Week 7 - Pre-class exercises Ch2 : Supply / Demand Model

Short Answer questions: Write your answer in the space provided or on a separate sheet of
paper.

1) The demand and supply functions for sweatshirts (the basic grey kind) are as follows:

Demand Supply
Quantity Quantity
Demanded Supplied
Price (per period) Price (per period)
$10 15,000 $10 22,000
9 15,500 9 19,000
8 16,000 8 16,000
7 16,500 7 13,000
6 17,000 6 10,000
5 17,500 5 7,000
4 18,000 4 4,000
3 18,500 3 1,000
2 19,000 2 0

a. Graph the demand and supply functions for sweatshirts and find the equilibrium price (Pe)
and quantity (Qe).

b. What effect will an increase in the price of gym shoes (a complement) have on the
equilibrium price and quantity of sweatshirts, all else constant? Illustrate the effect using your
graph.

c. What effect will a wage increase for workers in the sweatshirt industry have on the
equilibrium price and quantity of sweatshirts, all else constant? Illustrate the effect using your
graph.

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2) The demand and supply functions for sweatshirts (the basic grey kind) are as follows:

Demand Supply
Quantity Quantity
Demanded Supplied
Price (per period) Price (per period)
$10 15,000 $10 22,000
9 15,500 9 19,000
8 16,000 8 16,000
7 16,500 7 13,000
6 17,000 6 10,000
5 17,500 5 7,000
4 18,000 4 4,000
3 18,500 3 1,000
2 19,000 2 0
The equations for the demand and supply functions above are as follows:

Qd = 20,000 - 500P
Qs = -8,000 + 3000P

a. Solve for the equilibrium price and quantity. (Hint: at equilibrium, quantity supplied equals
quantity demanded.)

b. Assume the supply function changes to:

Qs = -5,000 + 3000P

Does supply increase or decrease? What is the new equilibrium price and quantity?

Additional exercises:

Use the Supply & Demand model to show and explain how the supply of a product decreases
and the demand for that product simultaneously (concurrently) increases will affect the price
and output. Label the axes and the curves.

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Lecture 6 Ch2 – Supply / Demand (Short Answer Question-Solutions)

1) a. Equilibrium price and quantity are $8 and 16,000 units.

At Market equilibrium, Qd = Qs.

b. An increase in the price of gym shoes will cause the demand for sweatshirts to
decrease, i.e., the demand curve for sweatshirts will shift left. The decrease in demand
will result in a decrease in the equilibrium price and quantity of sweatshirts.
(Assuming Sweatshirts and gym shoes are “complements” – CROSS-ELASTICITY in
Lect 7 ).

c. An increase in the wages of workers in the sweatshirt industry will lead to a decrease
in the supply of sweatshirts, i.e., the supply curve will shift left. This will result in an
increase in equilibrium price (Pe) and a decrease in equilibrium quantity (Qe).

2) a. Set the equations equal to each other (ie Qd = Qs) : 20,000 - 500P = -8,000 + 3000P
and solve for P. Then use either equation or the equilibrium value of P to solve for
equilibrium Q. Equilibrium P and Q are $8 and 16,000 units.

Eg Qd = Qs
20000 – 500P = -8000 + 3000P
3500P = 28000
Therefore P = $8
Substitute P into Qd or Qs :
Qd (Output, Q) = 20000 – 500 (8) = 1600 units

b. The change in the intercept of the supply function implies that supply has increased,
i.e., the supply curve has shifted right. The new equilibrium price and quantity are
(approximately) $7.14 and 16,420 units.

The new Qs1 = - 5000 + 3000P

Qd (unchanged) = 20000 – 500P
Eg Qd = Qs
20000 – 500P = -5000 + 3000P
3500P = 25000
There new P = $ 7.14
Substitute P into Qs1 :
Qs1 = - 5000 + 3000(7.14)
New equilibrium output = 16420 unit.
Additional exercises

1) Ans: equilibrium price must rise, but equilibrium quantity may either rise, fall, or
remain unchanged (ie undetermined).

If demand increases, the demand curve shifts right, therefore price goes up, quantity
output also goes up.

If supply decreases, the supply curve shifts left, therefore price goes up, output
decreases.

As a result, price will certainly increases while quantity output may go up or down
(undetermined).
 Supply & demand model Summary:

Self-practice: additional exercises - use a S/D diagram to show :

Notes:

Supply increases – supply curve shifts to the right – Price Down : Qs up

Supply decreases – supply curve shifts to the left – Price up : Qs down

Demand increases – demand curve shifts to the right – price up : Qd up

Demand decreases – demand curve shifts to the left -- price down : Qd down

Q1. A concurrent (SIMULTANENOUS) Supply decreases & demand increases =

Supply curve shifts up & demand curve shifts up =
price (P) rises & Qty (Q) can be up; equal or down (uncertain)

S1
P ($)
S

D1

Qty

Q2. A concurrent (SIMULTANENOUS) Supply decreases & demand decreases =

Supply curve shifts up & demand curve shifts down =
Price (P) can be up; equal or down (uncertain) & Qty (Q) down
S1

P ($) S

D1

Qty
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Q3. A concurrent (SIMULTANENOUS) Supply increases & demand decreases =
Supply curve shifts down & demand curve shifts down =
Price (P) down; quantity (Q) can be up, equal or down (uncertain)

P ($)
S

S1

D
D1

Qty

Q4. A concurrent (SIMULTANENOUS) Supply increases & demand increases =

Supply curve shifts down & demand curve shifts up =
Price (P) can be up; equal or down (uncertain) & Quantity (Q) up

D1
P ($) S
D

S1

Qty

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Lecture 7 Ch3 – Elasticity Pre-class Exercises (Solutions)

1a) A negative cross-elasticity coefficient indicates the two goods are viewed as
complements.

As such, when the price of peanut butter increases, the demand for grape jelly
decreases and vice versa.

b) An increase in the price of peanut butter would cause a movement up along

the existing demand curve for peanut butter, i.e., a decrease in quantity
demanded (Qd). Because peanut butter and grape jelly are viewed as
complements, this would also cause a decrease in the demand for grape jelly, i.e.,
the demand curve for grape jelly would shift left.

