Kami Export - Graded Assignment 7

Graded Assignment 7 Name: ID: 1. Do monopolists charge the highest possible price for their output? Explain. 2. The following represents a single firm's demand schedule. price $14.00 12.00 10.00 9.00 8.00 7.00 6.50 6.00 5.50 5.00 4.50 4.00 3.50 quantity 10 17 25 31 39 50 56 63 71 80 90 101 114 total revenue marginal revenue a. Is this a competitive or monopolistic market? Explain. b. Calculate the firm's total revenue schedule (third column in the above table). Then calculate the firm's marginal revenue schedule (fourth column). c. What is the firm's average revenue at each quantity? Explain. d. Explain why marginal revenue is less than price for this firm. Be precise and use examples (e.g. "when the price is $5.00, marginal revenue is $ because 587 Workbook pages may not be reproduced in any form without the written permission of the publisher.

588 Economics and Public Policy: An Analytical Approach The following represents the same firm's costs. output 10 15 20 25 30 35 40 50 55 60 65 70 75 80 85 90 total cost marginal cost $90 150 185 215 235 250 262 272 280 286 291 295 300 308 318 330 345 365 400 e. Calculate the firm's marginal cost schedule (third column in the table immediately above). f. Graph Total Cost and Total Revenue: g. In terms of this graph, what would a profit-maximizing firm try to do? h. The level of output that maximizes profits (approximately) is Workbook pages may not be reproduced in any form without the written permission of the publisher.

590 Econornics and Public Policy: An Analytical Approach If marginal revenue is greater than marginal cost at the current level of output, a firm output should (pick one): increase/decrease because: p. When this firm maximizes its profits, the market price will be q. Suppose that this firm's fixed costs increase (for example, the government increased its property taxes). Its average total cost will (pick one): increase/decrease/be unaffected Its average variable cost will (pick one): increase/decrease/be unaffected Its marginal cost will (pick one): increase/decrease/be unaffected Explain your answer in each case: "ATC will "AVC will CMC will because: because: because: r. As a consequence of this increase in the firm's fixed costs Its output will (pick one): increase/decrease/be unaffected Explain your answer: "The firm will its output in response to an increase in fixed costs because: s. If the price/quantity relationship in the table at the start of this question was the demand schedule in a competitive market and the output/marginal cost relationship you derived in the second table in this question was the supply schedule for a competitive industry supplying this market, the mar- ket price would be (approximately): t. Compare your answer in s with your answer in p. Explain the reasons for the difference between the two prices: 3. Price discrimination occurs when a supplier is able to charge a different price to each buyer of a good. Joe went to Sandy's Baseball Card Shop to buy a Derek Jeter rookie card. Joe was willing to pay up to $12 for the card but, of course, he hoped to pay less than that amount. No other card shop in the area was selling the card. Sandy was displaying a Derek Jeter rookie card for sale in her shop but without a price tag. She was willing to sell the card for as low as $8 but hoped to receive more for it. Workbook pages may not be reproduced in any form without the written permission of the publisher.

Graded Assignment 7 < 591 a. If Sandy knew exactly how much Joe valued the card but Joe did not know how much Sandy val- ued the card, the card would sell for b. If Joe knew exactly how much Sandy valued the card but Sandy did not know how much Joe val- ued the card, the card would sell for c. Given your answers in (a) and (b), what effect does information about a particular individual's value of a good have on one's ability to negotiate with that individual? 4. Suppose that marginal costs increase for a monopolist. Explain precisely and carefully why a monop- olist cannot simply pass along higher costs to its consumers. 5. In an industry characterized by increasing returns to scale, what would happen if the government pursued a vigorous policy of splitting larger firms with market power into smaller firms without market power? (Hint: Think carefully about the different possible effects on market prices.) What conclusions for antitrust policy are suggested by your answer? 6. Assume that two firms that compete against each other in the same market merge (there may be more than two firms that supply this market). a. In what ways can a merger between two firms be good for the firms? Be specific. b. In what ways can a merger between two firms be good for consumers? Be specific. c. Under what circumstances could a merger between two firms be bad for consumers? Be specific. Workbook pages may not be reproduced in any form without the written permission of the publisher.

