Microeconomics I

Undergraduate Programs: Business Administration and Economics

2011-2012 1st Semester

Professors: Fernando Branco (fbranco@ucp.pt)
Fernando Machado (fmachado@ucp.pt)

Bruno Pereira, Daniel Horta, Duarte Ribeiro, Joo Coelho and Nuno Clara.

1
The Firm in Competitive and Monopolistic Markets
Exercise 1.
Consider a perfectly competitive market represented by the following demand function:
p p Q
D
10 1700 ) ( = .
The short-run total cost function of each firm depends not only on its output quantity (q)
but also on the scale of production (k).
2 2 3
5 ) 8 ( 85 . 0 04 . 0 ) , ( k q k q q k q C + + =
a) In the short-run we have k = 1.5. Determine the supply curve of each firm.
b) The short-run market equilibrium price is 8. How much does each firm produce?
How many firms are there in the market? In the short-run, what is the profit level of
each firm?
c) Why is that that in the long-run, the situation described in b) is not sustainable?
Determine the long-run equilibrium price and the number of firms operating in the
market.

Exercise 2.
Mr. White has a firm whose cost function depends on the output (q) and on the installed
capacity (k) according to:
2 2 3
25 . 0 ) 8 ( 3 ) , ( k q k q q k q C + + =
a) Assuming that the installed capacity is fixed at k = 5 in the short-run, obtain the
short-run supply curve for this firm and plot it.
b) Obtain the long-run supply curve for this firm.
c) Compare the impact of a price variation on the quantity supplied by the firm, both in
the short-run and in the long-run. What is the difference due to?

2
d) Suppose there is a large number of firms operating in the market, all of which have
the same cost structure as Mr. Whites. Knowing that the demand curve is given by
p p Q
D
50 850 ) ( = , compute:
i. Mr. Whites profit, if there are 100 firms in the market, all of them producing
under the optimal level of capacity.
ii. The number of firms that will operate in the market in the long-run, assuming
that there is free entry and exit.

Exercise 3.
Assuming that the short-run cost function of a firm is given by the following
expression:
1 ) 10 ( 1 . 0 ) , (
2
+ + + = k q k q k q C
SR

a) Determine the short-run supply curve of this firm.
b) Assume now that the stock of capital of the firm is fixed and equal to 9. The firm is
operating in a market supplied by 100 firms with similar cost structures. The
expression for the market demand curve is p p Q
D
400 4000 ) ( = .
Determine the market equilibrium price and quantity, the quantity produced by each
firm and the respective profits.
c) Consider that the Government wants to introduce a specific tax on sales, whose rate
is 0.3 m.u. per unit sold by any firm. Analyze the effects of the tax on market
equilibrium in terms of quantity produced by each firm and the corresponding profit.
d) Re-do the analysis in c), for the case of an ad valorem tax of 10%.

Exercise 4.
In a competitive market there are n firms, the production function of which is the
following: { }
i i i
l k q , min = . The prices of both inputs are constant and equal to 10 and
market demand is given by: p p Q
D
= 90 ) ( .
Determine the long-run equilibrium for this market (q
i
, k
i
, l
i
, q, p) and represent it on a
graph.

Exercise 5.
Consider the market for an homogeneous good with the following demand:
p p Q
D
1000 6000 ) ( =
There are two different sources of supply. On one hand, domestic production is made
by 100 identical companies which, due to their relatively small size, have no power to
influence the market. The short-run total cost function of these firms is given by:
10 1 . 0 ) (
2
+ + = q q q C

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where q is the output produced. On the other hand, this country can import an unlimited
amount of the good at 3 m.u per unit.
a) Find the total supply curve of this market (i.e., domestic production plus imports).
b) Compute the market equilibrium price and quantity, the quantity produced by each
firm, their respective profits and the value of the imports.
c) Assume now that due to lobbying by national producers, the Government introduces
a customs duty of 1 m.u. per unit imported.
i. Determine the new market equilibrium.
ii. Check whether the introduction of this tariff is beneficial for the national
economy. Interpret it properly.

Exercise 6.
Suppose that in Orangeland there are 100 orange producers, with similar cost structures.
Each firms technology uses two inputs, k and l, and it can be described by the
following expression:
i i i i
k k l q + = 2
Where
i
q represents the quantity of oranges produced (in tons) by company i
(i=1,,100)
In the short-run, the quantity of the input k is fixed and equal to 4 and the prices of k and
l are 2 m.u. and 4 m.u. respectively.
a) Find the supply curve of each firm and represent it graphically.
b) Suppose the demand for oranges is given by p p Q
D
200 2000 ) ( = . Determine the
equilibrium price and quantity in this market, as well as each firms quantity
produced and profit level, under the following conditions:
i. Orangeland being a closed economy.
ii. In addition to domestic supply, demand can be satisfied by 100 firms from
Citrusland, with the following aggregated supply curve:
400 200 ) ( + = p p Q
S
CIT

c) Due to lobbying by the Orangeland producers, the Government decided to charge a
custom duty of 2 m.u. per ton of oranges imported from Citrusland. Find the new
equilibrium.

