Additional Practice Problems II: ECON2113

The purpose of this additional practice problem set is for you to better
understand and practice what we have learnt in the class. The problems
here are relatively hard. I may have typos, please feel free to point them
out to me.

1
Question 1
Consider a scenario of short-run production. A firm can only choose the
number of workers. The firm’s total product function is given by
Y
_
_
_
_
_l2 ; if 0 Æ l Æ 2,
_
]
T P (l) = 8l ≠ l 2
≠ 8; if 2 < l Æ 4,
_
_
_
_
_
[8;
_
if 4 < l.

where l is the number of workers hired by the firm, and T P (l) is the
corresponding amount of goods produced per day.
(1) How many products can the firm produce per day if the firm hires 2
workers? How many products can the firm produce per day if the firm hires
4 workers?
(2) What is the marginal product of the 1st worker (i.e., the marginal
product when the number of workers increases from 0 to 1)? What is the
marginal product of the 2nd worker (i.e., the marginal product when the
number of workers increases from 1 to 2)? What is the marginal product
of the 3rd worker (i.e., the marginal product when the number of workers
increases from 2 to 3)? What is the marginal product of the 5th worker
(i.e., the marginal product when the number of workers increases from 4 to
5)? What do you find?
(3) Suppose the wage of each worker is 100 dollars per day. Derive the total
variable cost of the firm if the firm wants to produce 4 products per day,
and derive the total variable cost of the firm if the firm wants to produce 7
products per day.
(4) Derive the total variable cost of the firm as a function of the number of
products the firm produces every day.
(5) Derive the average variable cost of the firm as a function of the number
of products the firm produces every day.
(6) What is the firm’s marginal cost for the 7th unit of the good (i.e., the
marginal cost of the firm to increase the quantity produced per day from 6
units to 7 units)?

2
Question 2
Consider a scenario of long-run production. A firm can choose both the
number of machines (plant) and the number of workers. The time duration
is 1 year. Throughout the problem, we assume that once the machine is
brought by the firm, it cannot be resold. The firm’s production function is
given by the following table.

(1) How many products can the firm produce per year if the firm hires 2
workers under plant 2? How many products can the firm produce per year
if the firm hires 4 workers under plant 3?
(2) Suppose that the unit price of the machine is 80000 dollars, and the
wage of each work is 20000 dollars per year. If the firm wants to produce
45000 products in the following year, how many machines should the firm
buy, and what is the firm’s long-run average total cost?
(3) Suppose that the unit price of the machine is 30000 dollars, and wage
of each work is 30000 dollars per year. If the firm wants to produce 45000
products in the following year, how many machines should the firm buy,
and what is the firm’s long-run average total cost?

3
Question 3
Consider a scenario of long-run production. A firm can choose both the
number of machines (plant) and the number of workers. The time duration
is one year. Throughout the problem, we assume that once the machine is
brought by the firm, it cannot be resold. The firm’s production function is
given by
F (m, l) = 10000 ◊ min{m, l},

where m is the number of machines, l is the number of workers, and F (m, l)

is the number of products produced. The formula min{m, l} means that we
take the minimum of the two numbers m and l. For example, min{2, 1} = 1.
To interpret, this production function means that 1 worker has to work
together with 1 machine to do the production. If the number of workers
is larger than the number of machines (l > m), then the extra workers are
wasted, and thus the number of products F (m, l) = 10000 ◊ min{m, l} =
10000m is pinned down by the number of machines. If the number of workers
is smaller than the number of machines (l < m), then the extra machines are
wasted, and thus the number of products F (m, l) = 10000 ◊ min{m, l} =
10000l is pinned down by the number of workers. Suppose that the wage
for each worker is 30000 dollars per year, and the price of each machine is
40000 dollars per unit. Obtain the long-run average cost function LRAC(Q)
as a function of the quantity produced.

4
Question 4
In each one of the following scenarios, determine the fixed cost and variable
cost.

(1) John has a factory that produces sweaters. John has signed a one-year
contract with the land owner, according to which he needs to pay 5000
dollars per month for renting the factory. John also signed a contract
with the renter of production machines. By the contract, John will
rent 10 machines for one year, and for each machine, John needs to
pay a renting fee of 1000 dollars per month. John is now recruiting
workers for the production of the sweaters. The monthly wage of one
worker is 3000 dollars. Temporarily, John hires 10 workers.

(2) John has a factory that produces sweaters. John has signed a one-year
contract with the land owner, according to which he needs to pay 5000
dollars per month for renting the factory. John also signed a contract
with the renter of production machines. By the contract, John will
rent 10 machines for one year, and for each machine, the more John
uses the machines, the more John needs to pay. In particular, for
each unit of good produced, John needs to pay 20 dollars of renting
fee. John is now recruiting workers for the production of the sweaters.
The monthly wage of one worker is 3000 dollars. Temporarily, John
hires 10 workers. John assigns one worker to one machine and requires
each worker to produce 100 products per month.

