Econ 2 Final Review- Spring 2014

Anh Pham

Monopoly
Q4. (Final Fall 2009) Caroline works as a massage therapist on evenings and weekends. She has
no fixed costs, and her opportunity cost of giving a massage is $125. She has ten potential
clients each week whose reservation prices are shown in the following table:
Client Reservation
Price ($ per
massage)
A 200
B 190
C 180
D 170
E 160
F 150
G 140
H 130
I 120
J 110

Quantity Price Total Revenue Marginal Revenue
1 200 200 200
2 190 380 180
3 180 540 160
4 170 680 140
5 160 800 120
6 150 900 100
7 140 980 80
8 130 1040 60
9 120 1080 40
10 110 1100 20


a. Suppose Caroline has to charge a single price to all of her clients. How many massages
per week should she give to maximize her profit? And what will her profit be? Show
your work.
Calorine maximizes profit as long as MR>=MC. Thus, Caroline will give 4 massages per week
because MR of 5
th
massage is 120< 125.
b. What is the socially efficient number of massages for Caroline to give? Explain.
The socially efficient number of massage is achieved when MSB=MSC. MSB is the reservation
price. Therefore, 8 massages will be provided because if the MSR or the reservation price of the
9
th
massage is 120<125.
c. Now, suppose Caroline can't perfectly price discriminate, but she is able to find a
hurdle that identifies those students who are willing to pay at least $160 for a massage
(the "list price" submarket), and those who are not (the "discount price" submarket).
What price structure should she employ to maximize her profit? Show your work.
List price submarket for people with reservation price >=160
Client Reservation
price
Quantity Price Total
Revenue
Marginal
Revenue
A 200 1 200 200*1=200 200
B 190 2 190 190*2=380 180
C 180 3 180 180*3=540 160
D 170 4 170 170*4= 680 140
E 160 5 160 160*5=800 120

Discount price submarket for people with reservation price<160
Client Reservation
Price
Quantity Price Total revenue Marginal
Revenue
F 150 1 150 150*1= 150 150
G 140 2 140 140*2=280 130
H 130 3 130 130*3=390 110
I 120 4 120 120*4=480 90
J 110 5 110 110*5=550 70

In the list price submarket, Calorine will provide 4 massages because MR of 5
th
massage is 120<
125. She will charge $170 each massage in the list price submarket

In the discount price submarket, Calorine will provide 2 massages because MR of 3
rd
massage is
110< 125. She will charge $140 each massage in the discount price submarket

d. What is the consumer surplus if Caroline uses the price structure in c.? Show our work
The CS is the difference between the amount each client was willing topay for a massage and the
price they are actually paying, for all 6 clients she will be giving the massages to.
CS= (200-170)+(190-170)+(180-170)+ (170-170)+(150-140)+ (140-140)= $70/week
Game Theory
Q1 (Final Spring 2010). Consider the news magazines Time and Newsweek, each trying to
choose between cover stories about AIDS and the national budget. The game below presents
information for both players. In each cell, the first payoff in the bracket represents Timess
payoffs and the second payoff in the bracket is Newsweeks payoff. The payoffs are the share of
the readers the magazines have.
Newsweek
AIDS Budget
Times AIDS (0.42, 0.28) (0.70, 0.30)
Budget (0.30, 0.70) (0.18, 0.12)

a. Do any of the players have a dominant strategy? Explain.
If times plays Aids, Newsweek plays Budget because 0.3>0.28
If times plays budget, NW plays Aids because 0.7>0.12
NW doesnt have a dominant strategy

If NW plays Aids, Times plays Aids because 0.42>0.3
If NW plays BG, Times plays Aids because 0.7>0.18
Times has a dominant strategy of playing AIDS
b. What is the Nash equilibrium for this game? Explain carefully.
Times has a dominant strategy of playing AIDS, it will play AIDS no matter what
Given times plays Aids, NW plays budget because 0.3>0.28.
NE: (0.7, 0.3) Times plays AIDS and NW plays budget
c.Is this game a prisoners dilemma type of game? What characterizes a prisoners
dilemma type of game
A prisoners dilemma satisfies:
(1) Each player has to have a dominant strategy
(2) NE Outcome when each player plays their dominant strategy is Pareto Inferior. This
means we can find another combination of strategies which would make both players
better off. That combination of strategies is not NE because once there, each player
has an incentive to deviate.