Exercise 7.
A good is produced and sold in two villages: A and B. Both villages have a perfectly
competitive market, with the following demand and supply curves:
A A
D
A
p p Q =100 ) ( , for 0 < p
A
< 100
50 2 ) ( =
A A
S
A
p p Q , for p
A
> 25

4
B B
D
B
p p Q 2 200 ) ( = , for 0 <p
B
< 100
10 4 ) ( =
B B
S
B
p p Q , for p
B
> 2.5
a) Determine the equilibrium for each village and illustrate graphically.
b) Suppose that the two villages, previously isolated, are now connected by a bridge.
This allows us to consider an integrated market of the two villages. What is the
equilibrium in this global market?
c) Investigate the effect of market integration on the levels of welfare of both
populations. Represent graphically.

Exercise 8.
A variable number of firms produces BENETTUM sweatshirts in Portugal. Due to their
reduced size relatively to the market, they have no power to influence the market price.
There are firms of three different types, whose daily total costs are given by the
following expressions:
Type A: 5 . 0 2
2
+ + q q , 20 =
A
n
Type B: 75 . 0 2 4
2
+ + q q , 80 =
B
n
Type C: 1 3 4
2
+ + q q , 200 =
C
n
Quantities (q) are measured in number of sweatshirts and costs in Euros.
a) Find the supply curve for the national industry of BENETTUM sweatshirts and plot
it.
b) Knowing that the demand curve for BENETTUM sweatshirts is given by:
p p Q
D
10 100 ) ( = (p in Euros)
compute the market equilibrium price and quantity, the quantities produced by the
different firms and their respective profits.

Exercise 9.
Mr. Victors cost function depends on the level installed capacity (k) according to:
2 2 3
3 ) 8 ( 2
3
1
) , ( k q k q q k q C + + = ,
where q represents output. The market demand curve is given by:
p p Q
D
50 950 ) ( =
a) Suppose that in the short-run, installed capacity is fixed at k = 4.
i. Find the short-run supply-curve for this firm.
ii. Knowing that there are 100 firms in this market, all of which have the
same cost structure, plot the market equilibrium and compute Mr. Victors
profit level. Discuss your results.

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b) Determine the analytical expression of the long-run cost function and characterize
Mr. Victors firm with regard to the economies of scale.
c) Determine the average number of firms operating in this market in a long-run
equilibrium situation.
d) Consider again, as a starting point, the short-run equilibrium. After a big
demonstration of producers, the Government of Mr. Victors country decided to
give a subsidy to the 100 producers of this market.
i. Determine the value of the specific subsidy required for the quantity traded
in the market to be 550.
ii. In the long-run, following the introduction of the subsidy, will the number
of firms operating in the market increase or decrease? Justify your answer.

Exercise 10.
Knowing that the demand curve facing a given monopolist is given by q p
D
5 . 0 20 =
and its total costs function is: q q q q C 96 . 32 94 . 1 04 . 0 ) (
2 3
+ = , determine the
monopoly output, price and profit.

Exercise 11.
Explain why the marginal revenue of a monopolist, unlike a perfectly competitive firm,
is different from the selling price of output.

Exercise 12.
Consider a monopolist with the following demand and total cost curves:
q p
D
2 300 =
2
5 . 0 2 400 q q C + =
a) Determine the values of p and q that satisfy the following objectives and represent
them graphically.
i. Minimization of average costs;
ii. Profit maximization;
iii. Maximization of revenues;
iv. Profit maximization, when the firm behaves as if it operates in a perfectly
competitive market.
b) Compare the consumer surplus of a) ii. and iv.




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Exercise 13.
A monopolist faces the following demand curve:
2
144

= p q
D

Knowing that its cost function is
5 . 1
5 ) ( q q C + = , determine the monopolists optimal
levels of output and price, as well as its maximum profit.

Exercise 14.
A monopolists uses an input (x), which he buys at a fixed price 5 = r , to produce
output q. The demand curve is given by q p
D
3 85 = and the production function is
x q 2 = .
Determine the values of p, q and x that maximize the monopolists profit.