(3) The total cost function is given by T C(Q) = Q2 + 100.

(4) The total cost function is given by T C(Q) = Q(Q + 1) + 100.

(5) The total cost function is given by T C(Q) = (Q + 10)2 + 100.

5
Question 5
Anna is deciding where to open a new restaurant. There are two places: one
is at TST and the other is at TKO. If Anna wants to open the restaurant
at TST, she needs to sign a one-year contract with the house owner and
pays 300 dollars per day. If Anna wants to open the restaurant at TKO, she
needs to sign a one-year contract with the house owner and pays 150 dollars
per day. The relationship between the number of workers hired and the
total number of customers served per day (i.e., the total product function)
is determined by the weather: either sunny or cloudy (rainy days are also
considered as cloudy days). Suppose that during the year, the number of
sunny days is equal to that of cloudy days. The total product functions of
the two places under different weather conditions are given by the following
tables.

Suppose that the wage of each worker is 200 dollars per day. On average,
during sunny days, each consumer pays 18 dollars for foods, of which
the ingredient cost is around 10 dollars (thus, the net revenue from each
consumer is 8 dollars); during cloudy days, each consumer pays 10 dollars
for foods, of which the ingredient cost is around 6.5 dollars (thus, the net
revenue from each consumer is 3.5 dollars) If at each day, Anna can either
choose to serve 350 consumers or 400 consumers (no matter where the
restaurant is and no matter what the weather is) by adjusting the number
of workers she hires, which place should Anna choose, TKO or TST?

6
 Question 6
Consider a competitive market. The cost curves of each firm are identical
and given by the following figure. The market demand schedule is given by
the following table. Answer the following questions.
(1) Suppose that there are 800 firms in the short-run, what is the short-run
equilibrium price and quantity? How many products does each firm produce
per day?
(2) Suppose that there are 1000 firms in the short-run, what is the short-run
equilibrium price and quantity? How many products does each firm produce
per day?
(3) Suppose that in the long-run, each firm can choose to remain or leave
the market. How many firms are there in the long-run equilibrium? What
is the long-run equilibrium price and quantity?

BreafceveonBoint Eprofif = 0 ]

!
.

MR= MC
幻 ( 2]

时 Qsper firam Qsperfirm

ε 0
= 1035 8300 =
83

l08 86 .

4
□ 回 88

112 5 . 90

7
口
Question 7
Consider a competitive market. In the market, there are two types of firms.
Type-1 firm rents one type-A machine for production, and type-2 firm rents
one type-B machine for production. Suppose that each firm can only rent
one machine (either type-A or type-B), and that deciding which type of
machines to rent is a long-run decision. The cost curves for the two types
of firms are given by the following figures. The market demand schedule is
given by the following table. Answer the following questions.
(1) Suppose that there are 80 type-1 firms and 80 type-2 firms in the short-
run, what is the short-run equilibrium price and quantity? How many
products does each type-1 firm produce per day? How many products does
each type-2 firm produce per day?
(2) What happens in the long-run?

8
 Qsperfirm

㝈
101 . S75
11份

9
Question 8
The in-class exercise question in Chapter 13.

Question 9
The in-class exercise question in Chapter 14.

10
 Question 10
MR 4600 = -
2Q
Consider a duopoly market. The market demand curve is given by P=4600-
Q. Firm 1’s marginal cost is given by M C1 = 2Q, and firm 2’s marginal
cost is given by M C2 = 4Q. Both firm 1 and firm 2 have zero fixed cost
(one can show that the total cost of firm 1 is given by T C1 = Q2 and that
of firm 2 is given by T C2 = 2Q2 ). / iQdQ
J 4QdQ
(1) Suppose that firm 1 and firm 2 decide to collude and produce as a
monopoly. Suppose there can only be a unique market price. What is the
optimal quantity they produce together, and what is the corresponding
market price? In this case, what is the quantity produced by each firm?

可0
(2) What is the Nash equilibrium of the game? In the Nash equilibrium,
IRo what are firm 1’s quantity and profit, and what are firm 2’s quantity and
profit? some MC tuey
waint thove
to

same Cost
:

C2) NE [ Q ,Q]
C1 ] Q = Q0 =
辈 is

FTrml' sDemand curvewheufivm arooses Q

θ= 些舞 MC
2 2

?
=
-
(4600 .
Q
ME = 去Q FTsmm 11s MR :
[ 4600 Q2} - -

2Q

M强
MC MR MC
=
=
. 1

告Q =
4600 -

3Q
4b08 Qr RQ
-
-
= 路

号 4600
Q 460 o =
Qr + 4 Q ,

Demandcurire mhen firm

'

Q = B80 Firmy i s 1 atrooses θ ,

?
Pzice = ψ600 -
1β 80 =$3220 = [ 4600 -
Q} Q
-

MC =
号 C 1380} $ 1840 : MR = [ 4600 -

Q] ~
三Q

Eachfirnhastoproduce p to MC MRa rCz :

