ECMC02 answers to final exam April 30, 2003. 1. Demand is P = 15 Q and MC = 3.

. The profit-maximizing output for a monopo ist !i "e !here M# = MC$ or !here 15 %Q =3$ or !here Q = &. 'u"stituting into the demand fun(tion$ !e ha)e 15 & = *+. The (orre(t ans!er is ,-.. %. /a(h duopo ist profit maximizes !ith the residua demand eft o)er after the other duopo ist produ(es his0her output. Duopo ist 11 "e ie)es that the duopo ist 1% !i 2eep its output (onstant ,that 1%3s de(isions are unaffe(ted "4 113s output de(isions.. 5nd )i(e )ersa. Therefore$ for 6irm 11$ demand (an "e !ritten as P = 15 7% 71. 'in(e$ firm 1%3s output is (onsidered (onstant$ M#1 = 15 7% %71. 'in(e MC = 3$ firm 11 !i profit-maximize !here 15 7% %71= 3$ or 71 = & 8.57% . This is firm 113s rea(tion fun(tion ,i.e$ its profit-maximizing output is a fun(tion of 6irm 1%3s output.. 6irm 1% has a simi ar rea(tion fun(tion9 7% = & 8.571 . The e7ui i"rium of these t!o rea(tion fun(tions is a :ash e7ui i"rium set of output de(isions$ !here 71 = & 8.5,& 8.571.$ or 8.;571 = 3 or 71 = <. 'in(e firm 1%3s output !i a so "e <$ tota output is = units. 5t this output$ P = 15 = = *;. The (orre(t ans!er is ,6.. 3. >ne firm is the output eader and the other is the fo o!er. The eader per(ei)es the rea(tion fun(tion of the other produ(er ,2no!s that the other firm !i (hange its output$ "ased on the output of the first firm.. The 'ta(2e "erg eader (an use this to gain !hat amounts to a ?first-mo)er@ ad)antage. 5ssuming 6irm 11 is the 'ta(2e "erg eader$ it per(ei)es the rea(tion fun(tion of 6irm 1%$ !hi(h is 7% = & 8.571 . Mar2et demand is P = 15 7% 71. /xpressing this in terms of 6irm 113s output$ this is P = 15 ,& 8.571. 71 = + 8.571 . Therefore$ M#1 = + 71 and MC = 3$ so the profit maximizing output for 6irm 11 is &. 6irm 1% !i rea(t "4 produ(ing 7% = & 8.571 = & 3 = 3 units. Tota output in the 'ta(2e "erg duopo 4 is + units. 'u"stituting into the demand fun(tion$ P = 15 + = *&. The (orre(t ans!er is ,/.. <. Aith a pri(e of *&$ output of + units in tota $ and (onstant margina and a)erage (osts of *3 per unit$ tota re)enue is *5< and tota (ost is *%;. Profit in this industr4 is the differen(e "et!een these or *%;. The (orre(t ans!er is ,-.. 5. Bn a Certrand mode $ firms !i fight a pri(e !ar unti pri(e is do!n to margina (ost. Bf P = 3$ and P = 15 Q$ then Q = 1%. The (orre(t ans!er is ,D.. &. Bf 6irm % produ(es a "ig (ar$ 6irm 1 !ou d "e "est off produ(ing a sma (ar. Bf 6irm % produ(es a sma (ar$ 6irm 1 !ou d "e "est off produ(ing a "ig (ar. 'imi ar 4$ if 6irm 1 produ(es a "ig (ar$ 6irm % !ou d "e "est off produ(ing a sma (ar. Bf 6irm 1 produ(es a sma (ar$ 6irm % !ou d "e "est off produ(ing a "ig (ar. 5 :ash e7ui i"rium is a pair of strategies$ ea(h of !hi(h is the optima mo)e gi)en the mo)e of the other p a4er. Therefore$ there are t!o :ash e7ui i"ria9 one !ith 6irm 1 produ(ing a "ig (ar and 6irm % produ(ing a sma (ar$ and another !ith 6irm 1 produ(ing a sma (ar and 6irm % produ(ing a "ig (ar. The (orre(t ans!er is ,/..