Exercise 15.
Marvin Co. is a countrys single manufacturer of helmets and it has two factories to
supply the domestic market. Heavy duties on imports protect Marvin Co. from
international competition. Domestic demand is given by:
p q
D
250 26000 =
The cost structure of the two factories is the following:
28000 12 04 . 0
2
+ + =
A A A
q q C
4000 72 02 . 0
2
+ + =
B B B
q q C
(values in euros)
In the perfectly competitive international market, the same product is traded at a price of
80, but the current tariff of 20 per unit raises the price to 100.
a) In the present conditions, what is the optimal volume of production in each factory?
What is the monopolists profit?
b) If the custom duty decreases from 20 to 10, how will the production level of each
factory be affected? How will the producers profits be affected? What will the
volume of imports be? Make a brief analysis in terms of consumer and producer
surplus.

Exercise 16.
Consider a monopolist with the following demand and cost functions:
q q p
D
2 163 ) ( =
400 3 6 ) (
2
1
+ + = q q q C
a) Assuming that the monopolist is a profit maximizer, compute its optimal output
quantity.

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b) Consider now that the monopolist has another factory, with the following total cost
function:
200 6 5
2
2
+ + = q q C
Determine the quantities produced in each factory.

Exercise 17.
Suppose that in Portugal there is only one firm NQ able to carry out market research
for the detergent market. There is, however, a reasonable number of firms selling
different brands of detergent. These firms are interested in knowing their position in the
market relative to the others.
Consider that the demand of these studies is given by Q p
D
2 300 = and that NQs
cost function is q q C 16 ) ( = , where q is measured in number of market studies.
a) Compute the equilibrium price, the optimal quantity of market studies and the level
of NQs profits under the above conditions.
b) Taking advantage of being the only firm operating in the market, NQ studied
carefully its client portfolio and was able to identify two groups of customers (1 and
2). Knowing that, in the optimum, the ratio of prices for these two groups is
2
2 1
= p p and that 3
2 2
,
=
p Q
c , determine
1
p ,
2
p and
1 1
, p Q
c .
c) Suppose now that NQ is able to engage in perfect price discrimination. What is the
optimal quantity of market research and what is the corresponding profit? Compare
the consumer, producer and global surpluses with the ones in a). Discuss the
differences between those two cases.

Exercise 18.
Mr. Antnio is the only restaurant owner of a given village in the north of Portugal. The
demand curve for meals is given by p p Q
D
25 . 0 250 ) ( = , where q is the number of
meals sold and p the respective unit price. It is also known that the total cost function is
given by q q C 16 ) ( = .
a) Determine the number of meals that maximizes Mr. Antnios profits. How much is
his profit and what price does he charge?
b) Mr. Antnio knows his lunch customers so well that he can estimate exactly how
much each one is willing to pay for a meal. Assuming that Mr. Antnio is only
selling lunches and that he is practicing perfect price discrimination, how much will
his profit be?
c) Consider now that Mr. Antnio is able to distinguish his lunch customers from his
dinner customers. The demand curve presented above describes the demand for
lunches, while the demand for dinners has a constant price-elasticity of demand of
-10/9. Determine the prices charged in the two different types of meal.



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Exercise 19.
Mr. Joo, a well-known monopolist, produces and sells a very special type of wind
proof umbrellas. Total costs of production are given by:
q q C 75 . 0 ) ( =
And the demand of this type of umbrellas in Mainland Portugal is described by the
following expression:
2
900 ) (

= p p Q
D

a) Determine the price charged by the monopolist and the quantity produced.
b) Mr. Joo decided to extend the sale of his umbrellas to Madeira. Since the two
markets are separated by transport costs, Mr. Joo was advised to engage in price
discrimination and charge different prices in Madeira and in mainland Portugal.
i. A market study revealed that the Madeiras demand for this type of
umbrellas is given by the following expression:
2
441 ) (

= p p Q
D

Assuming that the total cost curve did not change, what prices are charged in
each market and what are the corresponding quantities sold?
ii. How would you change your previous answer if the only information
available about the demand of these umbrellas in Madeira was that the
price-elasticity of demand is constant and equal to -4. Carefully justify
your answer.
iii. Assume that Mr. Joo was forbidden to practice price discrimination by
the Authority that regulates the market for umbrellas. Which would be
the prices and quantities in the market?