This type of game is not a prisoners dilemma because NW does not have a dominant
strategy.
Q7 (Final Fall 2009): P-TV and QRS-TV are planning their fall line-up. Suppose that sit-coms
are more popular than reality shows, and so generate more advertising revenue than do reality
shows, but they are more expensive to produce since real actors need to be hired. In the
following decision tree, QRS-TV announces its decision first and P-TV observes that choice
before it decides whether to air a sit-com in the same time slot or a reality show. Both stations
know all of the information shown in this diagram when they make their decisions.


a. If QRS-TV announces that it will air a sit-com, how much can QRS-TV expect to earn
or lose? Explain.
If QRS-TV plays sit-com, P-TV plays reality because (20 million>-5 million). As a result, QRS-
TV expect to earn $5 million.
b. Given the information in the above tree, what will be this season programming in this
time slot on QRS-TV and P-TV? Explain your answer.
If QRS-TV plays sit-com, P-TV plays reality outcome (5, 20) as shown in part a
If QRS-TV plays reality, P-TV plays reality because 10>5 Outcome (10, 10).
Knowing this, QRS-TV will play reality because (10>5). The final NE: QRS-TV, P-TV
both play reality, outcome (10,10)

c. Suppose QRS-TV executives meet with P-TV executives in order to convince them to
enter into a mutual beneficial agreement. The agreement would give QRS-TV the
exclusive right to air a reality show during this time slot. How much would QRS-TV
willingly pay P-TV to persuade them to enter is this agreement? (Note: there could be
a range of amounts that would work for this question. In that case, pick one of the
amounts.) Display the new decision tree, and show how the new equilibrium outcome
of the game is beneficial to both stations.
QRS-TV would be willing to pay up to $10 million dollar to get the exclusive right to play
reality show (because $20 million-$10 million= 10 million)
P-TV would be willing to play sit-com when QRS-TV plays reality if the minimum payment it
receives from QRS-TV is $ 5million ($10 million-5 million= 5million).
The price range: between 5 million and 10 million.


Information
Q2. ( Final Fall 2007) Two types of used Fender Stratocaster guitars are available for sale: those
originally made in the United States and those originally made in Mexico. Buyers value the US-
made Fender guitars higher than the ones made in Mexico. Assume that it is impossible for the
buyer to know which guitar is which, but the seller does. Buyers and sellers agree that the value
of a used US-made Stratocaster is $900, and that of a used Mexican-made one is $400. The US
Stratocasters are 30% of Fenders production and the Mexican Stratocasters are 70%. No seller is
forced to sell for less than the guitars value.
a. A nave buyer assumes that the proportion of US-made Fender Stratocasters currently for
sale in the used market is the same as in Fenders production. If the nave buyer is risk-
neutral, what is the most he is willing to pay for a used Fender Stratocaster guitar?
$900*0.3+ $400*0.7= $550
b. If a buyer offers the price computed in a. and that offer is accepted, what can you infer
about the country of origin of the guitar being transacted?
If price is $550 and get accepted, then the guitar is from Mexico because the US-one is
worth $900 and the US-seller would not want to sell their guitar for less than $900.
Mexican guitar is worth $400. Therefore, only Mexican guitar would be sold if the
offered price is $550.
c. What do you predict will eventually happen in this market? In your answer, make sure you
mention the price and type of guitars you think will be sold. Explain.
From part a& b, the maximum willingness to pay of a customer is $550. Given this maximum
willingness to pay, Only Mexican guitars get sold in the market. But Mexican guitars are only
worth $400. As a result, customers learn and will only pay $400. In equilibrium, only Mexican
guitars get sold with the price of $400.
d. Suppose that Fender discloses that a tiny code stamped inside the cavity of its Stratocaster
guitars identifies its country of origin. How much will sellers of US made used guitars and
sellers of Mexican-made used guitars receive for their guitars? Explain.
Under perfect information, customers can identify US-guitars with Mexican guitars. Therefore,
both types are sold in the market. US-guitars get sold with the price of $900, and Mexican
guitars get sold with the price of $400.