;. Bf 6irm 11 mo)es first$ it !i (onsider !hat 6irm 1% !i do "efore ma2ing its o!n de(ision. Bf 6irm 11 produ(es a sma (ar$ then 6irm 1% !i produ(e a "ig (ar ,and the pa4off to 6irm 11 !i =88.. Bf 6irm 11 produ(es a "ig (ar$ then 6irm 1% !i produ(e a sma (ar ,and the pa4off to 6irm 11 !i "e 1888.. Therefore$ 6irm 11 !i (hoose to produ(e a "ig (ar. The (orre(t ans!er is ,C.. =. 5 a o(ations on the (ontra(t (ur)e must ha)e Den3s margina rate of su"stitution e7ua to Car"ie3s M#'. Den3s uti it4 fun(tion is E = 6DCD and his M#' is e7ua to the ratio of the margina uti ities. E06D = CD and E0CD = 6D . Therefore his margina rate of su"stitution of fish for (hips is CD06D. Car"ie3s uti it4 fun(tion is E = 6CCC and her M#' is e7ua to the ratio of the margina uti ities. E06C = CC and E0CC = 6C . Therefore her M#' of fish for (hips is CC06C. /7ua M#'3 means that CD06D = CC06C or CD6C = CC6D. >f (ourse$ sin(e there are a tota of < units of fish and = units of (hips$ !e (an !rite CC = ,= - CD. and 6C = ,< - 6D. !hi(h means that CD,< 6D .= ,= CD.6D or <CD= =6D or CD06D = %. This means that CC06C = %$ as !e . The on 4 ans!er that gi)es this set of ratios is ,/.$ so that is the (orre(t ans!er. +. 6rom the (a (u ations a"o)e$ !e (an see that the (orre(t ans!er is ,F.. 18. 5n a o(ation is Pareto >ptima if there is no possi"i it4 of a unanimous agreement to mo)e to some a ternati)e a o(ation ,mo)ing to some a ternati)e a o(ation !ou d ma2e at east one person !orse off.. 5nother !a4 of thin2ing a"out the issue is to oo2 for a o(ations that are ?dominated@ "4 other a o(ations. Bn this termino og4$ a Pareto >ptima a o(ation is one that is not dominated "4 an4 other a o(ation. >ut(ome B is not dominated "4 an4 other out(ome. -o!e)er$ B dominates BB. There is no other out(ome that dominates out(ome BBB. >ut(ome BG is dominated "4 out(ome B. 6ina 4$ out(ome G is not dominated "4 an4 other out(ome. 5s a resu t$ out(omes B$ BBB and G are pareto optima . The (orre(t ans!er is ,>.. 11. Bf out(ome B is ta2en a!a4 then "oth BB and BG are no onger dominated "4 B. -o!e)er BG dominates BB$ so BG Hoins BBB and G as pareto optima out(omes. The (orre(t ans!er is ,:.. 1%. >ut(ome GB gi)es &$ + and 13 to the three indi)idua s. This is not pareto preferred to out(ome B or BBB or G$ so out(ome GB is not pareto optima . The (orre(t ans!er is ,C.. 13. Bf 6red3s M#' is I$ he is !i ing to trade I of a unit of J for 1 unit of K$ or 1 unit of J for % units of K. Bf Ci 3s M#' is L$ he is !i ing to trade L of a unit of J for 1 unit of K$ or 1 unit of J for < units of K. Bf 6red gets 3 units of K in ex(hange for 1 unit of J$ he !i (onsider that to "e a good dea . Bf Ci gets 1 unit of J in ex(hange of 3 units of K$ he !i (onsider that to "e a good dea . The (orre(t ans!er is ,C.. 1<. Char ie3s M#' !i "e 5C0CC. Doris3 M#' !i "e I. Ahen the M#' are e7ua $

this imp ies that 5C = I CC. Bn other !ords$ Char ie !i (onsume ha f as man4 app es as "ananas. The (orre(t ans!er is ,C..