Graded Assignment 7 < 593 9. Suppose that the market shares of the basketball shoe market were divided as follows: Company Nike Reebok Adidas Puma Avia Converse Market Share 25% 3% 40/0 8% a. Calculate the fraction of output produced by the four largest firms (This is the "four-firm concentration ratio." ) b. Calculate the four-firm concentration ratio if Puma and Avia merge c. The Herfindahl-Hirshman Index (HHI) for this market (pre merger) is d. If Puma and Avia merge, the HHI is e. Given your answers a through d, explain why the four-firm concentration ratio and the HHI differ: In what sense does the HHI give a more accurate picture of market concentration (when compared to the four-firm concentration ratio)? Be precise. f. Which would most likely adversely affect basketball shoe consumers, a merger of Reebok and Nike or a merger of Puma and Avia? Explain your answer. g. After a merger between Reebok and Nike, would you expect the price of basketball shoes to increase or decrease? Why? 10. OPEC is an oil cartel that works to control global oil prices. Suppose that Jerry is an oil producer that belongs to the OPEC cartel and has agreed at an OPEC meeting to limit his oil sales to 10,000 barrels per month. His marginal cost of extracting oil is $3 per barrel, and the current market price of a bar- rel of oil is $25. a. What might Jerry have the short-term incentive to do (if he did not feel morally obligated to honor his contracts)? Workbook pages may not be reproduced in any form without the written permission of the publisher.

594 Economics and Public Policy: An Analytical Approach b. If all members of OPEC have similarly agreed to restrict oil sales and therefore have incentives sim- ilar to Jerry's, what might happen to the price of oil when OPEC members began acting upon those incentives? c. What can be done to make cartels more stable? d. Is there any difference between the total quantity of production chosen by a monopolist and that chosen by a cartel? Why? 11. Suppose that Hometown Power Company provides power to a large metropolitan region. The com- pany has invested more than $1 billion in hydroelectric and coal-fired power plants and in a web of power lines that covers the city and suburbs. The marginal cost of producing electricity for Hometown Power is constant at just $0.02 per kilowatt hour. Since the cost of building the plants and infrastruc- ture to supply power to the area is so great, Hometown Power Company has a monopoly on electric- ity in the region. a. If Hometown Power Company were allowed to charge any price they wanted for power, would the amount of power produced and sold be greater than, less than, or equal to the economically efficient amount of energy? Explain. b. If the government required Hometown Power Company to sell the energy at P=MC, what would happen to the profitability of the company? Why? (Hint: Remember to consider the firm's fixed costs.) c. Now, suppose that the government required Hometown Power Company to sell that energy at P=ATC. Would the company break even? Why? Would the company have an Economic Profit that is greater than zero? Explain. Would the resulting level or production be greater than, less than, or equal to the economically effl- cient amount? Explain. d. Explain how a government subsidy to the power company could allow the company to sell energy at the economically efficient level of production without incurring a negative economic profit. Workbook pages may not be reproduced in any form without the written permission of the publisher.

596 Economics and Public Policy: An Analytical Approach 14. Suppose that a large drug manufacturing company has a patent on a particular drug that it devel- oped. Suppose, further, that the firm does not incur diminishing returns and, hence, marginal cost does not change with the number of bottles per month of the drug that it produces. The drug company faces a typical demand curve for its drug. a. Graph the firm's marginal cost curve and the market demand curve. Show the market equilibrium price and quantity and the firm's profits. b. Suppose that in order to generate revenue to fund its health care program, the government imposes a tax on each bottle the firm produces. Illustrate the outcome in the above diagram (a different colored pen or pencil will help). Show the new market equilibrium price and quantity and the firm's profits. c. The firm's profits in b must be lower than they are in a. Explain why you could have determined this without graphing anything. d. When the government indicated that it was going to tax the firm's output, the firm responded that since it had a monopoly, it would simply pass the tax along to its consumers and, hence, that the burden of the tax fall completely on consumers. Does the firm's argument make sense? Explain why or why not. Be specific. e. Instead of imposing a tax on each bottle of the drug, suppose that the government imposes a tax equal to the profits illustrated in (b). In the above diagram, show the market equilibrium price and quantity and the firm's profits after this tax is imposed (yet a different colored pen or pencil will help). Workbook pages may not be reproduced in any form without the written permission of the publisher.

Graded Assignment 7 597 f. Explain the results you derived in e in a way that someone who had not taken Econ 110 would understand. 15. True, False, Uncertain (circle one; explain your answer): "Since a monopolist faces no competition, it's free to set its price where it wants." 16. Find an application or example (good or bad) of one of the ideas covered in Chapters 13 or 14 from the Wall Street Journal, the Economist, or the New York Times. Write an at-least-one-page essay dis- cussing the economics of the article you selected. Attach the article or a copy and your essay to this assignment. Workbook pages may not be reproduced in any form without the written permission of the publisher.