∴ MC. .
= MCr =$ (840 4800 ☆ 1 -
-

2Q = 4Q

Q = = {20 4600 = Q 1 + 6Q

Q2 = =
460 计☆ 1 +Q 2 =4600_

Q . + 6Qz =4600—

∴ Q1 = {000 ③2 , = Go 0

Totod quantitf : 1600

P =
4600 .
1600 =$o00

Firam 17 s Pzofit =
多00 o { 10003 -1000 =$ 000000
]
FTom 2 ' spzoff = 000 { 0 多 tq
]

-Ʃ[600 :
$lw 80000

11
至
一
二
冖
Question 11
Consider the following game. There are two players. Player 1 can choose
from {A, B, C, D, E, F }, and player 2 can choose from {I, II, III, IV, V }.
The payoffs of the two players are given by the numbers in each bracket,
where the first number is the payoff of player 1, and the second one is that
of player 2. Find all Nash equilibria in this game.

0 : 0

0 0
00
0 0
0

0 0 0

12
Question 12
Consider a sequential game. There are two firms. Firm 1 is in the market,
and firm 2 is outside of the market. The market demand curve is P = 200≠Q.
Firm 1 has only three strategies: choosing a high quantity 100 units to
produce, choosing a medium quantity 80 units to produce, or choosing a
low quantity 50 units to produce. Firm 2, after observing the quantity
produced by firm 1, can choose either to enter or stay out of the market. If
firm 2 chooses to enter, firm 2 can choose any quantity to produce. Suppose
that both firms have constant marginal cost equal to 40, firm 1 has fixed
cost 1000, and firm 2 has fixed cost 1000. What is the optimal choice of
firm 1?

Question 13
Chapter 20 in-class question 2.

13
 Question 14
Consider a monopoly firm. The firm has zero total fixed cost and a
constant marginal private cost (MC) that is equal to 160 dollars. The
firm’s production creates marginal external benefit that is constantly equal
to 10 dollars. The market demand curve (which is also the social marginal
benefit) is given by P = 200 ≠ Q. What should the government do in order
for the monopoly firm to produce the efficient quantity?
1

MSB ( 0 +
= 200 -

Q
MSC = MSB

=
出O -

14
一
Question 15
Sarah loves to buy magazines and cakes from a convenient shop near her
home. The unit price of magazines is 20HKD. The unit price of cakes is
40HKD. Her utility from the two goods is given by the following table.
Throughout this problem, you only need to consider integer numbers of the
two goods.

Consider two choices. Under choice 1, Sarah will have 160 dollars for sure
to buy the two goods. Under choice 1, Sarah has a lottery that gives her
200 dollars with probability 35 and 120 dollars with probability 25 . Suppose
Sarah makes choices according to expected utility, what choice would she
make?

15
Answer to Q1
(1) We can simply take the value of l into the equation of the function
T P (l). When the firm hires 2 workers, we have l = 2, and according to the
formula of T P (l), we have T P (2) = 22 = 4. Thus, the firm can produce
4 products per day. When the firm hires 4 workers, we have l = 4, and
according to the formula of T P (l), we have T P (4) = 8 ◊ 4 ≠ 42 ≠ 8 = 8.
The firm can produce 8 products per day.
(2) The marginal product of the 1st worker is given by T P (1) ≠ T P (0) =
12 ≠ 02 = 1. The marginal product of the 2nd worker is given by T P (2) ≠
T P (1) = 22 ≠ 12 = 4 ≠ 1 = 3. The marginal product of the 3rd worker is
given by T P (3) ≠ T P (2) = (8 ◊ 3 ≠ 32 ≠ 8) ≠ 22 = 7 ≠ 4 = 3. The marginal
product of the 5th worker is given by T P (5) ≠ T P (4) = 8 ≠ 8 = 0. We find
that the marginal product is increasing first (from 1 to 3) but decreases to
0 in the end.
(3) If the firm wants to produce 4 products per day, then in order to
calculate the variable cost, we need to find the number of workers l such
that T P (l) = 4. By checking the formula of T P (l), we know that T P (2) = 4.
Thus, the firm needs 2 workers to produce 4 products per day. Therefore,
we have the total variable cost of producing 4 products a day is T V C(4) =
2 ◊ 100 = 200 dollars. Similarly, if the firm wants to produce 7 products a
day, it needs to hire 3 workers since T P (3) = 7, and the total variable cost
is T V C(7) = 3 ◊ 100 = 300 dollars.
(4) The difficulty of this question is that we need to consider separate cases.
Note that by the formula of T P (l), the firm can never produce more than
8 products per day. Hence, the quantity produced each day can only take
values between 0 and 8. We need to consider two cases. The cutoff case
is when l = 2, at which the firm produces 4 products per day. Thus, we
consider the following two cases: quantity less than or equal to 4 (when
l Æ 2) and quantity more than 4 (when 4 Ø l > 2).
Case 1. When the quantity Q is less than or equal to 4, we have

Q = T P (l) = l2 .

