CARLETON UNIVERSITY ECON1000

CARLETON UNIVERSITY

Department of Economics

ECON 1000 V – Introduction to Economics

2015 Summer

ASSIGNMENT 3: Covers Chapters 12-17. Topics: The design of the tax system, the costs of production, Firms in competitive markets, Monopoly, Monopolistic competition, Oligopoly.

There are three sections: MCQs (section A), T-F (section B), and free response questions (Section C). TOTAL MARKS: 100

The deadline to submit the answersonline(through cuLearn) is June 15 at 11:55 pm. This deadline will be strictly enforced.

PLEASE NOTE THE FOLLOWING

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SECTION A: Multiple Choice Answer any 20 of the following questions (40 marks). Do not attempt more than 20
questions as the extra ones answered will be crossed out.

Identify the choice that best completes the statement or answers the question.

____

1. When government receipts exceed total government spending during a fiscal year, what is the difference? a. a budget surplus b. a budget deficit c. the national debt d. the federal debt Scenario 12-1 Suppose Jim and Joan receive great satisfaction from their consumption of cheesecake. Joan would be willing to purchase only one slice and would pay up to $6 for it. Jim would be willing to pay $9 for his first slice, $7 for his second slice, and $3 for his third slice. The current market price is $3 per slice.

___ __

2. Refer to Scenario 12-1. If a tax of $4 is levied on each slice of cheesecake, how much tax revenue will be generated from sales to Jim and Joan? a. $0 b. $4 c. $8 d. $12

Figure 13-2

The figure depicts a total cost function for a firm that produces cookies.

____

3. Refer to Figure 13-2. What is the relationship between input and output of a production function? a. Output increases at a decreasing rate with additional units of input. b. Output increases at an increasing rate with additional units of input. c. Output decreases at a decreasing rate with additional units of input. d. Output decreases at an increasing rate with additional units of input. Scenario 13-4 A firm experiences decreasing marginal product of labour with the addition of each worker regardless of the current output level.

____

4. Refer to Scenario 13-4. How will average fixed cost behave? a. It will always rise. b. It will always fall. c. It will be U-shaped, first falling and then rising. d. It will remain constant.

Figure 13-3

b. $30.9

c. $40.9

d. $50.9

____ 6. At all levels of production beyond the point where the marginal-cost curve crosses the average variable cost

curve, what happens to average variable cost? a. It rises. b. It rises then falls. c. It falls. d. It falls then rises.

Table 13-3

Teacher’s Helper is a small company that has a subcontract to produce instructional materials for disabled

children in public school districts. The owner rents several small rooms in an office building in the suburbs

for $600 a month and has leased computer equipment that costs $480 a month.

	Output (instructional modules per month)	Fixed Costs	Variable Costs	Total Cost	Average Fixed Cost	Average Variable Cost	Average Total Cost	Marginal Cost
	0	$1080
	1	$1080	$400	$1480				$400
	2						$965	$450
	3		$1350	$2430
	4		$1900			$475
	5		$2500		$216
	6			$4280				$700
	7		$4100
	8		$5400		$135
	9		$7300
	10			$10 880		$980
____	7. Refer to Table 13-3. What is the average variable cost for the month if six instructional modules are produced? a. $180.00 b. $533.33 c. $700.00 d. $713.33
____	8. What happens when a business is operating a factory in the short run? a. The business cannot alter variable costs. b. Total cost and variable cost are usually the same. c. Average fixed cost rises as output increases. d. The business cannot adjust the quantity of fixed inputs.

