FINALF10AnswersExplained

FINALF10AnswersExplained - December 7, 2010 Final Exam...

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December 7, 2010 Final Exam Economics 1 True-False Questions: Fill in Bubble A for True, Bubble B for False. 1. If a monopolist is able to practice perfect price discrimination and it sets prices to maximize its profits, the outcome will be inefficient. Answer: False A monopolist practicing perfect price discrimination charges a different price to every buyer. If it maximizes its profits, it will set prices as high as it can, but it will never sell a unit of the good for less than the marginal cost of producing it. Therefore, for every buyer whose buyer value is greater than the marginal cost of the good, the monopolist will set the price equal to buyer value. All these buyers will buy a unit of the good. For buyers with buyer value less than marginal cost, the price will be marginal cost, and these buyers will not buy a unit of the good. In the end, therefore, every buyer with buyer value greater than the marginal cost of the good will buy a unit of the good, and no buyer with buyer value less than marginal cost will buy. That means the outcome is efficient. Everyone who values the good more than the cost of producing it will obtain the good. No one who values it less than its cost will obtain a unit. The monopolist gains the entire surplus from producing the good. 2. If a monopolist must charge the same price to everyone and its marginal cost is positive, demand will be elastic at the price it charges. Answer: True Suppose that demand were inelastic at the profit maximizing price. Because inelastic demand means that the price effect dominates the quantity effect moving along the demand curve, a small increase in price would decrease quantity and increase total revenue. Because the firm would be producing fewer units of the good, the cost of producing the good would also be lower. So, an increase in the price would increase total revenue and decrease cost. Profit would therefore increase. That means that the firm could not have been at a profit maximizing point.
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3. If a firm in a perfectly competitive market is selling its product for a price greater than the marginal cost of producing it, the firm can increase its profits by producing more. Answer: True In a perfectly competitive market, firms are assumed to take the price as given. That is, they can sell as much as they want at that given price. Marginal cost is the increase in cost from selling one more unit. If price is greater than marginal cost, the revenue a firm would gain from one more unit (the price) would exceed the additional cost of producing that unit (marginal cost) and thus a one unit increase in production would increase profit. 4. In the theory of perfect competition, the pursuit of economic profits by firms entering an industry implies that all firms in the industry will have losses (negative profits) in the long run.
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FINALF10AnswersExplained - December 7, 2010 Final Exam...

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