Dr.

Murasko
ECO 5136: Economic Policy & Applications Homework #1 ANSWERS Chapter 1 1. Problem #1, page 15 in text.

ECON5136

Many examples imperfectly competitive markets are possible. Common ones include: (1) Automobiles, (2) Beer, (3) Telephone/Telecommunications, (4) Jet Aircraft, (5) Patented Pharmaceuticals, and (6) Computer Operating Systems. Barriers to entry, small numbers of firms, and differentiated goods/services all play a role in these examples. 2. Problem #2, page 15 in text. In a perfectly competitive market, each agent is a price taker: decisions of individual firm or consumer do not affect the market price or environment. This, along with a perfectly standardized good, leaves no room for price or non-price strategic behavior. Chapter 2 3. Practice Problem 2.1, page 25 in text. a. A firm will maximize profit where P = MC: = 2 + 10 = 10 2

b. With 50 manufacturers, we aggregate market quantity to Q = 50q: 10 = 50 = 50 = 25 250 2 c. In equilibrium, quantity supplied equals quantity demanded: 25 250 = 6000 50 9

30.56 = 916.67 = $30 Q = 25($30) 250 = 500 , or = 6000 50($30) = 500 9

d. With 50 firms each will produce q = Q/50 = 500/50 = 10 units. Profit will be ($30 x 10) [((2 x 10) + 10) x 10] = $0.

Dr. Murasko
4. Practice Problem 2.4 part a only, page 37 in text. a. We first rearrange demand and supply to find P in terms of Q: Demand: = Supply: = 25 250 = 10 + .04 Now we can make the appropriate substitutions into CS and PS: CS = (a P*)(Q*) = (120 $30) (500) = $22,500 PS = (P* - c)(Q*) = ($30 10) (500) = $5,000 6000 50 = 120 .18 9

ECON5136

5. Problem #1, page 42 in text. (HINT: The area of a right triangle is given as x length x height.) a. Setting inverse demand function equal to the inverse supply function, we obtain the equilibrium quantity: 1,000 - .025Q = 150 + .033Q Q = 14,655.17 We can take price from either the inverse demand or inverse supply function: P = 1,000 - .025(14,655.172) = $633.62 P = 150 + .033(14,655.172) = $633.62 b. We can use the formulas given in the handout to derive consumer and producer surplus: CS = (a P*)(Q*) = (1,000 633.62) (14,655.17) = $2,684,680.59 PS = (P* - c)(Q*) = (633.62 150) (14,655.17) = $3,543,766.66

Dr. Murasko

ECON5136

6. Explain the profit-maximizing production decision of a perfectly competitive firm. Be sure to describe the market structure of perfect competition and the condition that guarantees maximum profit. Perfect competition assumes 1) firms are price-takers, 2) no barriers to entry, and 3) a standardized (non-differentiated) good or service. We know that profit will be maximized in any market structure when firms produce where MR = MC. In a PC market, MR will be equal to price since firms are price-takers: an increase quantity will always yield extra revenue by the amount of the market price regardless of how much is produced by the firm. Therefore a PC firm will maximize profit by producing where P = MC.

7. Problem #3, page 42 in text. a. We set price equal to marginal cost for any of the firms to obtain each firms optimal quantity: MC = 4q + 2 = P 4q = P 2 q = .25P - .5 b. Since the firms are identical, we simply multiply the function from part a by 100 to find the aggregate supply function: Q = 100q = 100(.25P - .5) = 25P 50 Rearranging to get P in terms of Q: Q = 25P 50 P = 2 + .04Q c. Suppose market demand is P = 10 - .06Q. What will be the short-run equilibrium quantity and price for that market? Setting the expressions for supply and demand equal: 2 + .04Q = 10 - .06Q Q* = 80 Putting Q* = 80 into either supply or demand gives the equilibrium price: P* = 2 + .04(80) = $5.20 P* = 10 - .06(80) = $5.20

Dr. Murasko

ECON5136

d. Suppose that firms engage in advertising. Advertising presumably provides information that results in consumers willing to pay more for a given quantity (or conversely, buy more at a given price). Suppose that this advertising changes market demand to P = 12 .06Q. What will be the new short-run equilibrium quantity and price for that market? Setting the expressions for supply and demand equal: 2 + .04Q = 12 - .06Q Q* = 100 Putting Q* = 100 into either supply or demand gives the equilibrium price: P* = 2 + .04(100) = $6.00 P* = 12 - .06(100) = $6.00 The effect from advertising is a higher equilibrium quantity and price. This resulted from an outward shift in demand.