The assignment consists of seven parts that test various microeconomic concepts, including monopoly, cartel, duopoly, game theory, and international trade.
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Directions: Download the examination between 12:01 am on Tuesday, December 16, 2014 and 8:30 pm December 31, 2014. This is an open book exam with hand calculator allowed. Please print your name clearly below andon each page of your answer sheets.Once downloaded, you are allowed to complete the examination in three and one-half hours -- three hours in total to focus on the examination, and one-half hour to allow for downloading/uploading technology-related logistical snafus. It would be best if you take the examination all in one setting. However, since some of you may be temporarily interrupted by work or family while taking the exam, the maximum time we will allow for you to upload the completed exam back is 3 hours after you initially downloaded the exam (download and upload times will be time stamped). No examinations will be accepted after midnight, December 31, 2014. Answer all questions as clearly and legibly as possible. The exam has a total of 180 points. The number of points and a suggested amount of time is indicated for each question. For those questions having multiple component parts, we have indicated the point allocation to each component part. In order to obtain full credit for your answers, you need to show your work.
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1. (40 total points, 40 minutes, 5 points for each question) Decide whether each of the following statements isTrue,FalseorUncertain, and give abrief but clear explanation supporting your answer. Most of the credit will be given for your explanation. A.If a firm having market power charges a price for its output that is less than its marginal cost, it should shut down and cease production. B.Dominique is planning to bid on an antique piece of fine jewelry in a second price sealed bid auction. Dominique’s private value for the antique jewelry is $10,000. Dominique should bid no more than $10,000 for the antique jewelry. C.Greater diversity among suppliers makes collusion more likely to emerge, since there is more likely to be something for everyone in the market. D.A monopolist’s long-run supply curve is that portion of its long-run marginal cost curve above its long-run average total cost curve. E.The demand for refrigerators is characterized by a partial adjustment process (inertia). Suppose a $250 tax is imposed on new refrigerators. The share of the burden of this tax borne by consumers (as opposed to producers) will rise. F.Deductibles and cost sharing copayments are tools used by insurers to mitigate or counter the effects of consumers’ adverse selection into health care insurance plans. G.Consider a Cournot game in which a Prisoners’ Dilemma-like payoff matrix is repeated a known finite number of times. In such a case, a tit-for-tat strategy is optimal. H.Whenever a firm has market power and can set its own output prices, deadweight loss will occur. Therefore, any firm having market power reduces economic efficiency compared to a perfectly competitive market outcome. 2.(30 total points, 30 minutes) Workers must travel from Residentsville to the Workplace copper mine and return every day. On a monthly basis, the inverse demand for bus rides is given by P = 300 – 4Q where P is in cents per ride and Q is in thousands of rides. The marginal cost of each ride is 50 cents (there are no economies of scale and no fixed costs).
a.(8 points) Suppose that the transit business is perfectly competitive, and there are no barriers to entry or exit. How many bus rides are sold, at what price are they sold, and what are the values of consumer and producer surplus? b.(10 points) Suppose that an exclusive license is obtained by Trailaway to provide transit services between Residentsville and Workplace, so that Trailaway is a monopoly provider of these bus rides. How many bus rides are sold, and at what price are they sold? What are Trailaway’s profits, and what is the deadweight loss relative to (a) above? c.(12 points) Suppose that a government subsidy of 40 cents per ride is paid to the Trailaway monopoly. How many bus rides are sold, and at what price are they sold? What are Trailaway’s profits, what is the cost of the government subsidy program, and what is the dead weight loss relative to (a) above? 3. (20 points total, 20 minutes) Bob is deeply in debt, with over $60,000 owed on credit cards at an annual rate of 20%, and $80,000 owed on student loans at an annual interest rate of 5%. Yet to maintain appearances, Bob must arrive at work in style. His only options are: (i) to continue to drive his fancy BMW to work; or (ii) to sell his BMW and hire the Lightning Limousine Service to chauffer him to work. (Assume Bob gets the same value from either alternative, and never has any reason to use his car other than to go to work.) Lightning Limousine charges $18,000 per year (with payment for the full year due at the end of the year). Bob’s BMW can be sold now for $50,000, whereas a year from now its resale price will only be $40,000. a.(10 points) What is the user cost of capital associated with owning the BMW for the next year? b.(10 points) Should Bob sell his car and employ Lightning Limousine, or not? Why? 4. (30 total points, 30 minutes) Suppose that two identical firms produce widgets and that they are the only firms in the market. Their total costs are given by C1= 30Q1and C2= 30Q2,where Q1is the output of Firm 1 and Q2is the output of Firm 2. Price is determined by the following inverse demand curve: P = 150 – Q, where Q ≡ Q1+ Q2. a.(8 points) Find the Cournot-Nash equilibrium. Calculate the profits of each firm at this equilibrium.