Q3.(Final Spring 2010): You're in an airport waiting for a flight. You've just finished reading a
book, so you stop off at the airport bookstore to see if you can find a new one. Suppose you
divide books into two categories: those you like and those you don't like. You value the ones you
like at $20, and you value the ones you dislike at $15. Assume all the books cost $10; so if you
buy a book you like, you get a surplus of $10, and if you buy a book you don't like, you get a
surplus of $5. In order to find out whether you like a book or not, you need to read a few pages
of it. Before your flight leaves, you only have time to sample two books. Furthermore, if you
only sample one, you'll have time to get a sandwich before your flight leaves, which will give
you a surplus of $2. Therefore, your opportunity cost of sampling a second book is $2. Suppose
you sample one book and find that you don't like it. Your choice now is to buy it, even though
you don't like it, and go and get a sandwich; or to sample another book. Assume that just buying
a random book without sampling it is not an option, and that you are risk-neutral.

a. Suppose you thought that you would like about 60% of the books in the bookstore.
Would you sample another one or go get a sandwich? Justify your answer.
MB of sampling another book: (20-10)*0.6+ (15-10)*0.4= 6+2=8
MC of sampling another book: $2+ (15-10)= 7
Will sample another book because 8>7

b. Suppose you thought that you would like about 20% of the books in the bookstore.
Would you sample another one or go get a sandwich? Justify your answer.

MB of sampling another book= (20-10)*0.2+ (15-10)*0.8= 2+4=6
MC of sampling another book= $2 + $(15-10)= 7
Wont sample another book because 6<7


Public & Tax Policy, Externalities and Property Right
Q5-Final Spring 2010. The very small city of Toontown is considering building a public
swimming pool that costs $1,000. The table shows the five voters in the city and their marginal
benefit of a swimming pool. It takes a 4/5 majority to pass any tax measure and all voters must
vote.

Voter Marginal Benefit Income
Amber $420 $2,000
Bernard $360 $1,950
Cosby $350 $1,600
Daniel $190 $1,350
Elizabeth $170 $1,100

a. Would building the swimming pool reduce or increase total economic surplus? Why?
Total social benefit= 420+360+350+190+170= 1490> 1000= Total social cost.
Therefore, building the pool increases Total economic surplus

b. Amber proposes that the city build the pool and finance it with a $200 tax from each
voter. What will be the outcome of this proposal (how many votes in favor and
opposed?). Will the measure pass? Show all your work.
When the tax is $200, only 3 people Amber, Bernard, and Cosby would vote in favor
because their MBs are greater than 200. Daniel and Elizabeths MB is less than 200,
so theyd vote against. Since it takes a 4/5 majority to pass any tax measure, this
measure wont pass. The pool wont be built.

c. Elizabeth proposes instead a proportional tax on income to finance the public good.
The incomes of the voters are provided in the table. What would the proportional tax
rate be? How many votes in favor and against? Show all your work.

Total income= 2000+1950+1600+1350+1100=8000

The tax rate is proportion and the government will tax everybody the same rate. Tax
rate= total cost of the pool/total income= 1000/8000=12.5%

With the tax rate of 12.5%:
Amber pays 2000*0.125= 250< 420 Ambers vote yes
Bernard pays 1950* 0.125=243.75<360 vote yes
Cosby pays 1600*0.125= 200<350 vote yes
Daniel pays 1350*0.125=168.75<190 Vote yes
Elizabeth pays 1100*0.125= 137.5<170 Vote yes

Everyone vote yes, the measure will pass. The pool will be built.

d. Suppose that Daniel proposes allowing a private firm to build the pool. That firm
would charge the same one time fee to everyone for unlimited access to the pool.
What would that one time fee be? (Hint: The owner of the pool will behave as
monopolist) Would this proposal pass? How many voters would use the pool in this
case?


Quantity Price Total Revenue
1 420 420
2 360 720
3 350 1050
4 190 760
5 170 850

The monopolist would charge at a price that makes Total revenue>=1000. In this case,
the monopolist would charge a price of $350, and only 3 people (Amber, Bernard,
and Cosby) would pay. Since this is a private firm and we find a price that makes
TR>TC=1000, this proposal would pass, and 3 people would use the pool.