2) Income elasticity = + 2.2 (Normal good)

3) The cross elasticity between butter and bread is – 0.56 (negative), therefore,
butter and bread are complements.

4) Refer to Lecture 7 slide no. 27

Ans : Cross elasticity between mutton and beef is + 2.2; therefore mutton and
beef are substitute. (due to the positive relationship between price of mutton to
quantity demand for beef). Normal goods and inferior goods are irrelevant to
mutton and beef because there is no information about income.

iii) The price elasticity for mutton is -2.75. The absolute value is 2.75. It’s greater
than 1, therefore, it’s price elastic.

v) The demand for beef will increase when the price of mutton goes up. The
demand curve will shift to the right.

vi) The total revenue for mutton at $15 is $750.00. The total revenue for mutton
at $18 is $540.00
When the price of mutton increases, the total revenue reduces -
Therefore, mutton is price elastic.

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5) Suppose that John receives a pay increase. We would expect John’s demand
for:
A. normal goods to remain unchanged
B. inferior goods to remain unchanged
C. inferior goods to decrease
D. normal goods to decrease

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Feedback exercises: Elasticity

Consider cherries and strawberries are substitutes.

1.) Strawberry farmers have a very good year; the production of strawberries
has increased from 600 tonnes to 900 tonnes. The price of strawberries drops
from $16 per kilo to $12 per kilo.

a. Calculate the price elasticity of demand for strawberries?

b. Are strawberries elastic or inelastic?

c. Would you expect the income (total revenue) for strawberry farmers to rise
or fall? Explain.

*Not related to the above question

2.) On the other hand, cherry farmers have a very bad year: 60% of the cherry
crops were destroyed. As a result, the cherry production falls from 600 tonnes
to 360 tonnes and the price of cherries has risen from $10 to $20, while the
quantity demanded for strawberries increases from 400 tonnes to 600 tonnes.

a. Calculate the price elasticity of cherries.

b. Would you expect the cherry farmers’ total revenue (TR) to increase or
decrease?

c. Calculate the cross-elasticity between strawberries and cherries. Are

strawberries & cherries substitutes or complements?

==
Answer:
2a. PED = -1.4 = |1.4|>1, b. elastic. C. strawberries are elastic, P falls, TR
rises.

2a. PED (Cherries) = - 0.75 = |0.75|<1, b. inelastic C. cherries are inelastic, P

rises, TR rises.

2c. CED between strawberries & cherries = + 0.6, therefore, strawberries &
cherries are substitutes.
 Pre-class Short Answer Questions Wk 8 : (Costs & production) SRCC

1) Use the following information on a hypothetical short-run production function to

answer questions a-c.
Units of Labour/Day 5 6 7 8 9
Units of Output/Day 120 140 155 165 168
The price of labour is $20 per day. Ten units of capital are used each day, regardless
of output level. The price of capital is $50 per unit.

a. Calculate the marginal and average variable product of each unit of labour input.
b. Calculate total cost (TC), average total costs (ATC), average variable costs (AVC),
and marginal costs (MC).
c. Can you tell where diminishing marginal returns sets in?

Lab cost Capital (10 unit

Labour output MP AP ($20/lab) @$50/unit )
(TP) TVC TFC TC AFC AVC A(T)C MC
5 120 100 500 600 4.17 0.83 5
6 140 20 24 120 500 620 3.57 0.86 4.43 1

7 155 15 22.2 140

8 165 10 20.6 160
9 168 3 18.6 180

2) Use the following table to answer questions a-c.

Output (Q): 0 1 2 3 4 5 6
Total Cost (TC):$36 $45 $52 $61 $74 $91 $110
a. What is the average fixed cost of producing 4 units of output?
b. What is the marginal cost of producing the third unit of output?
c. At what level of output does the firm encounter diminishing marginal returns?
How do you know?

Additional exercises :
(output) Fixed Variable Total Marginal Average Average Average
Quantity cost cost cost cost variable Fixed Total
(Q) (FC) (VC) (TC) (MC) cost cost cost
(AVC) (AFC) (ATC)
0 50 0 --- --- ---
1 15
2 22
3 33
4 56
5 90
6 130

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d. Sketch the AVC, ATC AND the MC

Q3) Complete the blanks :

TP TC FC MC
Output
0 36
1 45
2 52
3 61
4 74
5 91
6 110

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Pre-class Short Answer Questions Wk 8 : (Costs & production) SRCC - Solutions

1).

Lab cost Capital (10 unit

Labour output MP AP ($20/lab) @$50/unit)
(TP) TVC TFC TC AFC AVC A(T)C MC
5 120 24.00 100 500 600 4.17 0.83 5.00
6 140 20 23.33 120 500 620 3.57 0.86 4.43 1.00
7 155 15 22.14 140 500 640 3.23 0.90 4.13 1.33
8 165 10 20.63 160 500 660 3.03 0.97 4.00 2.00
9 168 3 18.67 180 500 680 2.98 1.07 4.05 6.67

c. Diminishing marginal returns sets in at some point prior to the 5th unit of labour.
Note that MP is declining for 5 - 9 units of labour

2) a. $9 b. $9
c. Between 2 and 3 units of output.
This is the point at which MC begins to increase.

Additional exercise:

(output) Fixed Variable Total cost Marginal Average Average Average

Quantity cost cost (VC) (TC) cost variable Fixed Total
(Q) (FC) (MC) cost cost cost
(AVC) (AFC) (ATC)
0 50 0 50 --- --- ---
1 50 15 65 15 15.0 50.0 65.0
2 50 22 72 7 11.0 25.0 36.0
3 50 33 83 11 11.0 16.7 27.7
4 50 56 106 23 14.0 12.5 26.5
5 50 90 140 34 18.0 10.0 28.0
6 50 130 180 40 21.7 8.3 30.0

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Q3) Complete the blanks :

TP TC FC MC
Output
0 36 36
1 45 36 9
2 52 36 7
3 61 36 9
4 74 36 13
5 91 36 17
6 110 36 19

Sketch the FC, MC and the TC curve

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Ch5 Production & costs (SRCC) Lecture 8

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
1) A firm's production function is the relationship between:
A) the firm's production costs and the amount of revenue it receives from the sale of its output.
B) the inputs employed by the firm and the resulting costs of production.
C) the demand for a firm's output and the quantity it is able to produce with available resources.
D) the factors of production and the resulting outputs of the production process.