Recall what we did in the class, we can replace l with TV C

wage
since T V C =
l ◊ wage. Thus, we have
TV C
l= .
100

16
Replacing l by T V C, we have when l Æ 4,
3 42
TV C
2
Q=l = .
100

That is, Ò
T V C(Q) = 100 Q.

Case 2. When the quantity Q is larger than 4 but smaller or equal to 8,

we have
Q = T P (l) = 8l ≠ l2 ≠ 8.

Thus, we have Ò
l =4± 8 ≠ Q.

Note that l should be less than 4 in this case, and thus we have
Ò
l =4≠ 8 ≠ Q.

By replacing l by TV C
100
, we have
Ò
T V C(Q) = 400 ≠ 100 8 ≠ Q.

In conclusion, we have the following formula of T V C(Q):

Y
_ Ô
]100 Q;
_ if 0 Æ Q Æ 4,
T V C(Q) = Ô
_
[400 ≠ 100 8 ≠ Q;
_
if 4 < Q Æ 8.

(5) The AV C(Q) can be directly obtained by ACV (Q) = T V C(Q)

Q
, and we
have
Y
_ 100
_
]Ô ; if 0 < Q Æ 4,
AV C(Q) = Q
Ô
_
[ 400≠100 8≠Q ;
_
if 4 < Q Æ 8.
Q

(6) The marginal cost for the 7th unit of good is given by T V C(7)≠T
Ô V C(6).
By the formula
Ô in (4), weÔhave T V C(7) ≠ T V C(6) = 400 ≠ 100 8 ≠ 7 ≠
(400 ≠ 100 8 ≠ 6) = 100( 2 ≠ 1).

17
 Answer to Q2
(1) 40000 products; 65000 products.
(2) In order to produce 45000 products, the firm needs 6 workers under
plant 1, 3 workers under plant 2, 2 workers under plant 3, more than 1 but
less than 2 workers under plant 4, and more than 1 and less than 2 workers
under plant 5. For each case, the firm’s total cost is given by the money
paid for the machines and the wage paid to the workers. Thus, under plant
1, the firm’s total cost is 80000 + 6 ◊ 20000 = 200000 dollars. Under plant
2, the firm’s total cost is 80000 ◊ 2 + 20000 ◊ 3 = 220000 dollars. Under
plant 3, 4, or 5, the firm’s cost on machines is already larger than 200000
dollars. Thus, the cost-minimization plan is plant 1. Under plant 1, the
average long run total cost is 200000/45000 dollars per unit.
(3) In order to produce 45000 products, the firm needs 6 workers under
plant 1, 3 workers under plant 2, 2 workers under plant 3, more than 1
but less than 2 workers under plant 4, and more than 1 and less than
2 workers under plant 5. Thus, under plant 1, the firm’s total cost is
30000 + 6 ◊ 30000 = 210000 dollars. Under plant 2, the firm’s total cost is
30000 ◊ 2 + 30000 ◊ 3 = 150000 dollars. Under plant 3, the firm’s total cost
is 30000 ◊ 3 + 30000 ◊ 2 = 150000 dollars. Under plant 4, the firm’s total
cost is larger than 30000 ◊ 4 + 30000 ◊ 1 = 150000 dollars. Under plant 5,
the firm’s total cost is larger than 30000 ◊ 5 + 30000 ◊ 1 = 180000 dollars.
Thus, plant 2 or 3 are both the cost-minimization choice. The long-run
average total cost is given by 150000/4500 dollars per unit.

[2) 2 M + 3w = &( 80000) t3 E20000]

= 20000

3 M +2W = 3[fouc] + 40000

与
2 0000

1 h + o ω= 80000 + 120000

.∵
“

+τ c
444 .

18
二
月
Answer to Q3
If the firm wants to produce Q units of the product, the firm needs to let
F (m, l) = 10000 ◊ min{m, l} = Q. The question is: what minimizes the
cost? The answer is quite intuitive: the firm wants the number of workers
to be equal to the number of machines so that there is no waste. Thus, the
cost is minimized when m = l. Thus, we have min{m, l} = m = l, and

Q = 10000 ◊ min{m, l} = 10000m = 10000l.

Thus, m = Q/10000 and l = Q/10000 is the optimal choice of machines and

workers. It means that in order to produce Q units of the good, the firm
has to pay a cost that is equal to 30000l + 40000m = 3Q + 4Q = 7Q dollars.
The long-run average cost is given by LRAC(Q) = 7Q Q
= 7 dollars per unit.

