FINAL Exam

# Principles of Macroeconomics (with Xtra!)

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1 Section (pick one): Monday Night Wednesday NAME SOLUTIONS STUDENT NUMBER UNIVERSITY OF TORONTO AT SCARBOROUGH ECM C40F ECONOMICS OF ORGANIZATION & MANAGEMENT Jack Parkinson FINAL EXAM INSTRUCTIONS: 1. Total time for this examination is 2.5 hours. 2. Total marks = 120 3. This test has fourteen (14) pages ! 4. Aids allowed: Non-programable Calculator MARKS PART A Q1 18 /18 Q2 20 /20 Q3 10 /10 Q4 20 /20 Q5 12 /12 Q6 20 /20 Q7 10 /10 PART B 10 /10 TOTAL 120 /120

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PART A Do ALL questions (100 MARKS - Various weights) Q1. (18 Marks) Suppose Linesville is a linear (straight) town 40 kilometres in length with 150 people uniformly distributed over each kilometre. Each person has a demand for two video rentals (per period). A person incurs transportation costs of \$0.15 per kilometre travelled to a store (two-way trip). Suppose each video rental firm has fixed costs of \$1000 (per period) and marginal costs of \$1 per unit rented. Suppose two video rental firms decide to set up, one at either end of the town. Determine their market shares and levels of profit in each of the following cases. A) They both charge the same rental price of \$1 per unit. Explain in words what would happen to your answer if transportation costs double due to a war in Iraq. We are given the following facts: 150 people uniformly distributed per KM (Linesville is 40 KM in length) one store on either end of the 40 KM long straight line city (6,000 customers) demand: rent 2 videos (per trip or per period) transportation cost t = \$0.15 (per KM, two-way trip) firms total costs TC = 1000 + 1q, where q = # of videos rented First, find the physical position (M) of the indifferent consumer (i.e. equal total costs): 2 2 40 P L t M P R t M = + - ( ) ( ) Since P L =P R , we have t(M) = t(40 - M), so that M = 40/2 = 20 (KM point) S So the left store serves the first M KMs of Linesville (i.e. Q L d = 2xMx150) and the right store serves the last (40 - M) KMs of Linesville (i.e. Q R d = 2x(40 - M)x150 ) S Since M=20 (KM) then Q L d = 6,000 = Q R d , both firms have equal market shares (50% market shares) S B L = P L q L - TC L = 1(6,000) - 1,000 - 1(6,000) = \$ - 1,000 = B R (Due to symmetry) S Since P L =P R (i.e. there is no price differentiation) then transportation costs (t) are irrelevant (i.e., there is no differentiation between the two firms; see the math above on how t cancels out; so t can lead to differentiation but only by re-enforcing price differences). Therefore, the change in transportation costs (t) leads to no change in market shares or firm profits. B) Suppose that after transportation costs doubled due to the war that the store on the left side (of town) continues to charge \$1 while the one on the right side raises its price to \$2. 2P L + t(M) = 2P R + t( 40 - M ) 2 + 0.3(M) = 4 + 0.3( 40 - M ), 0.6M = 4 + 12 - 2, M = 14/0.6 = 23.33 S q L d = 2xMx150 =7,000 & q R d = 2x( 40 - M )x150 = 5,000 S Market share of left side firm = q L d /( q L d + q R d ) = 58.33 % S Market share of right side firm = q R d /( q L d + q R d ) = 41.67 % S B L = P L q L - TC L = 1(7,000) - 1,000 - 1(7,000) = \$ - 1,000 S B L = P L q L - TC L = 2(5,000) - 1,000 - 1(5,000) = \$ 4,000
3 Question 1 (continued) C) Each firm charges \$1 per rental (as in part (A)). But suppose now that due to the economic downturn caused by the war consumers demand 1 rental (per period). Compare your answer to that from part (A) and explain the differences.

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