End term solution with grading scheme, long questions

MEM End Term Marks 40

Time 2hours and thirty minutes
Upload time 30 minutes
Total Questions 21 of which
MCQs : 18 questions each one mark

SECTION A

1) A price taker is
A) a firm that accepts different prices from different customers.
B) a consumer who accepts different prices from different firms.
C) a perfectly competitive firm.
D) a firm that cannot influence the market price.
E) both C and D
Answer: E

2) If current output is less than the profit-maximizing output, which must be true?
A) Total revenue is less than total cost.
B) Average revenue is less than average cost.
C) Average revenue is greater than average cost.
D) Marginal revenue is less than marginal cost.
E) Marginal revenue is greater than marginal cost.
Answer: E

3) Marginal profit is equal to

A) marginal revenue minus marginal cost.
B) marginal revenue plus marginal cost.
C) marginal cost minus marginal revenue.
D) marginal revenue times marginal cost.
E) marginal revenue divided by marginal cost.
Answer: A

4) The demand curve facing a perfectly competitive firm is

A) the same as its average revenue curve, but not the same as its marginal revenue curve.
B) the same as its average revenue curve and its marginal revenue curve.
C) the same as its marginal revenue curve, but not its average revenue curve.
D) not the same as either its marginal revenue curve or its average revenue curve.
E) not defined in terms of average or marginal revenue.
Answer: B
5) Bette's Breakfast, a perfectly competitive eatery, sells its "Breakfast Special" (the only
item on the menu) for $5.00. The costs of waiters, cooks, power, food etc. average out to
$3.95 per meal; the costs of the lease, insurance and other such expenses average out to $1.25
per meal. Bette should
A) close her doors immediately.
B) continue producing in the short and long run.
C) continue producing in the short run, but plan to go out of business in the long run.
D) raise her prices above the perfectly competitive level.
E) lower her output.
Answer: C

6) Use the following statements to answer this question:

I. The firm's decision to produce zero output when the price is less than the average variable
cost of production is known as the shutdown rule.
II. The firm's supply decision is to generate zero output for all prices below the minimum
AVC.
A) I and II are true.
B) I is true and II is false.
C) II is true and I is false.
D) I and II are false.
Answer: A

7) Ronny's Pizza House is a profit maximizing firm in a perfectly competitive local restaurant
market, and their optimal output is 80 pizzas per day. The local government imposes a new
tax of $250 per year on all restaurants that operate in the city. How does this affect Ronny's
profit maximizing decisions?
A) No impact on the restaurant's decisions
B) Ronny's will remain in business but will definitely produce less pizza
C) Ronny's will definitely shut down
D) Ronny's decision depends on the circumstances -- if their profits are larger than $250 per
year, then the tax does not impact output; otherwise, Ronny's Pizza House will shut down.
Answer: D

8) The short runsupply curve for a competitive firm is

A) its entire MC curve.
B) the upward-sloping portion of its MC curve.
C) its MC curve above the minimum point of the AVC curve.
D) its MC curve above the minimum point of the ATC curve.
E) its MR curve.
Answer: C

9) Which of the following is NOT true regarding monopoly?

A) Monopoly is the sole producer in the market.
B) Monopoly price is determined from the demand curve.
C) Monopolist can charge as high a price as it likes.
D) Monopoly demand curve is downward sloping.
Answer: C
10) Which of the following is true at the output level where P=MC?
A) The monopolist is maximizing profit.
B) The monopolist is not maximizing profit and should increase output.
C) The monopolist is not maximizing profit and should decrease output.
D) The monopolist is earning a positive profit.
Answer: C

11) Suppose Orange Inc. sells MP3 players and initially has monopoly power because there
are only a few close substitutes available to consumers. As more types of MP3 players are
introduced into the market, the demand facing Orange becomes ________ elastic and the
Lerner index achieved by the firm in this market ________.
A) less, declines
B) less, increases
C) more, declines
D) more, increases
Answer: C

12) A manufacturer of digital music players uses a proprietary file format that is not used by
the other firms in the market. This action by the firm may be an example of using a
________ to reduce the number of firms in the market and to maintain a relatively inelastic
demand for its products.
A) natural monopoly
B) positive externality
C) subsidy
D) barrier to entry
Answer: D

13) With respect to monopolies, deadweight loss refers to the

A) socially unproductive amounts of money spent to obtain or acquire a monopoly.
B) net loss in consumer and producer surplus due to a monopolist's pricing strategy/policy.
C) lost consumer surplus from monopolistic pricing.
D) none of the above
Answer: B

14) Assume that a profit maximizing monopolist is producing a quantity such that marginal
revenue exceeds marginal cost. We can conclude that the
A) firm is maximizing profit.
B) firm's output is smaller than the profit maximizing quantity.
C) firm's output is larger than the profit maximizing quantity.
D) firm's output does not maximize profit, but we cannot conclude whether the output is too
large or too small.
Answer: B

15) One of the main features of the platform market is:

A) Economies of scale
B) Returns to scale
C) Economies of scope
D) Network externality effects

Answer: D

16)A firm with market power would be more profitable through price discrimination when
A) the demand for its product is inelastic
B) the demand for its product is highly elastic
C) the elasticity of demand for its product are different for different sets of customers
D) the cost of production is very high
Answer: C