19
Answer to Q4
(1) The fixed cost is the factory renting fee plus the machine renting fee,
since those fees are not determined by the quantity produced. Thus, the
total fixed cost is 5000 + 1000 ◊ 10 = 15000 dollars. The variable cost is
the pay to the workers, which is 3000 ◊ 10 = 30000 dollars.
(2) The fixed cost is the factory renting fee, which is 5000 dollars. The
variable cost is the usage fees of the machines and the pay to the workers,
since those fees are determined by the quantity of products produced. We
have the total variable cost is given by 20 ◊ 100 ◊ 10 + 3000 ◊ 10 = 50000
dollars.
(3) The total fixed cost is given by the total cost at Q = 0, i.e., T F C =
T C(0) = 100. Thus, we have the total variable cost to be T V C(Q) =
T C(Q) ≠ T F C = Q2 .
(4) The total fixed cost is given by the total cost at Q = 0, i.e., T F C =
T C(0) = 100. Thus, we have the total variable cost to be T V C(Q) =
T C(Q) ≠ T F C = Q(Q + 1).
(5) The total fixed cost is given by the total cost at Q = 0, i.e., T F C =
T C(0) = (0 + 10)2 + 100 = 200. Thus, we have the total variable cost to be
T V C(Q) = T C(Q) ≠ T F C = Q2 + 20Q + 100 + 100 ≠ 200 = Q2 + 20Q.

20
 Opeermine mo
of ansfomarsto bse
.

serwed umderdiff , weather

② expeded poofif froum the plaae

Cdanlete
③ Compare expected profif

Answer to Q5
This is a hard problem. The key is to understand that deciding whether
to serve 350 or 400 is a short-run decision, which can be made on a daily
basis.
First, suppose that Anna is choosing TKO. Then the fixed cost is 150
dollars’ rent per day. When it is sunny, Anna can decide whether to serve
350 or 400 consumers, and her revenue from serving 350 consumers is
given by 350 ◊ 8 = 2800 dollars. Her total variable cost from serving 350
hefquue
consumers comes from wages for workers, which are given by 200 ◊ 4 = 800
dollars. Thus, by serving 350 consumers in a sunny day, Anna’s daily profit
is 2800 ≠ 800 ≠ 150 = 1850 dollars. Comparatively, if Anna decides to serve
400 consumers in a sunny day, her daily profit is 400◊8≠200◊5≠150 = 2050
dollars. Clearly, when it is a sunny day, Anna chooses to serve 400
consumers, and her daily profit is 2050 dollars.
When it is cloudy, Anna can only choose to serve 350 consumers, and
her revenue from serving 350 consumers is given by 350 ◊ 3.5 = 1225 dollars.
Her total variable cost from serving 350 consumers comes from wages for
workers, which are given by 200 ◊ 5 = 1000 dollars. Thus, by serving 350
consumers in a cloudy day, Anna’s daily profit is 1225 ≠ 1000 ≠ 150 = 75
dollars. Thus, when it is a cloudy day, Anna has to choose to serve
350 consumers, and her daily profit is 75 dollars.
Since half of the days in the year is sunny, Anna’s average daily profit
from choosing TKO is (2050 + 75)/2 = 1062.5 dollars.
ExPeceprofiffromTKO =÷ 2050 ] 六 [ 75 =$ 106
[
5
Next, consider the situation where Anna chooses TST. The fixed cost is
} 是

300 dollars’ rent per day. When it is sunny, Anna can decide whether to
serve 350 or 400 consumers, and her revenue from serving 350 consumers is
given by 350 ◊ 8 = 2800 dollars. Her total variable cost from serving 350
consumers comes from wages for workers, which are given by 200 ◊ 3 = 600
dollars. Thus, by serving 350 consumers in a sunny day, Anna’s daily profit
is 2800 ≠ 600 ≠ 300 = 1900 dollars. Comparatively, if Anna decides to serve
400 consumers in a sunny day, her daily profit is 400◊8≠200◊4≠300 = 2100
dollars. Clearly, when it is a sunny day, Anna chooses to serve 400
consumers, and her daily profit is 2100 dollars.
When it is cloudy, again, Anna can decide whether to serve 350 or
400 consumers, and her revenue from serving 350 consumers is given by
350 ◊ 3.5 = 1225 dollars. Her total variable cost from serving 350 consumers
comes from wages for workers, which are given by 200 ◊ 4 = 800 dollars.
Thus, by serving 350 consumers in a sunny day, Anna’s daily profit is
1225 ≠ 800 ≠ 300 = 125 dollars. Comparatively, if Anna decides to serve 400

21
十
consumers in a cloudy day, her daily profit is 400 ◊ 3.5 ≠ 200 ◊ 5 ≠ 300 = 100
dollars. Clearly, when it is a cloudy day, Anna chooses to serve 350
consumers, and her daily profit is 125 dollars.
Since half of the days in the year is sunny, Anna’s average daily profit
from choosing TST is (2100 + 125)/2 = 1112.5 dollars. Thus, choosing
TST is better than choosing TKO.