___	9. If a firm in a perfectly competitive market doubles the number of units of output sold, what will happen to total revenue? a. It will less than double. b. It will exactly double. c. It will more than double. d. It will increase, but by an unpredictable amount.
____	10. When a competitive firm triples the amount of output it sells, what is the result? a. Its total revenue triples. b. Its average revenue triples. c. Its marginal revenue triples. d. Its selling price triples. Table 14-3
	Quantity	Total Revenue	Total Cost
	0	$0	$4
	1	20	14
	2	40	26
	3	60	40
	4	80	56
	5	100	74
	6	120	94
	7	140	116
	8	160	140
	9	180	166
____	11. Refer to Table 14-3. If this firm chooses to maximize profit, it will choose a level of output where marginal cost is equal to what dollar amount? a. $14 b. $16 c. $18 d. $20
____	12. Refer to Table 14-3. If the firm finds that its marginal cost is $24, what should it do? a. It should reduce fixed costs by lowering production. b. It should increase production to maximize profit. c. It should decrease production to maximize profit. d. It should reduce variable costs by lowering production.

Figure 14-2

____	13. Refer to Figure 14-2. When price rises from P3 to P4, which of the following does the firm find? a. Profit is maximized at a production level of Q3. b. Fixed costs are lower at a production level of Q4. c. It can earn a positive profit by increasing production to Q4. d. Average revenue exceeds marginal revenue at a production level of Q4.
____	14. What do we know about the short-run supply curve for a firm in a perfectly competitive market? a. It is likely to be horizontal. b. It is likely to slope downward. c. It is determined by forces external to the firm. d. It is the same as its marginal-cost curve (above average variable cost).
____	15. The competitive firm’s short-run supply curve is that portion of the marginal-cost curve that lies above which average cost? a. average fixed cost b. average variable cost c. average total cost d. average marginal cost
____	16. At the profit-maximizing level of output, which equation is correct? a. Marginal revenue = Average total cost b. Marginal revenue = Average variable cost c. Marginal revenue = Marginal cost d. Average revenue = Average total cost

Figure 14-6

___ 17. Refer to Figure 14-6. When market price is P₁, which area represents a profit-maximizing firm’s total profit or loss?

a. P₁ ? Q₃; profit

b. (P₂ – P₁) ? Q₁; loss

c. (P₃ – P₁) ? Q₂; loss

d. (P₂ x P₁) ? Q₁; profit

____ 18. When a monopolist increases the amount of output that it produces and sells, what happens to the price of its output?

a. It may only increase if the demand is elastic.

b. It may only decreases if the demand is inelastic.

c. It decreases regardless of the elasticity of demand.

d. It increases regardless of the elasticity of demand.

____ 19. When a firm operates under conditions of monopoly, what do we know about its pricing? a. Its pricing is not constrained.

b. Its pricing is constrained by marginal cost.

c. Its pricing is constrained by demand.

d. Its pricing is constrained only by its social agenda.

____ 20. For which of the following firms can marginal revenue become negative?

a. competitive firms, since price is equal to marginal revenue

b. competitive firms, since they are facing downward-sloping demand curves

c. monopoly firms, since they are facing a downward-sloping demand curves

d. monopoly firms, since price is equal to marginal revenue

Scenario 15-2

A monopoly firm maximizes its profit by producing 500 units output (so Q = 500). At that level of output, its marginal revenue is $30, its average revenue is $40, and its average total cost is $34.

____ 21. Refer to Scenario 15-2. At Q = 500, what is the firm’s total cost?

a. $15 000

b. $17 000

c. $20 000

d. $22 500

___ 22. A monopolist faces market demand given by P = 60 – Q. For this market, MR = 60 – 2Q and MC = Q. What price will the monopolist charge in order to maximize profits?

a. $20

b. $30

c. $40

d. $50

____ 23. Which of the following explains the relationship between demand and output capacity of a firm in a monopolistically competitive market?

a. Since it faces a downward-sloping demand curve, it will generally operate with excess capacity.

b. Since it faces a downward-sloping demand curve, it will generally operate at efficient scale.

c. Since it faces a perfectly elastic demand curve, it will generally operate with excess capacity.

d. Since it faces a perfectly inelastic demand curve, it will generally operate at efficient scale.

____ 24. Firms that spend a large amount of money on advertising a particular product are likely to be providing consumers with which of the following?

a. information about the availability of the product

b. information about product price

c. a signal of product quality

d. a good example of wasted resources

____ 25. What can we say about advertisements that appear to convey no information at all?

a. They are usually associated with "infomercials."

b. They are mostly useless to consumers, but valuable to firms.

c. They are mostly useless to firms, but valuable to consumers for their entertainment quality alone.

d. They may convey information to consumers by providing them with a signal that firms are willing to spend significant amounts of money to advertise.

