110w10mid2keyscanned

110w10mid2keyscanned - Brigham Young University Department...

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Unformatted text preview: Brigham Young University Department of Economics Economics 110 — Principles of Economics Professor Kerk Phillips — Winter Semester 2010 Midterm #2 key 3/11 (Thu) — 3/12 (Fri) Testing Center This test is short answer and short essay. Write your answers in the space provided on this exam. The exam is closed book and closed notes. There is no time limit and you may use calculators; either those provided by the testing center or your own as long as it is not a programmable calculator. Read all questions carefully before answering. Section 1 Short Answer (5 points each) |. What is the difference between monopoly and oligopoly in terms of consumer welfare? Monopoly will give a larger loss of consumer surplus on average. However, if the firms in the oligopoly can effectively eollude they could replicate the monopoly outcome and the loss of CS would be the same in both cases. 2. Which type of competition among oligopolists is more likely to approximate the perfectly competitive outcome, price or quantity competition? Why? Price competition will tend to lead more quickly to a competitive outcome because the rewards from cheating on the cartel are higher than with quantity competition. 3. Give an example of a negative consumption externality. Explain. Smoking; it generates health and utility costs via second-hand smoke. Other examples of a similar nature should get full credit. 4. Give an example of a positive production extemality. Explain. A restaurant could generate a positive externality ifit gave offa pleasing smell ofcooked food. Other examples of a similar nature should get full credit. 5. Use a diagram to illustrate the deadweiglit losses associated with an impmt tariff. F A PE 4 A A cs. — Mesa“) 3 61.; + C pw'i—l-cmfl M4 - B - D v Pw deaf»: 13M 393.5 6. Use a similar diagram to illustrate the welfare effects of a subsidy. D A PS 4 AB A it + DE F a A 6K 'Pirso nu '~ C "' C: {iieeritor :gé-ia} w; '3 ti 7. How does monopolistic competition differ from monopoly? With MC there is free entry into the market, at ieast 'm the sense o’i being able to introduce a new variety ofthe good. This causes profits to go to zero in the long-run. 8. What is price discrimination? Charging a higher price to consumers who have a higher willingness to pay. 9. What is a deadwcight loss? The loss from a policy or change in allocation that is not merely distributed to other agents in the economy; i.e. a loss that no one in the economy can capture. 10. Use a diagram to illustrate the deadweight losses associated with monopoly. Rent.“ to Electing? {Qitpflitsgw Or we fiend getmwml AC3 :4 ~{5‘t8 c) we M3 — (De) . “2+ WM? at ‘ LBW.pr Q C (D i t‘ietzlwes‘f tee-r i055 Qn Qt. Section ll Short Essay ( 10 points each) 11. Briefly describe the prisoner’s dilemma and explain how it is related to oligopoly. A strategic game where the best aggregate outcome is to cooperate, but where regardless of the actions of the other party, the best individual outcome is to not cooperate. The result will be the worst outcome in aggregate and individually for both parties. Only if the game is repeated or if there is some enforcement mechanism will the best outcome be realized because of the incentives to not cooperate otherwise. In an oligopoly the best outcome for the group as a whole would be to behave as a monopolist. However, given fixed behavior by the other firms, the best outcome for an individual firm is to overproduce or underprice relative to the monopoly outcome. This means that oligopolies will behave like perfect competition unless there is some enforcement mechanism, perhaps because the game is repeated for many periods. 12. Given what we know about straight line demand curves and what we know about monopolists, does a monopolist sell a quantity that is associated with elastic or inelastic demand? Explain your reasoning. For a straight-line demand curve the upper half is elastic and the lower half is inelastic with the midpoint having an elasticity of one. For a monopolist facing a straight-line demand curve, the marginal revenue curve has the same vertical intercept as the demand curve, but has twice the slope. This means marginal revenue becomes zero when the quantity produced is at the midpoint on the demand curve. Because profit maximizing firms will always choose marginal revenue equal to marginal cost, and marginal cost cannot be negative, it must follow that the quantity produced is less than that at the midpoint on the demand curve. P Hence, monopolists will produce a quantity associated with elastic demand. 13. Explain how a monopolist might produce the socially optimal level of output at the socially optimal price without any government oversight, if the monopolist can perfectly price discriminate. With perfect price discrimination the monopolist will charge each consumer exactly what his/her willingness to pay is. Hence the monopolist will continue to produce and sell goods as long as there is a consumer with a willingness to pay that is greater than marginal cost. Since willingness to pay is the same as marginal social benefit, and marginal cost is the marginal social cost as well, this means the monopolist would be producing the socially optimal quantity. In this case consumer surplus is zero as it is all captured by the monopolist. Section III Model Building and Analysis (20 points) 14. Consider the effects of the proposed “cap and trade” legislation for carbon. Assuming carbon is a pollutant, show consumer surplus, producer surplus, and costs to 3‘d parties under the current regime with no attempt to solve the external ity. Next, consider how an optimal cap on carbon emissions would alter the welfare effects above. Finally, suppose the cap was set a too high a level. Illustrate and comment on this case as well. 1; S +< hJS @w‘é? Praiecwr Sfiplus D (MSMMY‘ fist A‘tE CG? ‘b 3” Riirtf; D’f'Ei’C APS : —F4AB 5 : -(Aac3 p: +CDCF) A€>R=8 'l D hei- imprwt’wa—l m Miami m1 fit/Dn‘dmg Saga! (@545 13% : ’f'tll Au : ~(AB) 1539: Mama} ...
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110w10mid2keyscanned - Brigham Young University Department...

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