2) Which of the following inputs is most likely to be "fixed" in the short run?
A) Labour. B) Raw Material. C) Energy. D) Capital.

3) In the mathematical formulation of the short-run production function:

A) the quantity of capital employed is usually assumed to be fixed.
B) the quantity of both labour and capital must be allowed to vary so that output can vary in the short run.
C) the quantity of output is usually assumed to be fixed.
D) the quantity of both labour and capital employed are usually assumed to be fixed.

Scenario 1: The following is a hypothetical short-run production function:

Hours of Total Marginal

Labour Output Product
0 ___ ___
1 100 100
2 ___ 80
3 240 ___

4) Refer to Scenario 1. What is the total output when 2 hours of labour are employed?
A) 80 B) 100 C) 180 D) 200

5) Refer to Scenario 1. What is the marginal product of the third hour of labour?
A) 60 B) 80 C) 100 D) 240

6) Refer to Scenario 1. What is the average product of the first three hours of labour?
A) 60 B) 80 C) 100 D) 240

7) Refer to Scenario 1. The production function illustrated in the table:

A) incurs diminishing marginal returns beyond the third unit of labour.
B) incurs diminishing marginal returns beyond the second unit of labour.
C) does not incur diminishing marginal returns because marginal product is positive for each unit of labour employed.
D) incurs diminishing marginal returns beyond the first unit of labour.

Scenario 3:
Total Product (Q): 0 1 2 3 4 5 6
Total Cost (TC): $50 $80 $105 $125 $155 $195 $250

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8) Refer to Scenario 3. The average variable cost of producing three units of output is:
A) $15. B) $25. C) $41.67 (approximate). D) $75.

9) Refer to Scenario 3. The marginal cost of producing the sixth unit of output is:
A) $33.33 (approximate). B) $55. C) $200. D) $250.

10) If a firm experiences constant returns to the variable input in the short run,
A) marginal product will be greater than average variable product, and the difference between the two will become larger
as output increases.
B) marginal product will be less than average variable product, but the two will become more equal as output increases.
C) marginal product will be greater than average variable product, but the two will become more equal as output
increases.
D) marginal product and average variable product will be equal over the range of output in question.

11) Economic profits are usually larger than accounting profits.

A) TRUE
B) FALSE
C) It’s all depends on the costs
D) It’s all depends on the revenue

12) Suppose a firm produced 500 units of output but sold only 400 of the units it produced. The average cost of
production for each unit of output produced was $100. Each of the 400 units sold were sold for a price of $80. The total
revenue of this firm would be:
A. $50,000
B. $40,000
C. $32,000
D. –$8,000

13) Which of the following describes the marginal product of labour?

A. the increase in labour necessary to generate a one-unit increase in output
B. the increase in output obtained from a one-unit increase in labour
C. the additional profit created with a one-unit increase in labour
D. the additional cost created with a one-unit increase in labour

14) As the quantity produced increases:

A. average fixed cost decreases
B. fixed cost increases
C. variable cost always decreases
D. none of the above are true

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ESSAY. Write your answer in the space provided or on a separate sheet of paper.
15) Use the following information on a hypothetical short-run production function to answer questions a-c.

Units of Labour/Day 5 6 7 8 9
Units of Output/Day 120 140 155 165 168

The price of labour is $20 per day. Ten units of capital are used each day, regardless of output level. The price of capital is
$50 per unit.

a. Calculate the marginal and average variable product of each unit of labour input.
b. Calculate total cost (TC), average total costs (ATC), average variable costs (AVC), and marginal costs (MC).
c. Can you tell where diminishing marginal returns sets in?

Lab cost Capital (10 unit

Labour output MP AP ($20/lab) @$50/unit )
(TP) TVC TFC TC AFC AVC A(T)C MC
5 120
6 140
7 155
8 165
9 168

16) Use the following table to answer questions a-c.

Output (Q): 0 1 2 3 4 5 6
Total Cost (TC): $36 $45 $52 $61 $74 $91 $110

a. What is the average fixed cost of producing 4 units of output?

b. What is the marginal cost of producing the third unit of output?
c. At what level of output does the firm encounter diminishing marginal returns? How do you know?

Additional exercises :
(output) Fixed Variable Total Marginal Average Average Average
Quantity cost cost cost cost variable Fixed Total
(Q) (FC) (VC) (TC) (MC) cost cost cost
(AVC) (AFC) (ATC)
0 50 0 --- --- ---
1 15
2 22
3 33
4 56
5 90
6 130
d. Sketch the AVC, ATC AND the MC

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Solution Chapter 5 (production) SRCC Lecture 8

1) D
2) D
3) A
4) C
5) A
6) B
7) D
8) B
9) B
10) D
11) B
12) C
13) B
14) A

15) a. b.

Labor Output MP AP TC ATC AVC MC

5 120 -- 24 $600 $5 $0.83 --
6 140 20 23.3 $620 $4.43 $0.86 $1
7 155 15 22.14 $640 $4.13 $0.9 $1.33
8 165 10 20.63 $660 $4 $0.97 $2
9 168 3 18.67 $680 $4.05 $1.07 $6.67

c. Diminishing marginal returns sets in at some point prior to the 5th unit of labour. Note that MP is declining
for 5 - 9 units of labour.