___ 26. According to the signalling theory of advertising, how do consumers respond to advertising?

a. They pay little or no attention to which firms advertise and which firms do not advertise.

b. They are often more impressed by a firm's willingness to spend money on advertising than they are by the content of the advertisement.

c. They are often more impressed by low-cost advertisements than they are by high-cost advertisements.

d. They gain little or no information about product quality from advertisements.

Scenario 17-1

Assume that the countries of Irun and Urun are the only two producers of crude oil. Further assume that both countries have entered into an agreement to maintain certain production levels in order to maximize profits. In the world market for oil, the demand curve is downward sloping.

____ 27. Refer to Scenario 17-1. As long as production levels are less than the Nash equilibrium levels, what do both Irun and Urun have the individual incentive to do?

a. decrease price

b. decrease production

c. increase production

d. increase price

Scenario 17-3

Consider two cigarette companies, PM Inc. and Brown Inc. If neither company advertises, the two companies split the market. If they both advertise, they again split the market, but profits are lower, since each company must bear the cost of advertising. Yet if one company advertises while the other does not, the one that advertises attracts customers from the other.

____ 28. Refer to Scenario 17-3. What will these two companies do if they behave as individual profit maximizers?

a. Neither company will advertise since they both play dominant strategies.

b. Both companies will advertise since they both play dominant strategies.

c. Neither company will maximize their profits.

d. Both companies will advertise since they maximize the profits.

____ 29. When is predatory pricing best exemplified?

a. when a firm exercises its oligopoly power by raising its price through the formation of a cartel

b. when a firm exercises its monopoly power by raising its price

c. when a firm cuts its prices in order make itself more competitive

d. when a firm cuts its prices temporarily in order to drive out any competition

____ 30. In which of the following markets is tying becoming increasingly important? a. crude oil

b. long-distance phone calls

c. computer software

d. wheat

Scenario 17-4

Assume that a local bank sells two services, chequing accounts and ATM card services. Mr. Tang is willing to pay $8 a month for the bank to service his chequing account and $2 a month for unlimited use of his ATM card. Ms. Gardner is willing to pay only $5 for a chequing account, but is willing to pay $9 for unlimited use of her ATM card. To keep this example simple, assume that the bank can provide each of these services at zero marginal cost.

____ 31. A central issue in the Microsoft antitrust lawsuit involved Microsoft's integration of its Internet browser into its Windows operating system, to be sold as one unit. What is this practice known as? a. tying

b. predation

c. wholesale maintenance

d. retail maintenance

SECTION B: True/False (20 marks, each one carries 2 marks)

Indicate whether the statement is true or false.

___	1. When government receipts fall short of spending, the government is said to run a budget surplus.
___	2. When economists speak of a firm’s costs, they are usually excluding the opportunity costs.
__	3. Accountants keep track of the money that flows into and out of firms.
____	4. Economists and accountants both include forgone income as a cost to a small business owner.
____	5. When a firm experiences zero-profit equilibrium, the firm’s revenue must be sufficient to cover all opportunity costs.

____	6. Declining average total cost with increased production is one of the defining characteristics of a natural monopoly.
____	7. Product differentiation generally leads to some measure of market power.
____	8. Suppose the government of Italy will not allow any restaurants from a leading North American chain to open in Italy. Defenders of the efficiency of brand-name markets would argue that this has hampered restaurant market efficiency in Italy.
____	9. Larger cartels have a greater probability of reaching the monopoly outcome than do smaller cartels.
____ 10. There are some logical economic arguments in favour of resale price maintenance.

SECTION C: FREE RESPONSE QUESTIONS. TOTAL MARKS: 40.ANSWER TWO OF THE FOLLOWING THREE QUESTIONS:

INSTRUCTION: Take a few minutes to plan and outline each answer. In answering the questions, you should emphasize the line of reasoning that generated your results; it is not enough to list the results of your analysis. Include diagrams, if useful, in explaining your answers. All diagrams should be correctly labeled.

