Economics 121
Page 1
Midterm Suggested Answers
Department of Economics
Fall 2004
University of California
Woroch/Lopez/Sydnor
Economics 121:
MIDTERM SUGGESTED ANSWERS
GENERAL INSTRUCTIONS
:
Write your name
and your TA’s name
on the front cover of each of
TWO BLUE BOOKS.
The exam has 3 parts.
Put Parts I and II.1 in one blue book, and Parts II.2
and III in the second.
Point assignments are given in the instructions for each part.
The exam is
worth 100 points.
You may check your calculation on scratch paper but be certain to put all of your
answers in the bluebooks
.
I.
TRUE or FALSE or UNCERTAIN and EXPLAIN
:
Choose 4 of the following 5 statements,
and decide whether each is true or false or uncertain, and then explain the reasoning behind
your answer in a few sentences; if appropriate, provide a diagram.
Each question is worth 8
points for a total of 32 points.
1. If the costs of producing two goods, 1 and 2, individually and jointly, are given by the cost functions:
C(q
1
, 0) = 125 +
q
1
2
C(0, q
2
) = 200 +
q
2
2
C(q
1
, q
2
) = 250 + q
1
2
+ q
2
2
+ q
1
q
2
then there are economies of scope
between the two products for all levels of production.
FALSE:
Economies of scope exist when the cost of producing the two goods jointly is cheaper than
producing them separately:
C(q
1
, q
2
)
<
C(q
1
, 0) + C(0, q
2
)
250 + q
1
2
+ q
2
2
+ q
1
q
2
<
(125 +
q
1
2
) + (200 +
q
2
2
)
q
1
q
2
< 250-325
q
1
q
2
< 75
Which signifies that economies of scope only exist for when q
1
q
2
< 75.
2. The Lerner Index increases as the number of symmetric Cournot oligopolists increases.
FALSE
:
The Lerner index, the measure of price markups falls as additional firms enter a Cournot
oligopoly.
In the symmetric Cournot oligopoly, the relationship is between the markup L = (P-c)/P and the
market share of an individual firm, s
i
.
As that market share falls, so does the markup.
(You are not
required to remember the exact formula, but the Cournot Oligopoly markup formula is (P-c)/P = s
i
/
η
).
Intuitively, as the number of firms increases, the residual demand faced by any one firm shifts back,
increasing competitive pressure and ultimately driving prices towards marginal costs.
3.
In the normal form game at the rights, if
2 < X < 3
and 3 < Y < 4, then (B1, B2) is a Nash equilibrium
and
it is also Pareto Optimal.
FALSE:
It is true that (B1,B2) is the only (pure
strategy) Nash Equilibrium of the game.
To get full
credit, you would need to show this, either by solving the
game and/or explaining why it is a Nash Equilibrium.
(B1,B2) is a NE because:
Firm 2
A2
B2
C2
A1
2
½
0
2
-1
7
B1
1
-3
Y
X
3
5
Firm 1
C1
4
3
5
1
-2
3