Lab cost Capital (10 unit

Labour output MP AP ($20/lab) @$50/unit)
(TP) TVC TFC TC AFC AVC A(T)C MC
5 120 24.00 100 500 600 4.17 0.83 5.00
6 140 20 23.33 120 500 620 3.57 0.86 4.43 1.00
7 155 15 22.14 140 500 640 3.23 0.90 4.13 1.33
8 165 10 20.63 160 500 660 3.03 0.97 4.00 2.00
9 168 3 18.67 180 500 680 2.98 1.07 4.05 6.67

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16)
a. $9
b. $9
c. Between 2 and 3 units of output. This is the point at which MC begins to increase.

Additional exercise:

(output) Fixed Variable Total cost Marginal Average Average Average

Quantity cost cost (VC) (TC) cost variable Fixed Total
(Q) (FC) (MC) cost cost cost
(AVC) (AFC) (ATC)
0 50 0 50 --- --- ---
1 50 15 65 15 15.0 50.0 65.0
2 50 22 72 7 11.0 25.0 36.0
3 50 33 83 11 11.0 16.7 27.7
4 50 56 106 23 14.0 12.5 26.5
5 50 90 140 34 18.0 10.0 28.0
6 50 130 180 40 21.7 8.3 30.0

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Lect 8 : Ch6 : Production & costs in the LR (Lecture 8) Tutorial Homework Exercises

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
1) Assume a firm uses two inputs, capital and labour. All else constant, an increase in the price of labour would create an
incentive for the firm to:

A) hire less capital while holding the amount of labour employed constant.
B) replace labour by capital in its production function.
C) hire more capital and labour.
D) replace capital by labour in its production function.

2) Long-run average cost is defined as:

A) the minimum average cost of producing any level of output when all inputs are variable.
B) the minimum average cost of producing any level of output when the amount of capital is varied and all other inputs
are held constant.
C) the minimum average cost of producing any level of output when all inputs are fixed.
D) the average of the short-run costs associated with each amount of capital employed by the firm.

3) Which of the following statements concerning the long-run average cost (LRAC) curve is correct?
A) The short-run cost curve at the minimum point of the LRAC curve represents the least-cost plant size for all levels of
output.
B) The LRAC curve is derived from a series of short-run marginal cost curves.
C) As output increases, the amount of capital employed by the firm is held constant along the LRAC curve.
D) The LRAC curve represents the least-cost input combination of inputs for producing each level of output.

4) Economies of scale are illustrated by:

A) a flat long-run average cost curve.
B) a downward sloping long-run average cost curve.
C) an upward-sloping long-run average cost curve.
D) a downward-sloping short-run average total cost curve.

5) All else constant, an improvement in technology at each scale of operation would cause:
A) a movement down an industry's LRAC curve.
B) a movement up an industry's LRAC curve.
C) a downward shift of an industry's LRAC curve.
D) an upward shift of an industry's LRAC curve.

6) The "minimum efficient scale" of operation in an industry is defined as:

A) the scale of operation by firms in an industry that is least efficient.
B) the smallest number of firms that could effectively meet demand for an industry's output.
C) the smallest plant size that can be operated by firms in the industry.
D) the scale of operation at which economies of scale are exhausted.

ESSAY (self-study)

Write your answer in the space provided or on a separate sheet of paper.

1) Assume a new technology is developed that increases the productivity of capital and creates additional economies of
scale. How would this affect the firm's minimum efficient scale of operation? Illustrate this effect graphically.
Solution Ch 6 - LRCC
Ch6 : Production & costs in the LR (Lecture 8) Tutorial Homework Exercises

1) B
2) A
3) D
4) B
5) C
6) D

ESSAY (self-study)

1) The increase in the productivity of capital would result in a decrease in the short-run and long-run average costs of
production. This is illustrated by a downward shift of both curves. In addition, the increased economies of scale implies
declining long-run average costs over a greater range of output. Thus, the firm's minimum efficient scale, i.e., the level of
output at which economies of scale are exhausted, would increase. As such, the minimum point on the firm's LRAC curve
would occur at a higher level of output than before the change in technology.
 Market Structure 1

Ch 7 Perfect Competition Home exercises (Lecture 9)

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
1) Which of the following is not a characteristic of perfect competition?
A) Large number of firms in the industry.
B) No barriers to entry or exit.
C) Firms face downward-sloping demand functions.
D) Outputs of the firms are perfect substitutes for one another.

2) The manager of a perfectly competitive firm has to decide:

A) the quantity of output the firm should produce and the price it should charge.
B) the price the firm should charge for its output.
C) the quantity of output the firm should produce.
D) neither the quantity of output the firm should produce nor the price it should charge because the market makes both
of these decisions.

3) The demand curve faced by the individual perfectly competitive firm is:
A) elastic or inelastic depending on price. B) perfectly elastic.
C) unit elastic. D) perfectly inelastic.

4) Marginal revenue is equal to:

A) the change in price divided by the change in output.
B) the change in P x Q due to a one unit change in output.
C) the change in quantity divided by the change in price.
D) price, but only if the firm is a price searcher.

5) Assume a perfectly competitive firm is producing a level of output at which MR < MC. What should the firm do to
maximize its profits?

A) The firm should decrease output.

B) The firm should increase output.
C) The firm should increase price.
D) The firm should do nothing it wants to maximize the difference between MR and MC in order to maximize its
profits.

6) When a firm is producing at the profit maximizing level of out put and P > ATC, the firm is:
A) earning an economic profit.
B) earning a profit or incurring a loss depending on the level of total fixed costs.
C) breaking even.
D) incurring an economic loss.

7) Assume a perfectly competitive firm is producing 300 units of output, P = $10, ATC of the 300th unit is $8, marginal
cost of the 300th unit = $10, and AVC of the 300th unit = $6. Based on this information, the firm is:

A) earning an economic profit of $1,200. B) earning an economic profit of $600.

C) incurring a loss of $1,200. D) incurring a loss of $600.

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8) Assume the firms in a perfectly competitive industry are initially in long-run equilibrium and the cost of labor
increases. How will the market adjust over time?

A) Firms will enter the market, causing price to fall until positive profits are eliminated.
B) Firms will enter the market, causing price to rise until losses are eliminated.
C) Firms will exit the market, causing price to rise until losses are eliminated.
D) Firms will exit the market, causing price to fall until positive profits are eliminated.

