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Econ 500 Spring 2021 Final Exam

Please clear your desk of any material except for a stack of BLANK paper, your pens or
pencils and a calculator. This is a closed book/notes exam.

Please keep your video on at all times. Make sure your microphone is working but muted.

Close all applications and browser windows except for Blackboard.

We reserve the right to ask any student to share their screen or show their surrounding at
any point during the exam.

Failure to follow these instructions or any other behavior that might jeopardize the
integrity of the exam will result in an F for the exam as well as other sanctions imposed by
the Office of Judicial Affairs.

This exam has 9 short answer questions and 5 problems.

In part 1 #1-8 are worth 4 points each and #9 worth 5 points for a total of 45 points.
In part two P1 is worth 15 points and P2-P5 are worth 10 points each for a total of 55 points.

Once you are done with these questions you can attempt a bonus question worth 5 points.
Total time allowed is 2 hours. Good luck.
 1. State the monopoly pricing rule and manipulate it to derive an index to measure monopoly power.
How does monopoly power relate to price sensitivity?

L P markup
Learner Index
Y
tale Revenuefunition ofprile P Itall M P
price sensitivity
If
monopolypricing

L markup Ppm Ffg d pre sensitivity is elasity

Marketpower is inversely proportional to

prileas tonsumers get lessandlesspricesensitive
Lowprilesensitivity consumersallowfirms to exercisemarketpower

02 C1 Ec 1 marketpowerloss
perfestcompetitive market power absolute E 1 market power Max

L2 0.5 0 0.561

2. If utility is given by U=4X2 + Y2 and PX = 2, PY= 1, I = 400, what is the utility maximizing combination of X
and Y?

44 24
I
It uxrxa.a
may not

8X 2d od 4X
Utility
24 a o d v4
minimizing
Y.LY
400 2 24 i Utilitymaximizing combination
100 4200

Utility 400 2X Y
maximizing x o 4400 Ux 4 0 4002 160000
2002 0 160000
You 200 by 4
 I
LR profits
mayattractnewfirmstoentry until P ATC
3. At its current profit maximizing quantity, a perfectly competitive firm finds that its AVC is rising and its
ATC is falling. What can this firm expect to happen in the short run and in the long run? Illustrate and
explain.

iii
iiiiii no in
9
Perfectlyrompetitive market in fm m

In the short-run, the rm will continue producing at the pro t maximizing quantity where MC=MR. The rm will earn positive
economic pro ts if P > ATC. The rm may experience decreasing pro ts or losses if AVC<P<ATC. The rm will not shut down production
o
as long as P>AVC. stilloperate
In the long-run, more rms will enter the market by the positive economic pro ts, increasing industry supply. This increase in industry
supply will lead to a decrease in price. As price falls, the rm’s economic pro ts will decrease and may eventually turn into losses. If the
rm continues to experience losses in the long-run, it may consider exiting the market.

whenATCsMa AVC P MC thecompanyis lossprofitbutstilloperate

AVC is risingandATC isfalling InLR P MC ATC stay inthemarket
4. Suppose that the private marginal benefit and private marginal cost in a competitive market are
PMB=100-Q and PMC=20+Q respectively. If there is an external marginal cost EMC=Q/2 that is being
ignored, what would be the Pigouvian tax necessary to restore the socially efficient equilibrium?

PMR too Q SM PMC EM

PMS 20 2 20 at IQ
EMS EQ wt Q

SMI PMB SMI 20 32 68

20 3Q 100 Q 0 32 PMS Tax SMC
250 80 0 32 Tax 68 12032 16
5. Briefly describe illustrate the property of diminishing marginal rate of technical substitution? How is
MRTS related to marginal productivities of the inputs? What is the necessary assumption on cross
marginal productivities to ensure diminishing MRTS? (Don’t derive the assumption just state it)

MRTS measureshowmuchcapitalcan bereplacedbyanadditionalunitoflaborwithoutchangingoutput

Itrepresents a firm'sinternalsubjectiveabilitytosubstitutelaborandlapital

A
tradeoff MRTS 8C

I Hatising mais
E T
I MPL MPK
Labor'sabilityto substitute

L K belomeslessandless

29 0 39 so co 82
Mp AP AP
MP AP AP
6. Is a binding price ceiling always good for consumers? Why or why not?