b.(8 points) Suppose the two firms form a cartel to maximize joint profits, which they agree to share equally. How many widgets will each firm produce? Calculate each firm’s profits. c.(6 points) Suppose Firm 1 were the only firm in the industry. How would the market output and Firm 1’s profits differ from that found in part (b) above? Why? d.(8 points) Returning to the duopoly of part (b), Firm 2 knows that Firm 1 will abide by the agreement, but Firm 2 decides to take advantage of Firm 1’s credible faithful commitment by increasing Firm 2’s production. How many widgets will Firm 2 produce? What will be each firm’s profits? 5. (16 total points, 16 minutes) The United States and Russia are considering policies to open or close their import markets. Suppose the payoff matrix has payoffs of x,y, where where x is the payoff to the United States and y is the payoff to Russia: Russia OpenClose Open|10,105,5 United│ States│ Close│ -100,51,1 a.(8 points) Assume that each country knows the payoff matrix and believes that the other country will act only in its own interest. Does either country have a dominant strategy? What will be the equilibrium policies if each country acts rationally to maximize its own welfare? b.(8 points) Now assume that Russia is not certain that the United States will behave rationally. In particular, Russia is concerned that United States’ politicians may want to penalize Russia even if that does not maximize United States welfare. How might this affect Russia’s choice of strategy? How might this change the equilibrium outcome? Would that be a Nash equilibrium? Why or why not? 6. (24 total points, 24 minutes) America’s Game, Inc., is a monopoly producer of baseballs. Suppose that the demand for baseballs is given as Q = 40,000 – 20,000P where P is in dollars per baseball. Baseballs can be produced in a facility in Southeast Asia where the total cost function is C(Q1) = (1/20,000)(Q1)2. Baseballs can also be produced in a facility in Latin America where the total cost function is C(Q2) = (1/40,000)(Q2)2
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a.(6 points) What principles and insights from microeconomic theory guide the profit- maximizing monopolist when allocating the firm’s total production of baseballs into the two geographically distinct plant facilities? b.(12 points) Illustrategraphicallythe monopolist’s problem. What is the monopolist’s optimal total production level over both production facilities, and what is the optimal production allocation for baseballs in the two distinct production facilities? Is any output produced in the Southeast Asia production facility, given that its cost curve is higher than that for Latin America, at all common output levels? Why or why not? a.(6 points) What is the optimal price of baseballs (show all calculations)? How many are produced in Southeast Asia? How many are produced in Latin America?What are total profits to America’s Game, Inc.? 7. (20 total points, 20 minutes) A monopolist must decide how to price in two markets and allocate product output between them. The markets are separated geographically (being either side of a national border).Demands in the two markets are as follows: Q1= 30 – 2P1andQ2= 24 – P2. The monopolists total cost are C = 5 + 2(Q1+ Q2). What are the prices charged, total product shipped to each market, and total profits to the monopolist under the following two conditions? a.(12 points) The markets are separated, and no arbitrage is possible (the firm can ship to both markets, but there is no other trade in the particular product)? b.(8 points) The border is opened to free trade and possible arbitrage.