Question C1 (20 marks): C1.1

1.1 Use a graph to demonstrate the circumstances that would prevail in a perfectly competitive market where firms are experiencing economic losses. (4 marks)

1.2 Identify costs, revenue, and the economic losses on your graph. (3 marks)

1.3 Using your graph, determine whether this firm will shut down in the short run or choose to remain in the market. Explain your answer. (3 marks)

C1.2.

- Complete the following total for marginal cost. (3 marks)

- How many units of output should this monopoly firm produce in order to maximize its profits? (3 marks)

- What is the market price of the product, and what is the maximum profit? (4 marks)

Quantity Marginal Total Marginal Sold Price Revenue Cost Cost

0 20 – 5

1 19 19 7

2 18 17 10

3 17 15 14

4 16 13 19

5 15 11 25

6 14 9 32

7 13 7 40

8 12 5 49

9 11 3 59 10 10 1 70

Question C2. 20 marks.The graph below shows the demand curve (D), marginal revenue curve (MR), marginal cost curve (MC), average total cost curve (ATC), and long-run average total cost curve (LRATC) for a monopolist.

Using the numbers given in the graph, identify each of the following for the profit-maximizing monopolist.

(a) The quantity produced

(b) The price

(c) The allocatively efficient quantity

(6 marks)

(d) At the profit-maximizing quantity from part (a) is the monopolist experiencing economies of scale? Explain (2 marks)

Now assume that the monopolist produces 10 units. Using the numbers given in the graph,calculate each of the following. Show your work.

(e) The monopolist’s economic profit

(f) The consumer surplus

(g) The deadweight loss

(6 marks)

(h) At what quantity is demand unit elastic?

(2 marks)

Suppose the monopolist perfectly price discriminates and chooses the quantity that maximizes profit. Determine the dollar value of each of the following.

(i) The monopolist’s profit

(j) The consumer surplus

(4 marks)

Question C3 (20 MARKS)

Question C3A: Prisoner’s dilemma

Question a1: What is prisoner’s dilemma? Explain the idea/dilemma in terms of the following story ( 4 marks):

Bonnie and Clyde have been captured. The police have enough evidence to convict them on a weapons charge (sentence = 1 year), but suspect that they have been involved in a bank robbery. Because they lack hard evidence in the crime, they need at least one of them to confess.

The police lock the two in separate rooms and offer each of them a deal: “We can lock you up for 1 year. However, if you confess to the bank robbery and implicate your partner, we will give you immunity. You will go free and your partner will get 20 years in jail. If you both confess, we won’t need your testimony and will avoid the cost of a trial, so you will both get 8 years.”

Questions:

a2. What is Bonnie’s dominant strategy and why? Explain (2 marks) a3. What is Clyde’s dominant strategy and why? Explain (2marks)

a4. Would both the better off if they had remained silent? Explain. What leads them to break silence leading to an inferior outcome? (3 marks)

Question C3B. Oligopolies as a Prisoners’ Dilemma

Example: Jack and Jill are trying to keep the production of water low to keep the price high. After reaching an agreement, each individual must decide whether to follow the agreement.

Suppose that they are faced with the following decision:

Figure 2

		Jack’s	Decision
40L	30L
Jill’s Decision	40L	$1600 profit for Jack $1600 profit for Jill	$1500 profit for Jack $2000 profit for Jill
30L	$2000 profit for Jack $1500 profit for Jill	$1800 profit for Jack $1800 profit for Jill

Question b1. What is jack’s dominant strategy? Explain (3 marks)

Question b2. What Jill’s dominant strategy? Explain (3 marks)

Question b3. Total profit would be highest if both produced at a low rate? Would they do that? Why or why not? (3 marks)

Question b4. Case Study: OPEC and the World Oil Market: As a cartel is OPEC any exception to the lesson learned from Jill and Jack’s fictitious example? Explain (2 marks)