Prileceiling
m
in
T.it ii man

if A Be0 Ocsso a bindingprileceiling is goodforconsumers

if ABoo as co abindingprileleiting isnotgoodforconsumers

Q Q
7. If a perfectly competitive firm has the total cost function TC = 75+500Q-5Q2+0.5Q3 and is indifferent
between shutting down and continuing to operate in the short run, what is the firm’s per unit loss?

To 75 5000 505 0.503 FC 75 VC 5000505 0.513

AN
5000
89050 500 50to.se

AUCis minimum
JAY 5 2 0
05
Firmis indifferent between shuttingdownand tontinningto operate intheshort run

P ATC 75 5000 502 01503 7510 500 Ja e502

Q
ATC 502.5

Is P 502.5 487.5 15

8. Find the Bertrand Nash equilibrium if two firms with the demand functions QA=36-3PA+2PB and

QB=36-3PB+2PA are competing in prices.

1
TA PA 363Pat21331 TB PB363PM2pA
36 GPA 2133 0 36 GPB 2Pa 0

PA 3133 18 313Pa18 18
span PA 9pA54 18
72 SPA PA 9
PAPB 9 QA 3627 18 27
QB 36 3 9 2 9 27

I
 9. How much would the deadweight loss change if two firms with identical total cost functions TCi = 80Qi
move from competing as Cournot duopolists to competing as Stackelberg duopolists facing the market
demand P = 800 – Q . (5pts)

Cournot Is 800101021Qn 800

5 a a an sodaQian ai 8002
Th 1800 Qatar Q 800 7200 QQ Qz
Sova a QQ 800
72001 Qi Qian
82 720 a 20 o

720 201 an Q2 7259

48054 720
80 800 a
720502 401 1440 7ntQ as 7202240 0 720
301 720 Or241
7 0 a 240
24 720
P Soo 1240240 320
320 800 Q
DWL 13208071720 4807 1 8
Q 480
ait 7201 Q 800
Stackelberg T 800
80001 Ita 3601 a 800
8 2 210,1 360 0

72001 EQT 3600 360 01 0 Q 360

2600 IQ Qr 720 180

1 800 1360180 260 i DWL 26080270540721 16201

94 800260540

ΔDWL 28800 16200 12600

 P1. Consumer Theory - 15 points
The utility a consumer derives from the consumption of two goods x, and y is given by
U ( x, y ) = xα yβ
The consumer has an income of I and the prices of the two goods x and y are px and py respectively.
a) Set up the Lagrangian for the consumer’s utility maximization problem, derive the first order
ix y conditions, and solve for the utility maximizing levels of x and y as a function of the consumer’s income
and the prices of the two goods. (4 pts)
b) Derive the indirect utility function and the expenditure function. Find the expenditure necessary to
six achieve a utility level of 400, when the prices are px = 10 and py = 4 and when α = 0.25 β = 0.75 (4pts)
c) What is the reduction in the price of good X necessary to increase the consumer’s utility score by 25%
(4pts) Px
d) Plot a linear approximation to the demand for good X based on the X consumption levels at Px=10 and
the reduced price level found in part C. Calculate and illustrate the approximate dollar equivalent of the
utility increase in part C under the demand function you just plotted. (3pts)

from 00

EE
my a Is If
If I PxX PyY

Indiret
off yr α ae p a is PE Pyβ α β

1 3540.401
iii I
it Intrease consumer'sutility
byo.is
1.50 1.25400 too
75075
4 75.0.25 a opx

41
py 4441e70291 opx 10 4.0911 5.9034
0
P2. Market Structures – 10 points
Compare and contrast perfect competition and monopoly in terms of the nature of product, price
sensitivity, entry barriers, market power, and welfare consequences (allocative and productive
efficiency). Graphically illustrate the long run equilibria of the two market structures and the welfare
consequences therein.

