A the firm should charge a price of
$75. At this price, the firm will sell Product A to Customers 2 and 3 earning $150 in revenue
(with $20 in cost). For Product B, the firm should charge a price of $30. At this price the firm
will sell Product B to Customers 1 and 2 earning $60 in revenue (with $10 in cost). The
firms profit will be total revenue, $210, less total cost, $30, or $180.
b) If the firm can bundle the products, what price should it charge to maximize profit and how
much profit can it expect to earn? How does this compare to result in part a)?
If the firm can bundle the products, then when determining the profit maximizing price it
looks at the reservation prices for the bundle. These are $90, $105, and $110 for the three
Customers. With these reservation prices, the firm will maximize profits by setting price at
$90 for the bundle. At this price, the firm will sell bundles to all three Customers earning
revenue of $270 and incurring cost of $45. The firm can expect to earn a profit of $225, or
$45 more than when they could not bundle.
10. Two players, Player 1 and Player 2, are playing a game with three possible strategies, Small,
Medium, and Large. The strategies represent potential advertising budgets. Profits for each
possible outcome are shown in the following table.

a) Does Player 1 have a dominant or a dominated strategy?

Player 1 does not have a dominant strategy. However, Strategy Small is a dominated strategy.
b) Does Player 2 have a dominant or a dominated strategy?
Player 2 does not have a dominant strategy. However, Strategy Small is a dominated strategy
c) What is the Nash equilibrium for this game?
A Nash equilibrium occurs when each player is making the best choice given the choice of
the other player. In this case, the first step is to remove the dominated strategy of Small from
the game, since neither player will choose Small. This reduces the payoff matrix to a 2x2
matrix.
 Now Player 2 has a dominant strategy of Medium. If Player 1 knows that Player 2 will
choose Medium, Player 1 will choose Medium. Thus, the Nash equilibrium is for each player
to choose Medium.

11. Good 1 is produced by firm 1 and good 2 by firm 2. Both goods are perfect complements.
Marginal costs for both products are constant and equal c=4. Both firms set simultaneously prices
P1and P2. Then the consumers buy equal amounts of both goods. The amount they buy is 14-P1-
P2. Calculate the Nash equilibrium for the model and compare it situation where both firms form
a cartel. What is better for the consumer?
Firm 1 maximizes (14-P1-P2) (P1-4) and so 0=18-2P1-P2. Firm 2 maximizes (14-P1-P2) (P2-4).
P1=P2=6. Demand is 2. Each firm makes the profit 2*2=4.
A monopoly would maximize (14-P1-P2) (P1-4) + (14-P1-P2) (P2-4) which give the first order
condition 0=22-2P1-2P2 for both prices. If we assume that the monopoly charges identical prices
we obtain P1=P2=5.5. The quantity demanded would be 3. The monopolist would earn 3*1.5=4.5
on each item which is more than when the firm compete. Consumers are better off under
monopoly because they get more at a lower price.

A homogeneous products duopoly faces a market demand function given by

P = 500 10Q. Both firms have a constant marginal cost of MC = 200.
a) What would the equilibrium price in this market be if it were perfectly competitive?
Set P = MC. Total market quantity sold will be Q = 30. Each firm will sell 15 units. Market
price will be $200.
b) What would the equilibrium price in this market be if the two firms colluded to set the
monopoly price?
If the firms collude, then they will set MR = MC. Total market output sold will be 15 units.
The market price will be $350.
c) What is the Bertrand equilibrium price in this market?
If the firms acted as Bertrand oligopolists, the equilibrium would coincide with the perfectly
competitive equilibrium of P = 200 and Q = 30, with each firm producing one-half of the
market output of 15 units each. If either firm tried to raise its price, it would lose its entire
market share

12. Ted and Joe each consume peaches, x, and plums, y. The consumers have identical utility
functions, with MRSjoe = 10y/x and MRSted = 10y/x. Together, they have 10 peaches and 10
plums. Verify whether each of the following allocations is on the contract curve:
i. Ted: 8 plums and 9 peaches; Jack: 2 plums and 1 peach.
ii. Ted: 1 plum and 1 peach; Jack: 9 plums and 9 peaches.
iii. Ted: 4 plums and 3 peaches; Jack: 6 plums and 7 peaches.
iv. Ted: 8 plums and 2 peaches; Jack: 2 plums and 8 peaches.
To be on the contract curve, an allocation must yield identical marginal rates of substitution
for each consumer.
i. MRSTed = 80/9 < MRSJoe = 20/1. Not on the contract curve.
ii. MRSTed = 10/1 = MRSJoe = 90/9. On the contract curve.
iii. MRSTed = 40/3 > MRSJoe = 60/7. Not on the contract curve.
iv. MRSTed = 80/2 > MRSJoe = 20/8. Not on the contract curve.