9) Assume that there is an improvement in the technology used by firms in a perfectly competitive industry that is
initially in long-run equilibrium. In the short run this would cause:

A) cannot be determined with the information given.

B) an increase in the firm's economic profit.
C) no change in the firm's economic profit.
D) a decrease in the firm's economic profit.

10) Assume goods X and Y are complements and are produced in perfectly competitive markets. All else constant, an
increase in demand for good X would cause:

A) a decrease in the number of firms that produce good Y.

B) an increase in the number of firms that produce good Y.
C) no effect on the number of firms that produce either good.
D) a decrease in the number of firms that produce good X.

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ESSAY. Write your answer in the space provided or on a separate sheet of paper.

11) Fill in the blanks to complete the following statements.

"Assume a perfectly competitive market is initially in long-run equilibrium. In the short run, a decrease in raw materials
prices will cause the firm's average costs to ________. As a result, the profits of existing firms will ________. However,
over the long run, this will cause the number of firms in the market to ________, and market price will ________ until
firms once again earn a ________."

12) Use the following pair of graphs, which illustrate the market for corn (which is used to produce corn-based ethanol)
and a representative firm, to answer the following questions.

Figure 7.1

a. Assume policymakers pass a law requiring that all gas sold in the United States contain at least 10 percent corn-based
ethanol. In the graphs above, illustrate the short-run effects of this law. In particular, show how the law would affect
• the short-run equilibrium in the market for corn,
• the short-run demand curve faced by the representative firm, and
• the representati e firm s short-run profit-maximizing level of output.
Label the new curves and equilibrium values using a subscript 2.

b. Next, graphically illustrate how, after the initial changes you illustrated in question 12, the corn market and the
representative firm would adjust back to long-run equilibrium. Label any new curves and equilibrium values using a
subscript 3. After all adjustments have taken place, what has happened to the equilibrium market price, the number of
firms operating in the market and the representati e firm s profits Wh

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SOLUTION Ch 7 Perfect competition Market Structure 1 (Lecture 9)

1) C
2) C
3) B
4) B
5) A
6) A
7) B
8) C
9) B
10) B

11) Decrease; increase; increase; decrease; zero economic profit

12) a. The new market demand curve will shift to the right of the original demand curve, causing market price and output
to increase. This will cause the demand curve faced by the firm to shift up to the new higher equilibrium price. As such,
existing firms will increase output and earn a positive economic profit.

b. The number of firms will increase. This will cause industry supply curve to shift right. The new supply curve intersects
D2 at P1 and a level of output greater than QM. In addition, firms will once again be earning an economic profit = 0.

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 Market structure 2
Monopoly Pre-class Homework exercises for Lecture 10

Short Answer Questions :

Use Figure 8.1, which represents the situation faced by a monopolist, to answer the
following questions.

Figure 8.1

1) For the firm in Figure 8.1, the profit-maximizing (loss-minimizing) price and level
of output for the monopoly firm are:

A) P2 and Q2. B) P4 and Q1. C) P1 and Q1. D) P3 and Q1.

2) The firm depicted in Figure 8.1 is:

A) earning a zero economic profit.
B) earning a positive economic profit.
C) incurring an economic loss but it should continue to operate in the short run so
long as price exceeds average variable costs.
D) incurring an economic loss and should shut down.

3) If so, show the economic profit or zero economic profit or loss in the diagram

4) Assuming instead that the market depicted in Figure 8.1 is perfectly competitive,
the equilibrium price and output would be:

A) P4 and Q1. B) P2 and Q2. C) P3 and Q1. D) P1 and Q1.

5) If so, in a competitive market, is it making a zero economic profit (normal profit,
breakeven), economic profit or loss?

(Monopoly) Q&A Page 1

 Market structure 2

Ch8 Monopoly Homework exercises for Lecture 9

Short Answer Solutions :

1) Ans B : Q1 & P4 (for a profit maximizing monopoly firm, it will charge at a Price =
P1 and produce an output Q1, ie where MR = MC).

2) Ans B : The monopoly firm is making an economic profit. At the output Q1, the
price is P4, the average cost (ATC) is P3, P > ATC, therefore, the firm is making an
economic profit.

3) Economic profit = (P4 – P3) x Q1 (as in the diagram)

4) Ans : B : For the competitive market, the output will be Q2 & the price is P2 (the
MC is the supply curve in a competitive market while the Price curve is the demand
curve). Therefore, the equilibrium level of output is Q2 and the equilibrium price is
P2.

5) At output Q2,
P= P2
ATC = P2

Therefore, P = ATC, it’s making a 0 Economic profit (normal profit, breakeven).

(Monopoly) Q&A Page 2

 Market Structure 1

Perfect Competition Pre-class exercises for Lecture 10

Short Answer questions: Write your answer in the space provided or on a separate sheet of paper.

1) Fill in the blanks to complete the following statements.

"Assume a perfectly competitive market is initially in long-run equilibrium. In the short run,
a decrease in raw materials prices will cause the firm's average costs to ________. As a result,
the profits of existing firms will ________. However, over the long run, this will cause the
number of firms in the market to ________, and market prices will ________ until firms once
again earn a ________."

2) Use the following pair of graphs, which illustrate the market for corn (which is used to
produce corn-based ethanol) and a representative firm, to answer the following questions.