22
Answer to Q6
(1) We can check each possible price to see whether we can have an
equilibrium. It turns out when price is equal to 100 dollars per unit,
the quantity demanded is 88000 units. In this case, the price is higher than
the minimum AVC, and thus each firm does production. Each firm supplies
110 units per day, and since there are 800 firms, the total quantity supplied
is 88000 units. The market reaches the short-run equilibrium.
(2) We find that when the market price is 80 dollars per unit, which is the
minimum AVC, each firm is indifferent between shutting down or producing
100 units. Since the quantity demanded now is 90000, we have 900 firms
are producing 100 units per day, and 100 firms are shutting down. The
market is exactly clear. ∵

profit= inlongrum
0

(3) In the long-run, the market price has to be the minimum ATC. Thus, the
market price is 120 dollars per unit. Given the price, each firm is producing
120 units per day. Given the price, the quantity demanded is 86400 units.
Thus, we need 86400/120=720 firms in the market.

23
Answer to Q7
(1) We need to check each price to see whether we can have a short-run
equilibrium. It turns out when the price is equal to 100 dollars per unit,
the quantity demanded is 16300 units. Each type-1 firm produces 110 units
(note that the price is higher than type-1 firm’s minimum AVC), which
leads to 8800 units in total by type-1 firms. Each type-2 firm can either
produce 0 or 150 units, thus type-2 firms can produce from 0 to 12000 units.
We need type-2 firms to produce 7500 units to reach the equilibrium. This
can be achieved if 50 type-2 firms produce 150 units, and the rest 30 type-2
firms temporarily shut down.
A = 120 < B = (40

(2) In the long-run, since the minimum ATC of renting type-A machine is
lower, each firm will rent type-A machine, that is, only type-1 firms will
remain in the market. The long-run equilibrium price is 120 dollars per unit,
the long-run equilibrium quantity is 14400 units per day (by the demand
schedule), and the long-run quantity of type-1 firms is 120.
Qs
T
lowestATC

24
Answer to Q8
To solve this question, one needs to know how to represent a linear curve
using a linear equation. Given that the demand curve is linear, we can first
obtain the equation for the demand curve. Suppose that the demand curve
is given by
P = aQ + b.

We have two points (0, 30) and (10, 25). Plugging in the two points into
the equation, we have

30 = a ◊ 0 + b, 25 = a ◊ 10 + b.

Thus, we have b = 30 and a = ≠ 12 , and the demand equation is given by

1
P = 30 ≠ Q.
2

The MR equation can be obtained by the following procedure:

1
M R(Q + ) = T R(Q + 1) ≠ T R(Q)
2

1 1 1
= (Q + 1)[30 ≠ (Q + 1)] ≠ Q(30 ≠ Q) = 30 ≠ (Q + ).
2 2 2
1
Thus, we can replace Q + 2
with Q and obtain

M R(Q) = 30 ≠ Q.

Given the MR, we know that the optimal quantity is chosen when M R =
M C, i.e.,
30 ≠ Q = 5 ∆ Q = 25.

Thus, the firm’s optimal quantity is given by Q = 25. Given that Q = 25,
we can also obtain that the market price now is equal to 17.5 dollars per
unit (using the demand curve P = 30 ≠ 12 Q).
Next, we calculate the firm’s profit, note that the firm’s MC is constantly
equal to 5, thus the firm’s total variable cost is given by

T V C = 5Q.

When quantity is 3, T C = 18 and T V C = 15, and thus we have T F C = 3.

25
Thus, when Q = 25, the firm’s total cost is given by 3 + 5 ◊ 25 = 128 dollars,
and the firm’s revenue is 17.5 ◊ 25 = 437.5 dollars. Thus, the firm’s profit
is 437.5 ≠ 128 = 309.5 dollars.

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Answer to Q9
3000
When there are N firms, the marginal revenue of each firm is M R = N
≠2Q.
Now, we answer the two questions.
(1) When N = 50, we have P = 60≠Q, and M R = 60≠2Q. Let M R = M C,
we have 60 ≠ 2Q = 16, and thus Q = 22. Given Q, we know the price now
is 60 ≠ 22 = 38 dollars per unit. Each firm’s markup is 38 ≠ 16 = 22, and
each firm’s profit is (38 ≠ 16) ◊ 22 ≠ 16 = 468 (note that 16 is the fixed
cost).
(2) For a given number of firms N , we have M R = 3000
N
≠2Q, and M R = M C
implies Q = N ≠ 8. The price is then given by P = 1500
1500
N
+ 8. In order for
each firm to have a zero profit, we need P = AT C, i.e.,

1500 16
+ 8 = 16 +
N Q

16
∆ Q + 16 = 16 +
Q
∆ Q2 = 16 ∆ Q = 4.

Hence, when Q = 4, we have each firm’s profit is exactly equal to zero.

In this case, P = Q + 16 = 20, and each firm’s markup is 20 ≠ ☆8 = 12.
z 4
1500
Moreover, the number N should satisfy Q = N ≠ 8 = 4, and thus N = 125.

