FINALW10AnswersExplained - Final Exam - Winter 2010...

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Final Exam -- Winter 2010 True-False Questions: 1. If a monopolist must charge the same price to all consumers and the marginal cost of producing its output is positive, the demand for its output will be inelastic at the quantity that maximizes its profits. Answer: False Suppose demand is inelastic at a certain level of output. Can that level of output be a profit maximum? No, because a small decrease in output would increase profit. Here’s the logic. A small decrease in output would increase price. Quantity decreases, and price increases. Because the demand curve is inelastic, the price effect dominates and revenue increases. Because the marginal cost is positive, a decrease in quantity would decrease the monopolist’s cost. So, a decrease in quantity would increase revenue and decrease cost. It would therefor increase profits. Another way to see this is to note that marginal revenue is negative when demand is inelastic. A small increase in quantity decreases revenue. A monopolist maximizes profit at the quantity at which marginal revenue equals marginal cost. If marginal cost is positive, marginal revenue can not equal marginal cost where marginal revenue is negative.

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2. When the demand curve for a good is downward sloping and the marginal cost of producing the good is constant, consumers' surplus will be higher with a profit-maximizing monopolist that must charge the same price to all consumers than with a profit-maximizing monopolist that can practice perfect price discrimination. Answer: True The monopolist who must charge the same price to everyone chooses a quantity at which marginal revenue equals marginal cost. That quantity is q* in the graph below. At that quantity, price is p* and consumer surplus is A. A monopolist practicing perfect price discrimination sets every buyer’s price equal to his or her buyer value. Consumer surplus is therefore zero. 3. If a competitive industry with free entry and exit is in long-run equilibrium, any firm that is not currently producing in the industry could not make a profit by entering the industry. Answer: True See the first paragraph of page 232 of Bergstrom and Miller. Check out the last sentence of that paragraph in particular. That’s a succinct definition of long run equilibrium. A demand price marginal revenue marginal cost quantity p* q*
4. If a small increase in a firm's output would decrease its average variable cost, the firm's marginal cost is less than its average variable cost. Answer: True Suppose the contrary. Suppose that a firm’s marginal cost is greater than its average variable cost. That means that the additional cost of one more unit of output exceeds the average variable cost of previous units of output. A small increase in a firm’s output would increase its average variable cost. But, average variable cost falls with increases in output. So, marginal cost can’t be greater than average variable cost.

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This note was uploaded on 12/12/2011 for the course ECON 1 taught by Professor Bergstrom during the Fall '07 term at UCSB.

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FINALW10AnswersExplained - Final Exam - Winter 2010...

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