If Atemin
Monopoly

ATC
ATC
P MR

perfect tompetition monopoly

Natureofprodust Pricesensitivity Entrybarrier Marketpower welfare silos

entlomp
Nodifferention prod.ef
No peNo
High NoDWL PMC min
High

monopoly low High Absolute pulso no no low

 P3. Imperfect Competition – 10 points
Suppose that two firms with identical marginal costs MC=30 are serving a market with the inverse
demand curve P = 130 – 0.25Q .
a) What would be the Cournot-Nash equilibrium in this market? (Price, quantities and profits) (3 points)
b) What would be the Stackelberg outcome if one firm is able to move first? (3 points)
c) What would be the cartel outcome? (2 points)
d) How much can the cartel increase its profits if it moves from typical per unit pricing to perfect price
discrimination? (2 points)

Me30 Pe130 o.UA T 300

a cournot Nash a altar
T PQTC zoosa
PQ 300 01 200 0.5200 0.50
130o.isQ Q2DQ1 30Q Q 100 0.50 Qi 133.3
130 0.2501 0.2502701 300
133.11
1300 e.zsai o.vsa.de300 01 P 130 o.isQitQn 63.325

10091 0.250,20.5092 02 133.33 Ti Th 63.31530 133.33 4444.56

The 10022 e2502 o.ssa.az

b Stalkelberg

8 so assai
I anana no Q 200 Q2 2000.501 100 D 130 dis 300 55
130 e.isQit2oo o5Qi1 Q1 20Q The45307 200 5000
No 0.11501 5070 3001 Th 5530 100 2500
180 0.125a an 2001 5001 a1250
aviatti

130 0.5070 300 9 92100

Boa e2502300 F 180307 200
10000
1000 0.250 Th Th 5000
100 0.50 0
0 200 P 1300.250 80
Pertant
13030 400 12200000

41 11
07 20000 10000 10000

30 Intrease 10000

400
 P4) Producer Theory – 10 points
Suppose a firm with a production function given by Q = 5𝐾 . 𝐿 . wage rate is $30 per unit and rental
rate of capital is $15 per unit.
a) Find the total cost increasing output from 500 to 600 units in the short run and in the long run. (6
points)
b) Should this firm relocate if it has access to input markets at an alternative location where w=32 and
r=12? (4 points)

9511820 WITH W 30 r 15

mm k sL

at Q 500 Q2600

LR 500 5K L 5182108 40L

4 12.5
45 2.5 15 00 1875 Is s xiro
zss sk
EI
421 248.832
o.sj 2
capitaldoesn't chagein

b w 38 r 12

3
Mm I 34 321 K L

72 2250 WL rK
321 1 L 15008 14.0625
2150 5 467.15
9 600
2250 1601 0
141
i Should NOTrelocatebesmalleroutputw samelost
P5. Market Interventions – 10 points
The current equilibrium price in a market is P=18 and the equilibrium quantity is Q=120
Price elasticity of demand is estimated to be εD=-1.4
Price elasticity of supply is estimated to be εS=+1.8
a) Reconstruct linear demand and supply functions for this market.
b) Compare the effects of $2 subsidy versus a price floor at $20.

1 18 0 120 120 4 18 6 120 12 18 61 P 288 QD

ED 1.4 b 288 b 96
Es 1.8
E
8 14 899 1
ELIS it za
e
i EÉ
c
is
am Ps Pptv
as a 42.67 surplus
is
Pn 1014 620 5Pa so
20 ricefloor
as 51 4 inst

101.3 120130.8144 a

pilefloor Prileceiling
in
as
E A
in
annum
1 mind
100 in Q QdÑ
AP Q
Bonus question: (5 points)
A representative firm in a competitive industry has the cost function is TC = 5q3 – 25q2 + 1250q.
a) What is the long run equilibrium price and quantity for each firm? (2pts)
Y
b) If the demand is Qd=1250-2.5p. How many firms are there in the industry in the long run? (2pts)
c) If demand increases to Qd=2500-5p how many firms would enter? (1 pt)

TC 593259412509
a LR
595259 1250
1892509 1250
MC
9
MC ATC 1592509 150 595259 1250
1092 259 0
295 59 0
p.GL fists
b 3
Qd 12502.5 50 2.5 1218.75 1796.875
offirms 1794875 179 875 718.75

c Qu 2500 sp 1250 5 1218.75 31.25

offirms 3 5 31 5 12.5
 Econ 500 Fall 2020 Final Exam

Please clear your desk of any material except for a stack of BLANK paper, your pens or
pencils and a calculator. This is a closed book/notes exam.

Please keep your video on at all times. Make sure your microphone is working but muted.

Close all applications and browser windows except for Blackboard.

We reserve the right to ask any student to share their screen or show their surrounding at
any point during the exam.

