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Unformatted text preview: EEP 100 Spring 2010 Final Answers May 14, 2010 1.(9 points) With the end of the Cold War the U.S. government decided to &downsize¡ the military. Along with a pink slip, the government o/ered exmilitary personnel their choice of $8,000 a year for 30 years or a lump sum payment of $50,000 immediately. The lumpsum option was chosen by 92% of enlisted personnel and 51% of o¢ cers (Warner and Pleeter, 2001). Assuming that all these individuals expect to live at least 30 years, what is the breakeven personal discount rate at which someone would be indi/erent between the two options? What can you conclude about the relative size of the personal discount rates of the enlisted personnel and of the o¢ cers? (Hint: You may treat 30 years as being essentially &forever.¡) Answer: (a). Suppose the breakeven personal discount rate is r*, then we have: 30 X t =1 8000 (1 + r & ) t = 50000 Using the hint, we can write the lefthandside as: 1 X t =1 8000 (1 + r & ) t = 8000 1 X t =1 1 (1 + r & ) t = 8000 1 r & Therefore we have: 8000 1 r & = 50000 ) r & = 8000 50000 = 0 : 16 = 16% i.e. the breakeven personal discount rate is 16%. (b). From the present value formula, we can see that one£s present value of the ¤rst option will be smaller than $50,000 if one£s personal discount rate is greater than r*. Since the lumpsum option was chosen by 92% of enlisted personnel but only 51% of o¢ cers, therefore 92% of enlisted personnel and 51% of o¢ cers should have personal discount rates greater than 16%. 1 2.(9 points) A monopoly has a marginal cost of zero and faces two groups of consumers. At &rst, the monopoly could not prevent resales between groups, so it maximized its pro&t by charging everyone the same price, p = $5. No one from the &rst group chose to purchase. Now the monopoly can prevent resales, so it decides to price discriminate. Will total output expand? Why or why not? What happens to pro&t and consumer surplus? Answer: When the monopoly could not prevent resales, since no one from the &rst group (denoted by group 1 afterwards) chose to purchase at p = $5, then there is no resales from group 2 to group 1 because the price is higher than the choke price of the demand (or the greatest willingnesstopay) of group 1. Now when the monopoly can prevent resales, it will use multimarket price discrimination. Since the marginal cost is zero, then the equilibrium price and quantity of group 2 won¡t change after the price discrimination. Since now there will be another price (lower than $5) for group 1, the new equilibrium quantity of group 1 will be positive. Therefore, the total output will expand after the price discrimination. More over, after the price discrimination, since the cost curves, demand functions, or equilibrium price and quantity won¡t change, and the new equilibrium quantity of group 1 will be positive, therefore the monopoly¡s pro&t will increase and consumer surplus will also increase due to the additional quantity purchased by group 1.group 1....
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This note was uploaded on 02/04/2011 for the course EEP 100 taught by Professor Perloff during the Spring '10 term at University of California, Berkeley.
 Spring '10
 PERLOFF

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