Q8-Final Fall 2009. Two firms, SouthCo and DukeCo, are currently emitting 5 tons of pollution
a day each in order to produce a certain amount of output. In order to reduce pollution, and
produce the same as before, each firm has to adopt cleaner but more expensive production
technologies. The marginal costs of reducing pollution for each firm are given in the
following table:
Marginal Costs ($/day) MC of
1
permit
MB of an extra permit
Pollution
Reduction (tons/day)
SouthCo DukeCo SouthCo DukeCo
1 200 30 350 1000 400
2 300 70 350 800 260
3 600 100 350 600 100
4 800 260 350 300 70
5 1000 400 350 200 30
In the absence of government oversight, both firms are emitting 5 tons of pollution each. The
government is considering plans to reduce pollution by 50% (i.e. from the current 10 tons to
5 tons of pollution a day).

a. The government wants to reduce pollution to 5 tons a day, and for that it orders
SouthCo to cut its daily pollution emissions from 5 tons to 3 tons, and it orders B to
reduce its emissions from 5 tons to 2 tons. What would be the total cost of pollution
reduction for the whole industry? Show your work.
Cost of pollution reduction: SouthCo: $200+ $300= $500
DukeCo: $30+ 70+100= 200
Total cost of the whole industry: $700

b. The government wants to reduce pollution by 5 tons. What is the least-cost method to
achieve that goal? Explain.
Who should reduce the first ton of pollution? Duke should reduce because (30<200)
Who should reduce the 2
nd
ton? Duke because 70<200
Who should reduce 3
rd
ton? Duke because 100<200
Who should reduce 4
th
ton? South because 200<260
Who should reduce 5
th
ton? Duke because 260< 300

Duke needs to reduce 4 tons with cost: 30+70+100+260= 460
South needs to reduce 1 ton with cost: 200
Total cost of the industry: 460+200= 660
c. Now, suppose the government is considering issuing pollution permits. Each permit
entitles the owner to emit one ton of pollution per day. Without a permit, no pollution
can be emitted. The government wants to sell 5 permits only. If the government sells
permit at $350 each, how many permits will each firm demand? Is $350 an
equilibrium price?
SouthCo wants 3 permits because MB of 4
th
permit is 300<350.
DukeCo wants 1 permit because MB of 2
nd
permit is 260<350.
4 permits demanded. Therefore, $350 is not the equilibrium price. The
equilibrium price should be lower if the government wants to sell 5 permits.


Q6- Final Spring 2010: The table below represents the marginal benefits of global
defense spy satellites for Tweedle Dee and Tweedle Dum, who are the only (very
wealthy) inhabitants of their planet.




a. Derive the marginal social benefit of spy satellites, and draw that curve in the graph
below. Show your work.





Quantity MSB
1 50+35= 85
2 45+30=75
3 35+25=60
4 25+20=45
5 10+15=25

b. If spy satellites cost $36 million apiece, how many spy satellites will Mr. Dee
purchase? What about Mr. Dum?
Mr. Dee will get 2 satellites because MPB of 3
rd
one is 35< 36.
Mr. Dum will get 0 because MPB of 1
st
is 35< 36
c. If spy satellites cost $36 million apiece, what is the efficient number to of Satellites?
Explain.
The social optimal number of satellites is 4 because MSB of 5
th
one is 25< 36.

Labor market
Q4-fall 2007. The table below represents the total output and total revenue curves for
Dougs Dog Grooming. This firm can hire workers from a perfectly competitive labor
market.

Quantity of labor Output Total Revenue
(workers) (groomings) (Dollars)

0 0
1 12 60
2 20 100
3 25 125
4 28 140
5 30 150

Quantity MP of
labor
MR
product of
labor
MR
(dollars)
MC of
labor
MR of product labor
when price= $6
1 12 60 60/12=5 16 12*6= 72
2 8 40 40/8= 5 16 8*6=48
3 5 25 25/5=5 16 5*6=30
4 3 15 15/3=5 16 3*6=18
5 2 10 10/2=5 16 2*6=12

a. What is the marginal product of the second unit of labor? Show your work.
MP of 2
nd
labor is 8 because 20-12=8
b. What is the marginal revenue product of the 3rd worker? Show your work.
MR product of 3
rd
worker is 25 because 125-100=25
c. Is Dougs Dog Grooming a perfectly competitive firm in the product market? Justify.
The firm is in a perfectly competitive market. It is because MR=$5, which is constant.
In a perfectly competitive output market, the extra revenue a firm gets from selling an
extra unit is constant and equal to the market price.

d. How many workers should this firm hire if the competitive wage in this labor market
is $16? Explain.
Only hire 3 workers because MR product of labor of 4
th
worker is 15< MC=16


e. If the price of the product is now $6, and competitive wage in this labor market is $16,
what is the optimal number of workers to hire?
Hire 4 workers because MR product of the 5
th
one is 12< 16.