15. The num"ers in the matrix ref e(t the pa4offs to p a4er 11. 5 maximin strateg4 (hooses the "est option amongst the minimum returns. 6or p a4er 11$ the minimum return to strateg4 5 is 8$ to strateg4 C is +$ to strateg4 C is 1 and to strateg4 D is 5. The "est ,the maximum. of these minimums is +$ so p a4er 113s "est mo)e is strateg4 C. P a4er 1% is doing the same thing$ "ut "e(ause the matrix ists the returns to p a4er 11$ p a4er 1% is des(ri"ed as (hoosing the minimum of the maximum returns that p a4er 11 might get. 6or strateg4 G$ the maximum is +$ for A it is 11$ for K it is 18$ for J it is 1% and for M it is 1<. The minimum of these maximums (omes from strateg4 G$ !hen the return is + ,-+ for p a4er 1%.. The maximin and the minimax are e7ua $ so the :ash e7ui i"rium is the (om"ination of strategies C and G. The pa4off to p a4er 1% !i "e +. The (orre(t ans!er is ,C.. 1&. 5 o(ation D is pareto-preferred to a o(ation N. This means that a o(ation is "etter for at east one person and is no !orse for a others. This imp ies that D is pareto optima . The (orre(t ans!er is ,/.. 1;. Coth Cert and /rnie !ant to "u4 ( othing and to se food. The pri(e of ( othing must "e too o! and the pri(e of food must "e too high. Bn other !ords$ the ratio of the pri(e of food to the pri(e of ( othing is too high. The (orre(t ans!er is ,C.. 1=. Coth Crusoe and his friend (an produ(e more ( othing than the4 (an food. Jet$ the4 regard ( othing and food as perfe(t su"stitutes ,the4 don3t (are !hi(h one the4 ha)e.. Therefore the4 !i "e "etter off if the4 Hust produ(e ( othing. The (orre(t ans!er is ,/.. 1+. Crusoe (an produ(e either 5 units of food or 18 units of ( othing. These !i "e !orth *%8 and *18 respe(ti)e 4. 'in(e the *%8 (ou d "e used to pur(hase %8 units of ( othing$ Crusoe shou d produ(e on 4 food ,and trade it a for ( othing.. -is friend (an produ(e either 18 units of food or 15 units of ( othing. These !i "e !orth *<8 and *15 respe(ti)e 4. 'in(e the *<8 (ou d "e used to "u4 <8 units of ( othing$ his friend shou d produ(e on 4 food ,and trade it a for ( othing.. The (orre(t ans!er is ,D.. %8. Car"ara3s M#' of K for J is J0K. 5t a pareto optima a o(ation$ this is <01& = L. 'in(e No4(e3s M#' must the the same ,in order for the a o(ation to "e pareto optima .$ No4(e3s M#' must "e L. The (orre(t ans!er is ,D.. %1. The (orre(t ans!er is ,/..