Figure 7.1

a. Assume policymakers pass a law requiring that all gas sold in the United States contain at
least 10 percent corn-based ethanol (ie the demand for corn will increase). In the graphs
above, illustrate the short-run effects of this law. In particular, show how the law would
affect
• the short-run equilibrium in the market for corn,
• the short-run demand curve faced by the representative firm, and
• the representative firm s short-run profit-maximizing level of output.
Label the new curves and equilibrium values using a subscript 2.

b. Next, graphically illustrate how, after the initial changes you illustrated in question 2, the
corn market and the representative firm would adjust back to long-run equilibrium. Label
any new curves and equilibrium values using a subscript 3. After all adjustments have taken
place, what has happened to the equilibrium market price, the number of firms operating in
the market and the representative firm s profits Wh

(Perfect Competition) Q&A Page 1

 Market Structure 1

Perfect Competition Pre-class exercises for Lecture 10

Short answer solution:

1) Decrease; increase; increase; decrease; zero economic profit

2) a. The new market demand curve will shift to the right of the original demand curve,
causing market price and output to increase. This will cause the demand curve faced by the
firm to shift up to the new higher equilibrium price. As such, existing firms will increase
output and earn a positive economic profit.

b. The number of firms will increase. This will cause industry supply curve to shift right.
The new supply curve intersects D2 at P1 and a level of output greater than QM. In addition,
firms will once again be earning an economic profit = 0.

(Perfect Competition) Q&A Page 2

 Market structure

Ch8 : monopolistic competition Homework exercises for Lecture 10

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
1) Which of the following is characteristics is common to both monoply and monopolistic competition?

A) Firms are price setters. B) Long-run economic profit equals 0.

C) A relatively large number of sellers. D) Ease of entry into the industry.

2) The monopolistically competitive seller's demand curve will tend to become more elastic the:
A) smaller the number of sellers.
B) greater the degree of product differentiation.
C) more significant the barriers to entering an industry.
D) larger the number of close competitors.

3) Suppose the firms in a monopolistically competitive market are incurring economic losses. What will happen to move
the market to its long-run equilibrium?

A) The firms that dropped out of the market will reenter once the level of economic losses is zero.
B) The demand functions of all the firms remaining in the market will become relatively more elastic.
C) More close substitutes will appear in the market until economic profits are zero.
D) Firms will continue to exit the market until economic losses are equal to zero.

4) If an industry is characterized by economies of scale:

A) barriers to entry are usually not very large.
B) the costs of entry into the market are likely to be substantial.
C) capital requirements are small due to the efficiency of the large-scale operations.
D) long-run average costs of production increase as the quantity the firm produces increases.

1
Short answer question. Write your answer in the space provided or on a separate sheet of paper.

Question 1) Use Figure 8.2, which represents the situation faced by a monopolist, to answer questions a-c.

Figure 8.2

a. In Figure 8.2, indicate the profit maximizing price and output level and label them P1 and Q1.

b. Shade in the area that represents the firm's economic profit (or loss).

c. If this firm wished to discourage entry by other firms it could produce the output level at which it earns only a zero
economic profit. Indicate the price and output level associated with a zero economic profit and label them P2 and Q2.
Ans : (P=ATC)

Question 2) Compare and contrast the potential for a perfectly competitive firm and a monopolistically competitive firm
to earn positive economic profits in the short run versus the long run. Explain your reasoning.

2
SOLUTION - Ch 8 Monopolistic competition Lecture 10

1) A
2) D
3) D
4) B

Question 1 :

Question 2) Both firms can earn positive economic profits in the short run. So long as price is greater than average total
cost at the profit-maximizing level of output, a firm will earn a positive economic profit.

In the case of both of these types of firms, however, long-run economic profits will equal 0. This is because of the
assumption of ease of entry and exit (resource mobility). To be specific, if existing firms are earning positive profits, this
will encourage entry by new firms.

Entry will continue until all positive profits are competed away and firms are earning an economic profit of 0. At this
point there is no incentive for either entry into, or exit from, the market.

3
Ch 9 Oligopoly Lecture 10 (Homework tutorial exercises)

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
1) The key distinguishing characteristic of an oligopoly is the:
A) presence of long-run economic profits.
B) near total absence of advertising.
C) mutual interdependence of the firms in the market.
D) fact that in all cases firms produce a standardized product.

2) Which of the following best describes the basic characteristics of non-cooperative oligopoly models?
A) When making decisions, managers basically ignore the mutual interdependence that exists among rivals.
B) Managers make decisions based on the strategy they think their rivals will pursue.
C) Managers attempt to deliberately mislead their rivals regarding the strategy they will pursue.
D) Managers refuse to negotiate with their rivals when it comes to such decisions as what price to charge.

3) The assumption that rival firms will match a firm's price decreases but not its price increases is a basic feature of:

A) the kinked demand curve model. B) model of limit pricing.

C) the predatory pricing model. D) cartel theory.

4) According to the kinked demand curve model, if an oligopolistic firm lowers its price, it should expect to see its total
revenue:
A) decrease
B) stay the same.
C) increase.
D) cannot be determined without more information.

5) The dominant strategy for each of the players in the prisoner's dilemma game does not yield the optimal outcome for
each player because:

A) the two players are not allowed to communicate or otherwise cooperate with each other.
B) the players do not understand the consequences of each of the choices they can make.
C) each player is misinformed about the decision that has been made by the other player.
D) each player fails to consider how the other player might act.

6) In order for "entry deterrance pricing" (limit pricing) to be effective, the firm practicing such a strategy must be able to
charge a price that is:

A) lower than the potential entrant's ATC but greater than the firm's own AVC.
B) greater than the potential entrant's ATC but lower than the firm's own ATC.
C) greater than the potential entrant's ATC but lower than the firm's own AVC.
D) lower than the potential entrant's ATC but greater than the firm's own ATC.

7) Entry deterrence pricing (Limit pricing) is used primarily to:

A) drive other firms out of a market.
B) discourage new firms from entering a market.
C) reduce (limit) the profits of all of the firms in the industry.
D) establish a minimum price all of the firms in the market will charge.

1
8) To maximize joint profits, a cartel must determine the level of output at which:
A) joint marginal revenue equals the marginal cost of the smallest member of the cartel.
B) marginal revenue equals joint marginal cost.
C) the horizontally sum of the members marginal cost curves is at a minimum.
D) joint marginal revenue equals the marginal cost of the largest member of the cartel.

9) Assume the firms in an oligopoly produce a differentiated product and are initially colluding. If each firm begins to
cheat (to increase sales) by under pricing the other firms, as the amount of cheating increases, the resulting industry price
and output will approach the outcome for:

A) perfect competition. B) non-cooperative oligopoly.

