Tutorial 5A Perfect Competition 1) Identify the truthfulness of the following statements for a competitive profit maximising firm in the short-run: |. The firm never produces where P < AVC. Il. The firm never produces where TR < TC. a. Both | and II are true. b. Both | and II are false. c. lis true; Il is false. d. Lis false; Il is true. Answer: (c) 2) Identity the truthfulness of the following statements for a competitive profit maximising firm: |. Profit maximisation implies that the firm will produce where P = MC. UI-The firm only produces if P 2 AC in the long run. a. Both | and Il are true. b. Both | and Il are false. c. lis true; Ilis false. 4. Lis false; Ilis true. ‘Answer: (a) Copyright Ting Mun Kwong212 3. Consider a competitive industry with several identical firms. You are given the following information about this industry. Market demand, Q° = 100 — 5P Market supply, QS = 20P Total cost function of a firm, C(q) = 2+ © Here P is the market price and q denotes the output of the representative firm (a) Find the equilibrium market price; the output of each firm; and the number of firms in the industry. (b) Would you expect to see entry into or exit from this industry in the long run? (c) What is the market price at which no further entry or exit would occur and the industry would be in long run equilibrium. (d) The government grants a unit subsidy of $1 to every firm. Will this raise the output of each firm and lower the market price in the long run? (a) At equilibrium, Market demand = Market supply So, Q? = QS = 100 — 5P = 20P P=4 and Q = 20P = 80. cq)=24+% => MC=q In a competitive industry, firms produce where P = MC=> 4 = q Number of firms n= £= = 20 (b) As P =4andq=4, m= Pq—C(q) =4(4)-2-S=6>0 Since the profit is positive, new firms will enter the industry. (0) In long run, firms are making zero profit. i =249 Mc=q, AC=i+$ So, MC = AC > it $=q = q=2and-.Ac=2 The long run equilibrium price is 2 4) (q)=2+ £- 4, Mc 1, AC +$-1 So, MC = AC => 4 $-1=q-1 => q=2remains unchanged. *. AC = The long run equilibrium price, p = 1 is lower than before. Copyright: Ting Mun KwongTutorial 58 Monopoly 1 ‘A monopolist maximises profits when: Select one: a) Average revenue equals average cost. b) Average revenue equals marginal cost. c) Marginal revenue equals average cost. d) Marginal revenue equals marginal cost. Answer: (d) With full (perfect) price discrimination, equilibrium output of the monopolist is: Select one: 2 ) The same as in a non-discriminating monopolist )_ Less than in a non-discriminating monopolist. ) The same as perfect competi )) The same as in monopolistic competition. Answer: (c) s eo Copyright: Ting Mun Kwong.3. A monopolist has two customers with the following demand functions: Q=70-P, Demand of customer 1 Q,=110-P, Demand of customer 2 MC = 10 Monopolist's marginal cost Here Pi is the price charged to customer i and i € {1, 2} The monopolist has a constant marginal cost of 10, and no fixed costs. a) Suppose the monopolist can differentiate between the customers, and the customers cannot trade between themselves, allowing the monopolist to engage in third degree price discrimination. What is the monopolist’s profit and the price charged to each customer? What is the total surplus? b) Now suppose the monopolist cannot differentiate between the customers and must charge them the same price. Calculate the monopolist's optimal single price P as well as the quantity sold to each customer. What is the total surplus? Copyright: Ting Mun Kwong.Page |3 a) Third degree price discrimination — monopolist charge different prices for different markets. Customer 1 Customer 2 P,=70-Q P, = 110-Q TH = (70 - QQ, = 100, W= (110 — Q2)Q2 — 10Q2 mm = 60Q,- G w= 100Q, — Q3 FE = 60- 20, =0 R= 100- 2Q, =0 Qi = 30, P, = 40. Q2 = 50, P, = 60. Monopolist's profit, 1 = 1, + mt = (PAC )Qi — (P2— AC2)Q2 = (40 — 10)30 + (60 - 10)50 = 3,400 P® Customer 1 P Customer 2 110 70 40 60 De 30 a 50 Q 1 1 C8, = 5 (70 ~ 40)(30) = 450. CS, = 5 (110 ~ 60)(50) = 1,250 Total surplus = monopolist's profit + consumer 1 surplus + consumer 2 surplus = 3400 + 450 + 1250 = 5,100 Copyright: Ting Mun Kwong,b) It is market segmentation with uniform price. Q, = 70-P, and Q, = 110-P, Aggregate demand, Q = Q, + Q: =70-P, + 110-P, = 180 -2P =90-5Q 1 PQ- TC = (90 - £9) Q— 109 = 809 -+ 2 an ae _ 4g = 80- Q=0. ~ Q = 80. SoP = 50. Q=70- Q = 110~P = 110-50 = 60 Monopolist’s profit, m= TR — TC = 50(80) — 10(80) = 3,200. 