%%. Bf P = 5 %"Q$ then M# = 5 <"Q. Profit maximization !i o((ur !here M# = MC$ or !here 5 <"Q = (. Therefore Q = ,5 (.0<". The (orre(t ans!er is ,F.. %3. 6or a monopo ist M# = P,1 O P10/DQ .. 'in(e$ at the profit maximizing output M# = MC$ !e 2no! that 18 = 38,1 O P10/DQ . = 38 O P380/DQ. Bn other !ords$ /D = -380%8 or 1.5. The (orre(t ans!er is ,P.. %<. The num"ers in the matrix ref e(t the pa4offs to p a4er 11. 5 maximin strateg4 (hooses the "est option amongst the minimum returns. 6or p a4er 11$ the minimum return to #o(2 is -1$ to '(issors is -1$ and to Paper is -1. The "est ,the maximum. of these minimums is 1 ,an4 strateg4.. P a4er 1% is doing the same thing$ "ut "e(ause the matrix ists the returns to p a4er 11$ p a4er 1% is des(ri"ed as (hoosing the minimum of the maximum returns that p a4er 11 might get. 6or #o(2$ the maximum is 1$ for '(issors it is 1$ and for Paper it is 1. The minimum of these maximums is 1. 'in(e the minimax does not e7ua the maximin$ there is no :ash e7ui i"rium. The (orre(t ans!er is ,/.. %5. The (orre(t ans!er is ,C.. %&. The (orre(t ans!er is ,C.. %;. The (orre(t ans!er is ,M.. %=. The (orre(t ans!er is ,D.. %+. The (orre(t ans!er is ,C.. 38. The (orre(t ans!er is ,5..
Short Answer and Graphical Q estions 31. ,a. Bf the mar2ets are separa" e$ then in -a ifax9 P = %< Q- and M# = %< %Q-. 6or profit maximization$ M# = MC$ so %< %Q- = & or Q- = +. 'u"stituting into the demand fun(tion$ !e find that P = %< + = *15. 6or Dartmouth$ P = 1% - .5QD and M# = 1% QD. 6or profit maximization$ M# = MC$ so 1% QD = & or QD = &. 'u"stituting into the demand fun(tion$ !e find that P = 1% .5,&. = *+. Tota profit a(ross the t!o mar2ets is T# TC = ,15 x +. O ,+ x &. ,15 x &. = *135 O *5< - *+8 = *++. ,". The dead!eight oss measures the effi(ien(4 osses (ompared to the optima (ompetiti)e mar2et so ution ,!here P = MC.. Bn the -a ifax mar2et$ the optima output !ou d "e 1= units and in Dartmouth it !ou d "e 1% units. The dead!eight oss for -a ifax is ,15 &. x ,1= +.0% = *<8.58. 6or Dartmouth$ the dead!eight oss !ou d "e ,+ &. x ,1% &.0% = *+.

,(. Bf the monopo ist is not a" e to separate these t!o mar2ets$ it !i ha)e to (harge a sing e pri(e to "oth. Ae (an (a (u ate tota demand "4 summing the 7uantities so d in ea(h mar2et at ea(h possi" e pri(e. Q- = %< P and QD = %< %P. The sum of these demands gi)es QT = <= 3P or P = 1& 103QT . Bn this mar2et$ P = 1& 103QT 6or profit maximization$ 1& %03QT = & or QT = 15. The pri(e (an "e found "4 su"stituting into the tota demand (ur)e9 P = 1& 103,15. = *11. The margina re)enue at the profit maximizing 7uantit4 is M# = 1& %03,15. = *&. The profit earned "4 the sing e pri(e monopo ist !i "e ,15 x 11. ,& x 15. = *;5. ,d. The dead!eight oss from sing e pri(e monopo 4 !i "e ,11 &. x ,38 15.0% = *3;.58. ,e. The amount of dead!eight oss ,!hi(h in this pro" em is a ost (onsumer surp us. is ess under sing e-pri(e monopo 4 that it is under mar2et-separating pri(e dis(rimination. Bn aggegate then$ (onsumers are "etter off ,ha)e more (onsumer surp us. under sing e pri(e monopo 4. -o!e)er$ the (hange to sing e pri(e monopo 4 does not affe(t these t!o (ities simi ar 4. Consumers in -a ifax are "etter off under sing e pri(e monopo 4 "e(ause the4 no! pur(hase 13 units at *11 ea(h (ompared to + units at *15 ea(h under mar2et separation. Consumers in Dartmouth are !orse off under sing e pri(e monopo 4 "e(ause the4 no! pur(hase % units at *11 ea(h (ompared to & units at *+ ea(h under mar2et separation. 3%. ,a. Ae 2no! that R6 O RC = %88$ in other !ords that the maximum num"er of hours of a"our a)ai a" e for produ(tion is %88. Ae a so ha)e the produ(tion fun(tions for fish and (o(onuts !hi(h are 6 = ,R6.2and C = ,RC.2. Ae (an su"stitute these into the a"our (onstraint to get a produ(tion possi"i ities frontier sho!ing the maximum amounts of fish and (o(onuts a)ai a" e in (om"ination 6% O C% = %88. #o"inson Crusoe3s uti it4 fun(tion is E = ,6C.2. To find the optimum$ form the Ragrangean fun(tion9 = 62C2 O ,%88 - 6% - C%..