C) non-cooperative monopoly. D) monopolistic competition.

10) It has been observed that whenever one imported beer distributor raises its price, other imported beer distributors
quickly raise their price as well. Such behaviour is characteristic of:

A) the kinked-demand curve model of oligopoly.

B) price leadership.
C) explicit collusion.
D) the barometric-firm model of price leadership.

ESSAY. Write your answer in the space provided or on a separate sheet of paper.
11) Use the information in the following table, which summarizes the payoffs (i.e., profit) to two firms that must decide
between an average-quality and a high quality product, to answer the questions that follow:

Firm 2
Average Quality High Quality
Firm 1 Average Quality 600, 600 400, 1100
High Quality 1100, 400 900, 900

a. What is each player's dominant strategy? Explain your reasoning.

b. Referring to the table above, is this an example of a prisoner's dilemma game? Why or why not?

c. Is there a Nash equilibrium? If so, what is it?

12) What is the significance of the mutual interdependence among the firms in an oligopolistic market?

2
Solution : Ch 9 – oligopoly (Lecture 10)

1) C
2) B
3) A
4) A
5) A
6) D
7) B
8) B
9) B
10) B

11) a. Firm 1's dominant strategy is to go with the high quality product. Note that if firm 2 decides to go with the average
quality product, firm 1 maximizes its profits by choosing the high quality product. If firm 2 decides to go with the high
quality product, firm 1 is still best off choosing the high quality product as well. Using the same reasoning, firm 2's
dominant strategy is to go with the high quality product.

b. This is not an example of the prisoner's dilemma. Note that each party is as well off as they would be with cooperation.
Joint profits are maximized when each firm chooses to go with the high quality product.

c. The dominant strategies comprise the Nash equilibrium. Each firm knows that the other firm will choose the high
quality product. Thus, it does likewise.

12) The assertion that the firms in an oligopolistic market are mutually interdependent means that the decisions of one
firm have an effect on the decisions of the other firms in the market. This stems from the fact that each of the dominant
firms in the market possesses a relatively large market share. Thus, for example, if firm A decides to raise its price, the
other firms are likely to leave their prices unchanged in anticipation of being able to take away part of A's market share.
This could result in a significant decrease in A's revenues and a corresponding increase in the revenues received by its
competitors.

3
Ch10 Pricing (Lecture 10)

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
1) The practice of setting price by increasing the average costs of production by some percentage is referred to as:
A) mark-up pricing. B) average cost pricing.
C) rate-of-return pricing. D) percentage pricing.

2) When the marginal revenue resulting from a decrease in price is negative (TR falling), demand for the product is:
A) inelastic.
B) elastic.
C) unit elastic.
D) cannot be determined without more information.

3) Assume the price elasticity of demand for a product is - 4. In this case, the firm's optimal mark-up is (approximately):

A) 400 percent. B) 100 percent. C) 33 percent. D) 25 percent.

4) Assume there is a decrease in the number of substitutes for a good produced by a profit-maximizing price-setting firm.
All else constant, this would cause the firm's ability to markup price above average cost to:

A) increase.
B) decrease.
C) stay the same.
D) cannot be determined with the information given.

5) Third-degree price discrimination refers to situation in which:

A) a firm divides a market into thirds and charges each segment a different price.
B) a firm is able to charge the maximum price consumers are willing to pay for each unit of output.
C) a firm separates markets according to the price elasticity of demand.
D) a firm charges different prices for different blocks of output.

ESSAY. Write your answer in the space provided or on a separate sheet of paper.
8) Many restaurants offer "early-bird specials" to dinner customers. These specials consist of a significant price reduction
on selected menu items purchased before some pre-determined time, e.g., 6 p.m. Is such a practice a form of price
discrimination? If so, what type?

1
SOLUTION Ch10 Pricing Lecture 10

1) A
2) A
3) C
4) A
5) C

8) "Early-bird specials" are indeed a form of price discrimination; specifically, third-degree price discrimination. In this
case, the restaurant is dividing customers into two distinct markets; one consisting of people who prefer to eat dinner
earlier and another consisting of people who prefer to dine later in the evening. It is also worth noting that the "early"
group generally consists of senior citizens who frequently live on fixed incomes and, as such, are more sensitive to price.
It is also routinely observed that senior citizens tend to prefer eating dinner earlier than their younger counterparts.

2
Game Theory Practice :

Question 1:

Mary

Comply (L) Cheat (R)

John Comply (U) 250, 250 500, 200
Cheat (D) 200, 500 300, 300

Question 2 :

Firm B

Average High
quality (L) Quality (R)
Firm A Average
Quality (U) 600, 600 400, 1100
High
Quality (D) 1100, 400 900, 900

Question 3:
Kmart

R&D (L) No R&D (R)

Target R&D (U) $7M, $7M $10M, $1.5M
No R&D (D) $1.5M, $10M $4.5M, $4.5M

Game Theory Page 1

 Question 4:
JB Hifi

High Price (L) Low price (R)

Bing Lee High price
(U) $3.5M, $3.5M $10M, $8M
Low Price
(D) $8M, $10M $14M, $14M

Question 5 (not examinable):

Ben

Do not
Advertise (L) advertise (R)
Advertise (U)
Joe
Don’t
Advertise (D)

Question 6:
Samsung

High Low
production production
High
iPhone
production $40M, $40M $60M, $30M
Low
production $30M, $60M $50M, $50M

Game Theory Page 2

Question 7:
Australia

High tariffs Low tariffs

High tariffs $20M, $10M $4M, $20M
NZ
Low tariffs $10M, $2M $2M, $4M

Questions:

1) Is there any dominant strategy for each player?

2) Is there “NASH” equilibrium?

3) Where is the ‘NASH’ equilibrium and the outcome in the matrix?

4) Does the Nash equilibrium outcome maximise the total payoff to players?
(Is the outcome optimal or sub-optimal? )

5) if so, is it a ‘Prisoner’s Dilemma’ case?