0-50 = 20 P® Customer 1 P Customer 2 110 70 50 50 Dy De 20 a 60 0 Cs; = $ (70 50)(20) = 200. CS, = 5 (110 ~ 50)(60) = 1,800. Total surplus = monopolist's profit + consumer 1 surplus + consumer 2 surplus 200 Total surplus = monopolist's profit + consumer 1 surplus + consumer 2 surplus = 3400 + 450 + 1250 = 5,100 = 3200 + 200 + 1800 = The total surplus under single pricing is higher as 5,200 > 5,100. The single pricing extracts lesser consumer surplus than that under price discrimination. Copyright: Ting Mun Kwong.Page |1 Tutorial 6 Oligopoly 1 Which market structure is characterised by a long-run equilibrium where price is equal to average cost, but is greater than marginal cost and marginal revenue? a) perfect competition b) monopolistic competition ©) oligopoly d) monopoly. Answer: (b) It an imperfectly competitive firm is producing a level of output where marginal cost is equal to marginal revenue, marginal revenue is below average variable cost, and price is equal to average total cost, then the firm: a) should shut down b) should decrease output, but should not shut down c) should increase output d) none of the above is correct Answer: (d) Copyright: Ting Mun Kwong212 3. Suppose there are two identical firms in an industry. The output of firm 1 is denoted by qi and that of firm 2 is denoted by qe. Each firm can produce output at a constant marginal cost of 3. There are no fixed costs. The inverse demand curve is given by P = 30 — Q, where P is the market price. a) Find the Cournot-Nash equilibrium quantity produced by each firm and the market price. b) Suppose firm 2 can only produce 3 units due to licensing regulation, how much will firm 1 produce? ©) Suppose the two firms collude and share the profit equally. Find the market output, price, and profit of each firm. d) What would be the quantities produced by each firm and market price under the Stackelberg duopoly if firm 1 moves first? a) m = Pai — C(q1) = (30 - gi ~ G2 — 3)q1 = (27 — G1 ~ G2) 28 = 27-2q,-q2 =0. eq(1) dar By symmetry, due to similar cost function, qz = =... ...eq(2) Solving equations (1) and (2), qi = a -q; =9. Substitute into eq(1), q2 =9 Market quantity, Q = q; + q2 = 18. Market price, P= 30 — 18 = 12 b)qi= c) The monopoly profit function, 1 = (P — 3)Q = (30- Q-3)Q = (27- QQ Sh = 27-2Q=0. .Q=135. P=30-Q= 165 w= (27 -QQ= (27 — 13.5)13.5 = 182.25 18225 _ 91 4) «Profit of each firm, m = d) From eq(2), q2 Firm 1 profit function, m; = (30 — qi — 42 — 3)q: = (27-41 - anor Substitute qz = 7% (13 5 a )a zap 2-4 into m, : -a Ja: = 6.75 28 = 135-qi:=0. -.q,:=135 and qo Q= a1 +42 = 20.25. P= 30-2025 = 9.75 Copyright: Ting Mun KwongTutorial 7 General Equilibrium 1. In an Edgeworth Box, a reallocation of resources from the initial endowment to any point on the contract curve always constitutes a Pareto improvement. Which of the following statements is correct? {a) True, if the initial endowment bundle is on the contract curve. (b) True, as every point on the contract curve is Pareto efficient. (c) False, if the initial endowment bundle is on the contract curve. (d) True based on the Second Welfare Theorem of welfare economics. (c) is correct. 2. Consider an exchange economy with two goods (1 and 2) and two consumers (A and B). There are 8 units available of each of the two goods. Agent A is endowed with 3 units of X and 3 units of Y. Suppose the utility functions of agents A and B are U = X°5y°s The figure shows an Edgeworth Box for this exchange Which of the following statements is correct? Good X Agent B 9 8 Contract curve Good Y Us: --) Use 3 0 3 3 Agent A Good X (a) The endowment bundle is bundle C. (b) The endowment bundle is bundle A and is Pareto efficient. (c) The endowment bundle is not Pareto efficient because agent A can become better off by trading to point D on the contract curve (d) Agent's B endowment is 5 units of X and 4 units of Y. (b) is correct. Copyright: Manfred Ting Mun Kwong212 3. Consider an exchange economy with two goods (tea and milk) and two consumers (A and B). There are 10 units available of each of the two goods. Consumer A is endowed with 6 units of tea and 4 units of milk. Consumer B is endowed with 4 units of tea and 6 units of milk. The preferences of the two consumers are as follows. Consumer A uses a unit of milk with each unit of tea. Tea and milk are perfect complements for him Consumer B drinks milk and tea separately, and the two goods are perfect substitutes for her. Draw an Edgeworth box and show the area of mutually beneficial trades between the two consumers. Milk and tea are perfect complements for consumer A. Hence, consumer A’s indifference curves are L shaped Milk and tea are perfect substitutes for consumer B. Hence, consumer B's indifference curves are downward sloping straight lines. Tea 4 Fi Milk Milk Mutually « beneficial trades - lo g Tea The endowment point is at point E(6,4). The triangle EYZ is the area of mutually beneficial trades where Consumer A and B can be made better off. Hence point E is Pareto suboptimal.The contract curve is the dashed line, and the line ZA is the part of the contract curve on which equilibrium trades lie Copyright: Manfred Ting Mun Kwong