MC = 1

27
Answer to Q10
(1) If the two firms produce together as a monopoly, we first need to figure
out what is their aggregate marginal cost curve. Recall that in Chapter 5,
we talked about how to aggregate individual supply (marginal cost) curves.
We fix a given marginal cost level, say M C. Given M C, we know firm
1’s quantity is Q1 = M2C and firm 2’s quantity is Q2 = M4C . Given M C,
the total quantity is Q = Q1 + Q2 = 34 M C. Thus, the aggregate marginal
cost curve is M C = 43 Q. The market demand curve is P = 4600 ≠ Q,
and thus the marginal revenue is M R = 4600 ≠ 2Q. Let M R = M C, we
have the quantity 4600 ≠ 2Q = 43 Q, and Q = 1380. Thus, the optimal
plan is to produce Q = 1380 together, and the market price is given
by P = 4600 ≠ 1380 = 3220. Since the marginal cost now is equal to
4
3
Q = 1840, each firm has to produce up to this marginal cost. It means
that M C1 = M C2 = 1840. Thus, we can obtain the quantity produced by
each firm: Q1 = 18402
= 920 and Q2 = 1840
4
= 460, which precisely sum up
to 1380.
(2) Assume that the NE is (Q1 , Q2 ). Firm 1’s demand curve when firm
2 chooses Q2 is given by P = (4600 ≠ Q2 ) ≠ Q. Thus, firm 1’s marginal
revenue is M R1 = 4600 ≠ Q2 ≠ 2Q. Let M R1 = M C1 , and we have

4600 ≠ Q2 ≠ 2Q = 2Q.

The above equation holds when Q = Q1 , and thus we have

4600 = 4Q1 + Q2 .

Similarly, for firm 2, if firm 1 produces Q1 units of the good, firm 2’s demand
curve is given by P = (4600 ≠ Q1 ) ≠ Q. Thus, firm 2’s marginal revenue is
M R2 = 4600 ≠ Q1 ≠ 2Q. Let M R2 = M C2 , and we have

4600 ≠ Q1 ≠ 2Q = 4Q.

The above equation holds when Q = Q2 , and thus we have

4600 = Q1 + 6Q2 .

Combining the two equations

4600 = 4Q1 + Q2 , 4600 = Q1 + 6Q2 ,

28
we have Q1 = 1000 and Q2 = 600.
Finally, we compute each firm’s profit. Now, the total quantity is Q1 + Q2 =
1600. Thus, the market price is 3000. Firm 1’s profit is given by

3000 ◊ 1000 ≠ T C1 = 3000000 ≠ Q21 = 3000000 ≠ 1000000 = 2000000.

Firm 2’s profit is given by

3000 ◊ 600 ≠ T C2 = 1800000 ≠ 2Q22 = 1800000 ≠ 720000 = 1080000.

29
Answer to Q11
After checking one-by-one, the only Nash equilibrium is (C, IV ).

Answer to Q12
This is a hard problem. We need to figure out what happens if firm 1 makes
the three choices respectively. Then, we go backward to figure out what is
the optimal choice of firm 1.
Case 1: If firm 1 chooses 100 units to produce. Then, if firm 2 stays
out, firm 2’s profit is 0. If firm 2 enters, firm 2’s demand is given by
P = 200 ≠ 100 ≠ Q = 100 ≠ Q. Thus, firm 2’s marginal revenue is
M R = 100 ≠ 2Q. Let M C = M R, we have 100 ≠ 2Q = 40, and the optimal
quantity to produce for firm 2 is 30 units. Given the quantity, we know the
market price now is 200 ≠ 100 ≠ 30 = 70 dollars per unit. Hence, the profit
of firm 2 is 30 ◊ (70 ≠ 40) ≠ 1000 = ≠100 dollars, which is negative. Thus,
firm 2 does not want to enter.
Given that firm 2 does not enter, and firm 1 chooses 100 units of the
good, we know that the market price now is 100 dollars. Firm 1’s profit is
100 ◊ (100 ≠ 40) ≠ 1000 = 5000 dollars.
Case 2: If firm 1 chooses 80 units to produce. Then, if firm 2 stays out,
firm 2’s profit is 0. If firm 2 enters, firm 2’s demand is given by P =
200 ≠ 80 ≠ Q = 120 ≠ Q. Thus, firm 2’s marginal revenue is M R = 120 ≠ 2Q.
Let M C = M R, we have 120 ≠ 2Q = 40, and the optimal quantity to
produce for firm 2 is 40 units. Given the quantity, we know the market
price now is 200 ≠ 80 ≠ 40 = 80 dollars per unit. Hence, the profit of firm
2 is 40 ◊ (80 ≠ 40) ≠ 1000 = 600 dollars, which is positive. Thus, firm 2
chooses to enter and produce 40 units of the good.
Given that firm 2 chooses to enter and produce 40 units of the good, and
firm 1 chooses 80 units of the good, we know that the market price now is
80 dollars. Firm 1’s profit is 80 ◊ (80 ≠ 40) ≠ 1000 = 2200 dollars.
Case 3: If firm 1 chooses 50 units to produce. Then, if firm 2 stays out,
firm 2’s profit is 0. If firm 2 enters, firm 2’s demand is given by P =
200 ≠ 50 ≠ Q = 150 ≠ Q. Thus, firm 2’s marginal revenue is M R = 150 ≠ 2Q.
Let M C = M R, we have 150 ≠ 2Q = 40, and the optimal quantity to
produce for firm 2 is 55 units. Given the quantity, we know the market
price now is 200 ≠ 55 ≠ 50 = 95 dollars per unit. Hence, the profit of firm
2 is 55 ◊ (95 ≠ 40) ≠ 1000 = 2025 dollars, which is positive. Thus, firm 2
chooses to enter and produce 55 units of the good.