Then 06 = I 6-10% C10% %6 = 8 5nd 0C = I C-10% 610% %C = 8 5nd 0 = %88 - 6% - C% = 8 Ae (an manipu ate the first t!o e7uations to find that C06 = 60C or 6% = C%. 'u"stituting into the e7uation for the PP6$ !e ha)e %88 - %C% = 8$ or C% = 188$ or C = 18. This imp ies that 6 = 18$ as !e $ and so uti it4 is E = ,6C. 2 = 18. The #ate of Produ(t Transformation is the negati)e of the s ope of the PP6. Bf 6% O C% = %88$ then 6 = ,%88 - C% .10%. Therefore d60dC = -,10%,%88 - C% .-10% x %C. = C06 = 18018 = 1. The #PT is 1.
,". The Ragrangean for this (onstrained maximization pro" em is9 = 6C2CC2 O ,%88 6P% CP%. O ,%6P %6C - CC O CP.. Therefore$ 06( = I 6( -10% C( 10% %6 = 8 0C( = I C(-10% 6(10% = 8 06P = -%6P O % = 8 0CP = -%CP O = 8 0 = %88 6P% CP% = 8

0 =%6P %6C - CC O CP = 8 Ae (an manipu ate the first t!o e7uations to find that %6C = CC . Ae (an manipu ate the se(ond t!o e7uations to find that %CP = 6P . 'u"stituting this into the fifth e7uation$ !e find that <CP% O CP% = %88 or that CP% = <8 or CP = &.3%5. This means that 6P = ,1&8.10% = 1%.&<+. Ae (an su"stitute into the sixth e7uation to find CC = 15.=1 and 6C = ;.+8&. #o"inson Crusoe3s uti it4 after internationa trade "egins is E

= ,6C.2 = ,;.+8& x 15.=1.10% = 11.1=.

33. ,a. the matrix !ith 'usan as one p a4er and Non as the other has a pa4off of O5 if Non and 'usan "oth p a4 one finger. Bf "oth p a4 t!o fingers$ the pa4off is O1. Bn the other t!o (e s$ the pa4off ,to Non. is 1. ,". 5ssume that PH is the pro"a"i it4 that Non !i ho d out one finger. Then$ the pa4offs to 'usan (an "e (a (u ated as9 Pa4off to one finger = -5 PH O 1,1 - PH. = 1 - & PH Pa4off to t!o fingers = 1PH O ,-1.,1 - PH. = %PH 1 Non 2no!s these pa4offs and !i see2 to adHust these pa4offs unti there is no parti(u ar ad)antage to 'usan in p a4ing one strateg4 rather than another. -e (an do this "4 e7ua izing the pa4offs$ so 1 - & PH = %PH 1 or PH = .%5. Bn other !ords$ Non !i ho d out one finger !ith pro"a"i it4 .%5. 5ssume that P' is the pro"a"i it4 that 'usan !i ho d out one finger. Then$ the pa4offs to Non (an "e (a (u ated as9 Pa4off to one finger = 5 P' O ,-1.,1 P'. = & P' - 1 Pa4off to t!o fingers = -1P' O 1,1 P'. = 1 - %P' 'usan 2no!s these pa4offs and !i see2 to adHust these pa4offs unti there is no parti(u ar ad)antage to Non in p a4ing one strateg4 rather than another. 'he (an do this "4 e7ua izing the pa4offs$ so & P' - 1 = 1 - %P' or P' = .%5. Bn other !ords$ 'usan !i ho d out one finger !ith pro"a"i it4 .%5$ and therefore !i ho d out t!o fingers !ith pro"a"i it4 .;5.