No government fine true false the expected cost of

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(no government fine) True False The expected cost of the safety flaw to the firm if it does not fix the car is 6 million dollars. It is 7.9 million The executives would fix the car only if they are risk averse. (false: … even if they were risk neutral) In deterring safety flaws, a lower probability of detection means that a higher fine is necessary to obtain the same level of deterrence. In general, an individual with a concave (i.e. negative second derivative) utility function over wealth always exhibits risk averse behaviour. 9. Constructing plastic containers produces air pollutants. Therefore, in the market for plastic containers, True False the marginal social cost curve is above and to the right of the demand curve. the marginal social cost must be increasing. the marginal social cost curve is above and to the left of the supply curve. 6
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there is a gap between quantity supplied and quantity demanded in equilibrium. 10. Other things being equal, the increase in rents that occurs after rent controls are abolished is smaller: True False EITHER ACCEPTED FOR THESE FOUR QUESTIONS the lower is the own price elasticity of demand for rental homes. the more elastic is own price elasticity of demand for rental homes. the closer the own price elasticity of demand for rental homes is to 1.0. the lower the cross-elasticity of demand between rented homes and owned homes. 7
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PART II Long Answer Questions ANSWER 4 OF THESE 5 QUESTIONS. Answer all of the chosen questions in the space provided. Marks are allocated for clear answers. QUESTION 1 (4 marks) A. Explain why a monopolist, if it chooses to sell a positive quantity, always sets a price in the elastic portion of its demand curve. If a monopolist did not do this – i.e. if it set a price in the inelastic part of its demand curve – then an increase in P would raise revenue. Since Q must fall with the increase in P, costs must fall and therefore the increase in revenue would also bring an increase in profits. The firm could not be at a profit-maximizing price, if it is possible to raise profits further. That is, any profit-maximizing price must be at a point where the elasticity of demand exceeds 1. Or: MR = P / (1 – 1/|e| ) and MR = MC which is positive, implying that |e| must exceed 1. (4 marks) B. Explain fully why a competitive market, under ideal conditions (i.e. with no externalities), achieves the socially optimal output level. The competitive equilibrium is at the quantity that maximizes total surplus, as shown in the diagram below: Cons surp S Prod surp D Qc - show that any other quantity results in a lower total surplus. 8
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(7 marks) C. In the competitive market for roses, household demand can be expressed as: Qd = 60 - 5P where Qd is the number of roses demanded per year and P is the price of each rose. Garden supply stores are willing to supply an amount of roses given by the following, providing that the price is at least 5 dollars: Qs = 2 P – 10
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