Exercise 20.
Suppose Estdio da Luz has 80 000 seats. Benficas management is interested in
maximizing profits and estimated the following demand curves for an important
Champions League match:
General fans:
G
D
G
q p
120000
2
2 =
Club members:
M
D
M
q p
20000
8 . 0
8 . 0 =
Assume there are fixed costs related to the opening of the stadium but there are no
marginal costs related to the admission of additional spectators.
a) What prices should Benfica charge for this game?
b) If a part of the stadium was closed for renovations, and there were only 53 000 seats
available, what prices should be charged?
c) Repeat the previous question, but assume now that there are constant marginal costs
of 0.2 per spectator.

9
d) What would happen if the visiting team got 20% of all revenues? (continue
assuming that marginal cost is 0.2)
e) Suppose that, due to electoral reasons, the objective of Benficas management is to
maximize the surplus of club members, as long as the club does not incur into
losses. Determine the new equilibrium situation and the members surplus,
considering the conditions of the previous question.
f) Due to an imposition of UEFA, Benfica cannot charge prices above 0.5 m.u. What is
the effect of this measure on market equilibrium? How are Benficas profits
affected? (assume the initial conditions of the problem)

Exercise 21.
Dr. Almeida is the only doctor in Corvo Island. He can only service one patient per hour
and he never works more than 40 hours per week. Dr. Almeidas working hours are split
between two types of patients - the ones of his private practice (PP) and the ones of the
National Health Service (NHS). The number of patients of his PP varies with the price
of each appointment according to:
q p
D
=100
where q is the number of patients of his PP, per week. On the other hand, Dr. Almeida
can treat whatever number of patients of the NHS he wants, at a price of 40 m.u. per
patient.
a) If Dr. Almeidas costs are independent of the number of patients serviced, what
price per appointment should he charge at the PP?
b) Consider now that the doctor does not have costs associated with the number of
patients in the PP, but has a cost of 10 m.u. per appointment in the NHS, related to
filling out forms required by the Government. How much should he charge per
appointment in the PP?
a) What price should Dr. Almeida charge if his costs per appointment were 10 m.u. in
the PP and zero in the NHS?

Exercise 22.
The dishwashing liquid market has many operating firms producing differentiated
products. Let us consider two firms in this market: Fairy (F) and Superpop (S). Firm F
has a loyal clientele. The demand for its product Fairy Ultra is given by the expression
p q
F F
= 20 . Its cost structure is given by C q q
F F F
( ) = + 50
2
. Firm S, on the other
hand, produces Super Pop Limo, a product with high degree of substitutability
relatively to the products of other firms. It currently faces an estimated demand of
p q
S S
= 20
2
5
and its costs are given by
2
2
1
100 ) (
S S S
q q C + = .
a) Compute the optimal output of firm F. Plot and discuss the result.
b) Compute the optimal output for firm S. Plot and discuss the result.

10
c) Following a diversification strategy, another company, Tide (T) decided to take
advantage on technological complementarities with its well-known laundry
detergent Tide-mquina and enter the dishwashing liquid market by launching Tide-
limo. By doing so, it was able to attracted some of firm S customers, but none from
firm F. What percentage of demand would T have to conquer from firm F, so that a
long-run equilibrium would be achieved in this market.

Exercise 23.
In the Tuga Island, the market demand for plums can be described by the following
expression:
q p 2 100 =

where q is the quantity of plums.
Due not only to the specificity of this product but also to Governments protectionism,
there is only one firm producing plums in the Tuga Island, the Queen Claudia (QC).
This firms cost structure is given by:
2250 50 2 1 . 0 ) (
2 3
+ = q q q q C
a) The monopoly solution leads to a consumer surplus of 500. Noting the welfare
inefficiencies caused by this solution, the opposition parties proposed setting a price
that maximizes social efficiency. Compare these two equilibrium situations (with
and without Government intervention) in terms of welfare for the consumers of
plums.
b) The perfectly competitive foreign market for plums the prevailing price is 50 m.u.
Assuming that QC, which intends to enter the foreign market, is able to differentiate
the Tuga consumers from international consumers:
i. Show that the analytical expression of QCs aggregate marginal revenue is:

>
s
=
5 . 12 , 50
5 . 12 , 4 100
q
q q
MR
agg

ii. Determine the quantity of plums that QC should sell in each market, the
corresponding price and the total profit of the firm.

Exercise 24.
There are 100 firms in Perfectland whose cost structure is the following:
2 2
5 . 0 ) 3 ( 5 . 2 ) (
i i i i i
k q k q q C + + =
a) Capital (k) is fixed and equal to 2 in the short-run. Find the short-run market supply
curve and describe the equilibrium (p, q), having into consideration that the demand
in Perfectland is represented by the expression:
p p Q
D
10 100 ) ( =
b) What is the equilibrium if all firms are able to optimally allocate their resources?
Represent it graphically and compute the producers surplus.