# Answers-s04 - Department of Economics University of California Economics 121 MIDTERM EXAM ANSWERS Spring 2004 Woroch/Lopez/Tovar GENERAL

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Econ 121 Spring 2004 Page 1 Midterm Exam Answers Department of Economics Spring 2004 University of California Woroch/Lopez/Tovar Economics 121 : MIDTERM EXAM ANSWERS GENERAL INSTRUCTIONS : Write your name on the front cover of your blue book. The exam has 3 parts and is worth a total of 100 points. Point assignments are given in the instructions for each part. You are encouraged to check your calculations on scratch paper but be certain to put all of your answers in the bluebooks . I. TRUE or FALSE or UNCERTAIN and EXPLAIN : Choose 3 of the following 4 statements, decide whether each is true or false or uncertain, and then explain the reasoning behind your answer in a few sentences. Supply any assumptions you may think necessary to draw your conclusion . Each question is worth 7 points for a total of 21 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) = 75,000 + (1/2) q 1 2 C(0, q 2 ) = 100,000 + (1/2) q 2 2 C(q 1 , q 2 ) = 125,000 + (1/2) (q 1 + q 2 ) 2 then the average incremental cost of good 2 is given by: 2 000 , 25 2 2 2 q q AIC + = . FALSE. IC = C(q 1 , q 2 ) - C(q 1 , 0)= 125,000 + (1/2) (q 1 + q 2 ) 2 - [75,000 + (1/2)q 1 2 ] = 50,000 + (1/2)(q 1 2 + 2q 1 q 2 + q 2 2 - q 1 2 ) = 50,000 + (1/2)(q 2 2 + 2q 1 q 2 ) AIC = (50,000/q 2 ) + (q 2 /2) + q 1 2. Too many firms will enter an industry if after entry the firms behave as Cournot oligopolists. UNCERTAIN. First, consider an industry with constant marginal cost and falling average costs (i.e., positive fixed cost). With such a cost structure, it would be most efficient to have just one firm producing all the production and pricing at marginal cost (or at average cost if there was no way to make up the losses caused by marginal cost pricing). Assuming identical firms in an undifferentiated product market, firms continue to enter until profits are zero as we saw in problem #4 of PS1. The inefficiency occurs because each firm incurs a fixed cost in order to gain its (equal) share of Cournot profits. Second, if the firms offer differentiated products, then there could be too few firms that enter even when they compete as Cournot described. The reason it that a firm is unable to derive a positive profit even when its entry generates a net increase in total welfare, i.e., the increment in consumer surplus is greater than the firm’s loss. This could occur even in the natural monopoly situation described above; it would take the form of an average cost curve everywhere above the demand curve and yet total welfare positive. The same could hold in oligopoly situations because then the firms have less opportunity to generate revenue due to competition. The source of the problem is firms’ inability to extract the full consumer surplus in the form of profits. Linear/uniform pricing is often the culprit. Nonlinear and discriminatory pricing could help in this case to make entry profitable. 3.

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## This note was uploaded on 05/05/2008 for the course ECON 121 taught by Professor Woroch during the Fall '07 term at University of California, Berkeley.

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Answers-s04 - Department of Economics University of California Economics 121 MIDTERM EXAM ANSWERS Spring 2004 Woroch/Lopez/Tovar GENERAL

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