17) Suppose that the competitive market for rice in Japan was suddenly monopolized. The
effect of such a change would be:
A) to decrease the price of rice to the Japanese people.
B) to decrease the consumer surplus of Japanese rice consumers.
C) to decrease the producer surplus of Japanese rice producers.
D) a welfare gain for the Japanese people.
E) increase the consumption of rice by the Japanese people.
Answer: B

18) Compared to the equilibrium price and quantity sold in a competitive market, a
monopolist will charge a ________ price and sell a ________ quantity.
A) higher; larger
B) lower; larger
C) higher; smaller
D) lower; smaller
E) none of these
Answer: C

SECTION B
Q19)

a) DD in location 1 is given by 75- 2

= 75 – 4

DD in location 2 is given by = 160- 10

= 160- 20

Total cost, C = 40 + 50Q. Where Q = +

We first consider profit maximization in location 1:

  = MC
 = 50


 = 6.25 1 mark
 = 75-2 = 75- 2*6.25 = 62.5 1mark

Profit maximization in location:

=> = MC

=> 160- 20 = 50

=> 110 = 20

=> = 5.5 0.5 mark

= 160- 10*5.5

= 105 0.5 marks

Profit to the monopolist by practicing 3rd degree price discrimination,

π= + – (40+50( ))

= (62.5*6.25) + (105*5.5) – (40+50(6.25+5.5))

= 390.625+ 577.5 – (627.5) = 340.625 1 mark

Note: = 11.75< 400 (the capacity constraint doesn’t bind since 11.75 is less than 200)

b) Uniform Pricing:

The profit accruing to the monopolist when it charges uniform price

π = p*q- TC Since the monopolist changes the same price in both the markets,

Therefore = =p

= p*q –(40+50Q)…………………..(1) 1 mark

Now, Q

We need to find &

From the demand function it follows that

= (75- )/2
 = (160- )/ 10

Q= + = (since = =p)

P= 0.5 marks

Substitutes the expression of p in equation 1 we obtain

π= )Q – (40+50Q)

Profit max => = 0 => Q = 11.75 1 mark

Therefore p = = 69.58 0.5 marks

π = p*Q- TC = 69.58*11.75- (40+50*11.75)

= 190.1 1 mark
Note Q= 11.75<400. (here also the capacity constraint does not bind)

Q20) Answer:
a.
Given the competitive nature of the market, Bud should equate P to MC.
2.50 = 0.001Q……………………………(1)
Q = 2500

TR = 2.5 × 2500 = 6250

TC = 2000 + 0.0005(2500)2
TC = 2000 + 3125
TC = 5125……………………………(1)

π = 6250 - 5125……………………….(1)
π = 1,125

Since the cost function is an economic cost function, we can conclude that this is an
economic profit. ………………………………………(1)

b.
Tax shifts total cost curve to:
TC = 2000 + 0.0005Q2 + 0.5Q
MC becomes
MC = 0.001Q + 0.5
setting P = MC ………………………………(1)
2.50 = 0.001Q + 0.5
2.00 = 0.001Q
Q = 2000

TR = 2.50 × 2000
TR = 5000

TC = 2000 + 0.0005(2000)2 + 0.5(2000)

TC = 2000 + 2000 + 1000
TC = 5000……………………………(0.5)

π = 5000 - 5000
π = 0………………………………(1)

Given that this is zero economic profit, Bud should continue operating. ………………(0.5)

The impact upon Bud's competitors will be favorable or neutral. As he curtails output, 500
six packs worth of business will either shift elsewhere or choose temperance. ……(1)

SECTION C
Q21)
(a)SRC function = 14 + 4q + q2/40
MC = 4 + 2q/40
= 4 + q/20
The profit maximization condition is given by
p = MC
6 = 4 + q/20 [1 mark]
q = 2*20
q = 40

π = R – C = 6*40 – (14 + 4*40 + (40)2/40) [1 mark]

= 240 – (14 + 160 + 40)
= 240 – (214)
= 26
 (b) If the market price of Peruvian coffee is p = 4.5
The profit maximizing level of output is obtained by equating
p = MC i.e. 4.5 = 4 + q/20
0.5*20 = q
q = 10
The level of profit
π=R–C
= 4.5*10 – (14 + 4*10 + 100/40)
= 45 – 56.5
= -11.5 [1 MARK]
The firm will actually produce this level of output since by producing this level of output the
firm will actually cover up (14 – 11.5) = 2.5 units of fixed cost. If the firm shuts down
production, then the firm incurred a loss of 14 units. A loss of 11.5 units is better than a loss
of 14 units. [1 mark]
14-11.5=2.5?

[c] The lowest price at which the firm will produce a positive level of output
p ≥ min (AVC)
AVC = VC/q
Min (AVC)=4
Hence, the lowest price at which the firm will produce is 4. ---[1 mark]

d) Short run supply function of firm = MC curve above the AVC.

P=MC for p ≥ min (AVC)

=0 for p< min (AVC)

MC=d/dq (14 + 4q + q2)

MC=4 + 2q

So, P=4+2q

q=20p-80

Supply function: S(p)=20p-80 for p≥ min(AVC) = 4

S(p)=0 for p<4 ---[1 mark]