# answers-f01 - Department of Economics University of...

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Econ 121 Fall 2001 Page 1 Midterm Exam Answers Department of Economics Fall 2001 University of California Woroch/Lopez/Pinsonneault Economics 121 SUGGESTED SOLUTIONS FOR MIDTERM EXAM I. TRUE or FALSE or UNCERTAIN and EXPLAIN : For each 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; if appropriate, provide a diagram. Each question is worth 7 points for a total of 28 points. 1. The two-product cost function C(q 1 , q 2 ) = 100 + q 1 + q 2 + q 1 q 2 exhibits falling ray average cost when two units of q 2 are produced for each unit of q 1 . FALSE If we let a bundle (q) be one unit of q 1 and two units of q 2 , then: RAC(q) = C(q, 2q) / q = (100 + q + 2q +q*2q) / q = 100/q + 3 + 2q To see if RAC(q) is falling, we can check the derivative: dRAC(q)/dq = -100 / q 2 + 2 RAC(q) is falling when the derivative is less than zero, i.e. when –100 / q 2 + 2 < 0 &L 100 / q 2 > 2 &L q 2 < 50 So, RAC falls until the square-root of 50, but then it rises. 2. In an industry composed of two equal-sized firms, if a new firm enters at the same time that the two incumbent firms merge, the change in the HHI will indicate that the industry is more concentrated. TRUE Before the merger, there are 2 firms of equal size, so HHI is equal to ½ , which is the minimum HHI possible with 2 firms. After the merger and entry, there are again two firms. So, the only way that the HHI will not indicate that the industry is more concentrated is if the two firms after merger/entry are of equal size (which seems unlikely). 3. An airline may find it profitable to offer an “express service” that allows a passenger paying an additional \$100 per ticket to go through separate security check-in lines even though those lines are no different than existing ones. TRUE Because express service saves time, all would prefer it, though some would value it less than \$100. This partitions consumers into two groups based on willingness to pay for this benefit. If zero marginal cost of service, then profit increases. This is just like the Paris Metro example. 4. In the Hotelling model with one store located in the middle of Main Street, a monopolist’s price does not change as consumers’ transportation cost increases. UNCERTAIN This depends on the initial level of the transportation cost. If the initial transportation cost was high enough such that initially the monopolist served less then the entire market, then an increase in the transportation cost will have no effect on price because price is (v+c)/2 and doesn’t depend on t. If the

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Econ 121 Fall 2001 Page 2 Midterm Exam Answers initial transportation cost was low enough such that the monopolist initially serves the entire market, then the monopolist is charging a price of P = v – t/2. An increase in the transportation cost will cause the monopolist to either keep full coverage by dropping price or to drop the price to (v+c)/2. Either way, the monopolists price will change when the monopolist is initially serving the entire market.
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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 Berkeley.

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answers-f01 - Department of Economics University of...

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