Answer:

Q1) The dominant strategy for Mary is to ‘comply’.

The dominant strategy for John is to ‘comply’.
The ‘NASH’ equilibrium is both Mary & John to ‘comply’ on the left top
quadrant.
The outcome is ‘sub-optimal’ for Mary and John, both individually will make
$250, both of them are worse of compared to both ‘Cheat’, therefore it’s a
case for Prisoner’s Dilemma.
Mary & John will be better off when both ‘cheat’! If so, both individually will
make $300, a total of $600.

Q2) The dominant strategy for Firm A = High Quality.

The dominant strategy for Firm B = High Quality.
The ‘NASH’ equilibrium is on the right hand bottom quadrant, both Firm A &

Game Theory Page 3

Firm B choose ‘High Quality’.
The outcome is ‘optimal’ for both firms, therefore No Prisoner’s Dilemma.

Q3) The dominant strategy for Kmart is with R&D.

The dominant strategy for Target is with R&D.
The ‘NASH’ equilibrium is on the top left hand quadrant, both Kmart & Target
choose ‘R&D’.
The outcome is ‘optimal’ for both firms, therefore No Prisoner’s Dilemma.

Q4) The dominant strategy for JB HIF is low price.

The dominant strategy for Bing Lee is low price.
The ‘NASH’ equilibrium is on the bottom right hand quadrant, both JB HIFI &
Bing Lee choose ‘Low price’ strategy.
The outcome is ‘optimal’ for both firms, therefore No Prisoner’s Dilemma.

Q5) Not examinable

There are two ‘NASH’ equilibrium; there is also a ‘mixed NASH’ equilibrium –
not required in this course.

Q6) The dominant strategy for iPhone is to ‘high production’.

The dominant strategy for Samsung is to ‘high production’.
The ‘NASH’ equilibrium is both iPhone & Samsung to ‘high production’ on the
left top quadrant.
The outcome is ‘sub-optimal’ for iPhone & Samsung (both firms only make a
total profit of $80M), therefore it’s a case for Prisoner’s Dilemma. [the optimal
outcome is when iPhone & Samsung both choose ‘Low production’ and make a
total profit of $100M).

Q7) The dominant strategy for Australia is ‘low tariffs’.

The dominant strategy for NZ is ‘high tariffs’.
There is a ‘NASH’ equilibrium’ in this game, where Aust Low; NZ high; This is
not a case for “Prisoner’s Dilemma” because Australia is better off.

Game Theory Page 4

Special case:
Woolworth

Do not
Advertise advertise
Coles Advertise $400M, $400M $200M, $500M
Do not
advertise $500M, $200M $100M, $100M

1) Is there any dominant strategy for each player?

2) Is there “NASH” equilibrium?

3) Where is the ‘NASH’ equilibrium and the outcome in the matrix?

4) Is the outcome optimal or sub-optimal?

5) if so, is it a ‘Prisoner’s Dilemma’ case?

Answer:

1) There is no dominant strategy for Coles & Woolworth.

Therefore, No NASH equilibrium (in our case). (However, if you are interested,
there is a mixed NASH equilibrium to be learnt). No required in this course.

Game Theory Page 5

Game Theory Page 6
Pre-class Short Answer Questions Week 11 : Monopolistic competition

SOLUTION -

Short Answer question:

Question 1 :

Question 2) Both firms can earn positive economic profits in the short run. So long as price is greater
than average total cost at the profit-maximizing level of output, a firm will earn a positive economic
profit.

In the case of both of these types of firms, however, long-run economic profits will equal 0. This is
because of the assumption of ease of entry and exit (resource mobility). To be specific, if existing firms are
earning positive profits, this will encourage entry by new firms.

Entry will continue until all positive profits are competed away and firms are earning an economic profit
of 0. At this point there is no incentive for either entry into, or exit from, the market.
Pre-class short answer questions for Week 11: Oligopoly 0

Short Answer question Solution:

1) a. Firm 1's dominant strategy is to go with the high quality product. Note that if firm 2 decides to go
with the average quality product, firm 1 maximizes its profits by choosing the high quality product. If
firm 2 decides to go with the high quality product, firm 1 is still best off choosing the high quality
product as well. Using the same reasoning, firm 2's dominant strategy is to go with the high quality
product.

b. This is not an example of the prisoner's dilemma. Note that each party is as well off as they would be
with cooperation. Joint profits are maximized when each firm chooses to go with the high quality
product.

c. The dominant strategies comprise the Nash equilibrium. Each firm knows that the other firm will
choose the high quality product. Thus, it does likewise.

2) The assertion that the firms in an oligopolistic market are mutually interdependent means that the
decisions of one firm have an effect on the decisions of the other firms in the market.

Assumption for the “Kinked Demand Curve”:

This stems from the fact that each of the dominant firms in the market possesses a relatively
large market share. Thus, for example, if firm A decides to raise its price, the other firms are
likely to leave their prices unchanged in anticipation of being able to take away part of A's
market share. This could result in a significant decrease in A's revenues and a corresponding
increase in the revenues received by its competitors.
Pre-class Short Answer questions for Week 11: Pricing

Short Answer Question :

Write your answer in the space provided or on a separate sheet of paper.

1) Many restaurants offer "early-bird specials" to dinner customers. These specials

consist of a significant price reduction on selected menu items purchased before some
pre-determined time, e.g., 6 p.m. Is such a practice a form of price discrimination? If so,
what type?
Pre-class Short Answer Questions for Week 11: Pricing

Short Answer Solutions:

1) "Early-bird specials" are indeed a form of price discrimination; specifically, third-

degree price discrimination.

In this case, the restaurant is dividing customers into two distinct markets; one
consisting of people who prefer to eat dinner earlier and another consisting of people
who prefer to dine later in the evening.

It is also worth noting that the "early" group generally consists of senior citizens who
frequently live on fixed incomes and, as such, are more sensitive to price. It is also
routinely observed that senior citizens tend to prefer eating dinner earlier than their
younger counterparts.