Failure to follow these instructions or any other behavior that might jeopardize the
integrity of the exam will result in an F for the exam as well as other sanctions imposed by
the Office of Judicial Affairs.

This exam has 9 short answer questions and 5 problems.

In part 1 #1-8 are worth 4 points each and #9 worth 5 points for a total of 45 points.
In part two P1 is worth 15 points and P2-P5 are worth 10 points each for a total of 55 points.

Once you are done with these questions you can attempt a bonus question worth 5 points.
Total time allowed is 2 hours. Good luck.
 1. What is the relationship between demand elasticity and market power for a monopolist? How can
market power be measured and indexed? Illustrate and explain.

2. If utility is given by U=4X2 + Y2 and PX = 2, PY= 1, I = 400, what is the utility maximizing combination of X
and Y?

04 4 Px 2 Py I 1 400 400 2 4

MRS

Ux 4002 160000
2002 160000
UY 4
3. At its current profit maximizing quantity, a perfectly competitive firm finds that its AVC is rising and its
ATC is falling. What can this firm expect to happen in the short run and in the long run? Illustrate and
explain.

4. What is Cap and Trade? How does it relate to emission standards and fees? How does it help in
keeping emissions at the socially efficient level and discovering the price of pollution?

The government sets an emission cap and a quantity of emission allowance related to cap. Firms must hold
allowance for CO2/gas that they emit, rms can buy and sell allowances, the market can set emission prices.
5. Briefly describe illustrate the law of diminishing marginal productivity and its implications for average
and marginal product curves. Can average productivity increase while marginal productivity is falling?

Y MRS mmHg

ΔY
slopeof curvedecreasing

when a variableinput L is addedtofixedlapital1k

hp MPhasshortgoingdown

6. Is a binding price floor always good for suppliers?

7. If a perfectly competitive firm has the total cost function TC = 75+500Q-5Q2+0.5Q3 and is indifferent
between shutting down and continuing to operate in the short run, what is the firm’s per unit loss?

isIndifferent

1451 0 505 0.503

M I Joo tout 50Th
o sato.ae too 1oa N5Q
Q 50 0
a sat asa 9 5 Qr O
AVS 500 50 0.50 If
500 100 1.5 a
5 5
IIIIs Hexatta
487.5 5 487.5 5 751
75
perunitloss I 15

8. What circumstances can necessitate a monopoly? Can a monopoly ever be desirable from a social
welfare perspective?

Terminalbarrier economies state marketshare

Legal barrier
I tethnology ownership
uniqueresouries
governmentprotection regulation
intellectual property
right
socialwelfare leadtoinnovation
provide stableservice
9. How much would price change if two firms with identical total cost functions TC = 80Qi move from
competing as Cournot duopolists to competing as Stackelberg duopolists facing the market demand
P = 800 – Q . (5pts)

7 80Qi P 800 Q 8 720 201 Q 0

Cournot 0 01 0 01 360 ÉQu

I anana soa a.no E Ei iso a

80001 Q QiQu 800 Q 180 Qi 240 02 240
72001 Qi QQ Pe800 240 2 320
Ti Th 3to 8 24040 115200

Stackelberg
to za8 3oo ixia
a.jo 360 01 0
800 Q 02701 80 21 360 02 36051360 180 0 540
800 Q1 360 201121 800 P 800 360180 260
440 2017Q1 800 7 26080713604180 97200
440Q IQ Soa
36001 Iai
 P1. Consumer Theory - 15 points
The utility a consumer derives from the consumption of two goods x, and y is given by
U ( x, y ) = xα yβ
The consumer has an income of I and the prices of the two goods x and y are px and py respectively.
a) Set up the Lagrangian for the consumer’s utility maximization problem, derive the first order
conditions, and solve for the utility maximizing levels of x and y as a function of the consumer’s income
and the prices of the two goods. (4 pts)
b) Derive the indirect utility function and the expenditure function. Find the expenditure necessary to
achieve a utility level of 100, when the prices are px = 2 and py = 8 and when α = 0.25 β = 0.75 (4pts)
c) What is the reduction in the price of good Y necessary to double the consumer’s utility level (4pts)

C
d) Calculate and illustrate the approximate dollar equivalent of this utility increase under the Marshallian
demand function. (3pts)