30
Given that firm 2 chooses to enter and produce 55 units of the good, and
firm 1 chooses 50 units of the good, we know that the market price now is
95 dollars. Firm 1’s profit is 50 ◊ (95 ≠ 40) ≠ 1000 = 1750 dollars.
Combining the above three scenarios, firm 1’s optimal choice is to choose
quantity 100 units.

31
Answer to Q13
We need to figure out what is the final profit of John at each one of the two
locations. At location 1, the demand curve is deterministic: P = 200 ≠ Q.
We have M R = 200 ≠ 2Q = M C, and thus 200 ≠ 2Q = 40 leads to Q = 80.
The price is P = 120. The total profit of John becomes 80 ◊ (120 ≠ 40) ≠
3000 = 3400 dollars. His final wealth is given by 3000 + 3400 = 6400. His
1
utility is thus given by 6400 2 = 80.
At location 2, with probability 0.5, the demand curve is P = 100 ≠ Q. In
this case, the optimal quantity is Q = 30 and price is 70. John’s profit
is 900 ≠ 3000 = ≠2100 dollars, and his final wealth becomes 900 dollars.
1
His final utility is 900 2 = 30. With another probability 0.5, the demand
curve is P = 340 ≠ Q. In this case, the optimal quantity is Q = 150 and
price is 190. John’s profit is 150 ◊ 150 ≠ 3000 = 19500 dollars, and his
1
final wealth becomes 22500 dollars. His final utility is 22500 2 = 150. Thus,
John’s expected utility is 12 ◊ 150 + 12 ◊ 30 = 90. Since 90 > 80, he should
choose location 2.

32
 Answer to Q14
Marimalexternad banefit : Marsondernadcost
-

Since the firm’s production creates a constant marginal external benefit, it

means that the true social marginal cost is lower than the firm’s marginal
private cost: We should also take into account the marginal external benefit,
and the social marginal cost of production is 160 ≠ 10 = 150 dollars. Now,
the efficient quantity is given by SM C = SM B, which is 150 = 200 ≠ Q.
Thus, the efficient quantity is Q = 50.
The monopoly firm’s decision is simple: M C = M R, that is, 160 =
200 ≠ 2Q, and thus Q = 20, which is below the efficient quantity.
In order for the firm to produce the efficient quantity, the government
needs to subsidize the firm k dollars for each unit of the good. With the
subsidy, the firm’s marginal cost becomes 160 ≠ k, and let M C = M R, we
have the firm’s optimal quantity to produce is given by 160 ≠ k = 200 ≠ 2Q.
Thus, Q = 20 + k2 . In order for Q = 50, we need k = 60 dollars. That is, the
government needs to subsidize the firm 60 dollars for each unit of the good.

33
一
Answer to Q15
We just need to figure out Sarah’s utility under situation. If she has 160
dollars, she can buy (8, 0), (6, 1), (4, 2), (2, 3), or (0, 4), where the first
coordinate denotes the number of magazines she buys, and the second
one denotes the number of cakes she buys. The total utilities are given
respectively by

U (8, 0) = 426, U (6, 1) = 482, U (4, 2) = 496,

U (2, 3) = 467, U (0, 4) = 384.

Thus, with 160 dollars, she will buy (4, 2), which gives her utility 496.
If she has 200 dollars, she can buy (10, 0), (8, 1), (6, 2), (4, 3), (2, 4), (0, 5).
The total utilities are given respectively by

U (10, 0) = 468, U (8, 1) = 546, U (6, 2) = 586,

U (4, 3) = 584, U (2, 4) = 539, U (0, 5) = 440.

Thus, with 200 dollars, she will buy (6, 2), which gives her utility 586.
If she has 120 dollars, she can buy (6, 0), (4, 1), (2, 2), or (0, 3). The total
utilities are given respectively by

U (6, 0) = 362, U (4, 1) = 392, U (2, 2) = 379, U (0, 3) = 312

Thus, with 120 dollars, she will buy (2, 2), which gives her utility 392.
Her expected utility from choice 1 is 496. Her expected utility from choice
2 is 586 ◊ 35 + 392 ◊ 25 = 508.4. Thus, choice 2 is better.

34