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Assignment 4-Dr Sher-Key

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38 views

Assignment 4-Dr Sher-Key

Uploaded by

jovera shakeel
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Assignment # 4 KEY

You are required to turn in ONE Word document with your solutions to ALL questions on LMS by
Saturday, 30th March, 5 PM (LMS), and turn in your hard copy to the TA on Monday, 1st April, after class.
There is no tolerance for plagiarism and late submissions will be subjected to a penalty.

Total Marks: 45

Question 1: [20 marks]

Q.1 Two firms, M and N operate in two different differentiated goods markets. The total cost functions
corresponding to each firm are given below:

- Firm M: C = 4Q

- Firm N: C = 10 + 4Q

You are also told that each of the two firms have maximum production capacity of 40,000 (max
quantity) which is produced in batches of 4,000.

a) Use relevant plots of the Cost functions for the two firms above to explain the relationship
between each firm’s marginal cost curve and the zero-profit isoprofit curve. [10 marks]

b) Now use the plots from part a) along with plots of isoprofit curves of values Rs. 36,000 and Rs.
64,000 for the two firms to identify any differences in the shapes of the isoprofit curves for the
two firms? Also provide brief reasoning for any differences you observe. [5 marks]

c) Given the information provided on firms M and N, assess whether isoprofit curves further away
from the origin would always get closer to the average cost curve upon producing more units of
output? Provide reasoning to support why or why not. [5 marks]
Question 2: [15 marks]

−∆ Q P
Q2 As discussed in Units 7, elasticity of a demand curve is given by the formula: ε = . We also
∆P Q
−(P−MC)
learned that the slope of the iso-profit curve is given by: slope= , where P denotes the
Q
price of the normal good, Q denotes the quantity demanded, MC is the marginal cost of producing the
good, and ε determines the demand elasticity of good. Use this information to answer below:
a) Draw an iso-profit curve, to show via a contrast, and explain the relationship between
elasticity of demand and markup that monopolist charges (Hint: Recall that the equilibrium
is the point of tangency between the demand curve and iso-profit curve) [Marks = 10]

b) How and why does the deadweight loss change with the elasticity of the product? Illustrate
your answer with appropriate well-labelled figures. [Marks = 5]

Ans a: The answer should contrast demand curves with different elasticities and show the
numerical relationship between elasticity of quantity demand and mark-up:
1) Elastic demand:

2) Inelastic demand:
3)

And justify the above using this derivation:


*Make sure they clearly derive the relation between slope and elasticity themselves (it was not in
the book but covered in recitation)

Ans b) Use the diagrams above to contrast the DWL sizes. Answer with respect to how more
elasticity means a lower markup or the bargaining power on part of the differentiated goods’
firms. This means the optimal quantity gets closer to the socially optimal quantity and so a lower
DWL.
(Should emphasize the role of DD curve in deciding the maximum willingness to pay for
consumers- the price the firms HAVE TO SET to induce the sale of the extra output being
produced—that information is contained in the DD curve (elasticity)).

Question 3: [5 marks]

Q3 In the scenario wherein a worker is paid a high salary because of his high Econometrics skills and the
economy currently lacks people with the same level of skills, what would happen to the economic rents?

A qualified econometrician will be able to find other jobs easily at a similar salary, so the economic rent
is low.

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