Ib Expenditurefunition

51
a VI PxPy 100
I ftp
BI E 992.1
if β1

1 999265 29125
e.is
75
e75 OPy 83.174 4.826

pye
Py 2.278 Py 3.174

75
Idl E doux 2 g 1985.29
25 0.750.75
e 25
ΔE 1985.29992.65 99264 Thereis anintreaseof992.64
P2. Market Structures – 10 points
Compare and contrast perfect competition and monopoly in terms of the nature of product, price
sensitivity, entry barriers, market power, and welfare consequences (allocative and productive
efficiency). Illustrate the long run equilibria of the two market structures and the welfare consequences
therein.
 P3. Imperfect Competition – 10 points
Suppose that two firms with identical marginal costs MC=20 are serving a market with the inverse
demand curve P = 110 – 0.25Q .
a) What would be the Cournot-Nash equilibrium in this market? (Price, quantities and profits) (3 points)
b) What would be the Stackelberg outcome if one firm is able to move first? (3 points)
Yc) What would be the cartel outcome? (2 points)
d) How much can the cartel increase its profits if it moves from typical per unit pricing to perfect price
discrimination? (2 points)

12110 0.250 MC20

at Cournot Nash Q a Q2
900.501 0.25 o P 1100.251120 1201
I a an a 200 9 180 0.502 02 1800.50 P 50
1110 0.50 0.250270 200 i Qi 180 0.51180 0.5011
11001 o.zsdi e 5aa 20 01 180 90 0.250
God e250 e 5QQr a.za go Q1 Q2120
The9002 0.2502 0.250,02 F The50 20 20 3600 117201
bi Stackelberg
01 180 0.502 P 110 0.50 45 0.2501 0
Th PQ MCQ

IE Ema fE.iiEiiiii
if 110 0.501 45 0.1250170 200
a
Ti 42.5207 180 4050
a
4050 205 6075
65 0.1250 Q 200 Fr 42.524 90 2025 profitis to
6501 0.1250 wQ
4501 0.12505
c Cartel
Pa Maa
1100.25010 200 area
1100 0.502200 D 11002590 87.5
9000150
180 12 8100
1101 4
87.5
W

90 180 y
P4) Producer Theory – 10 points
Suppose a firm with a production function given by Q = 5𝐾 . 𝐿 . wage rate is $20 per unit and rental
rate of capital is $10 per unit.
a) Find the total cost increasing output from 500 to 600 units in the short run and in the long run. (6
points)
b) Should this firm relocate if it has access to input markets at an alternative location where w=16 and
r=8? (4 points)

a 5K w n r 10 R
if age
s
a so

8 7t1.57 K
K E.it
ai
4 24.736 4 181.886 I
SR capitalfixed K 151.572
000 5 151.572
8 t

2458.6
IE IIHm
OTs 563.96

b 4 11 8 8 0 60LR TCCTC WLtlok

4 81
i SmallerT
TC 164 8k Yes thefirmshould relolate
 P5. Market Interventions – 10 points
The current equilibrium price in a market is P=18 and the equilibrium quantity is Q=120
Price elasticity of demand is estimated to be εD=-1.5
Price elasticity of supply is estimated to be εS=+3.75
a) Reconstruct linear demand and supply functions for this market.
b) Compare the effects of $2 subsidy versus a price floor at $20.

P 18 9 12 En 1.5 Es 3.75
ai it as
D 1.5
1 8 to

3.75 is EE Ia 33

i
61 2 subsidy

Ps Pptv
as

ii.it
Ii
Pd 16.571 Ps 18.57
i Em

1 as
pricefloor 2 is A B

Exist 100 in a
no
Qs 100 251323
430 25Ps Ps 17.2
Bonus question: (5 points)
A representative firm in a competitive industry has the cost function is TC = 5q3 – 25q2 + 1250q.
a) What is the long run equilibrium price and quantity for each firm? (2pts)
b) If the demand is Qd=1250-2.5p. How many firms are there in the industry in the long run? (2pts)
c) If demand increases to Qd=2500-5p how many firms would enter? (1 pt)

at TC 59 1591 12509 b Qd offirms 179 875

I 718.75

1796.875

MC
If 1592 509 1250 C Qd 2500 57
1218.75
ms 35 75 1437.5

592259150 1591509 1 I
1092259 0
D 1437.5 718.75 718.75

fi I iiE