Problem Set #4

I. Multiple Choice/Multiple Responses Questions

1. A firm is considered as a natural monopoly if it exhibits the following

characteristics as its output increases.
a. increasing total revenue
b. increasing marginal cost
c. decreasing marginal revenue
d. decreasing average total cost

2. Price discrimination refers to charging different prices based on

a. the consumer’s willingness to pay.
b. the consumer’s racial or ethnic group.
c. the cost of producing the good for a particular consumer.
d. whether the consumer is likely to become a repeat buyer.

3. For a profit-maximizing firm in an uncompetitive market that charges a single

price, what is the relationship between price P, marginal revenue MR, and
marginal cost MC?
a. P = MR and MR = MC
b. P > MR and MR = MC
c. P = MR and MR > MC
d. P > MR and MR > MC.

4. What is untrue of a monopolistically competitive market in long-run equilibrium?

a. Price is greater than marginal cost.
b. Price is equal to marginal revenue.
c. Firms make positive economic profits.
d. Firms produce at the minimum of average total cost.
II. Critical Thinking Questions

1. Figure below shows two demand curves for firm’s product. Panel A illustrates a
perfectly elastic demand curve of a firm in a competitive market while panel B
shows a demand curve for a monopolist’s product.

a. Why do you think that the demand curve for a competitive firm is
horizontal? What would happen to the quantity of output of that firm if we
increase the price?

Answer: horizontal curve reflects the reality that regardless of how much individual firms
produce, they cannot affect price. Simply put, no matter how much they produce, price
is still the same. And if individual firm increases price alone, the demand for their output
will be 0.

b. Why do you think that the demand curve for a monopolist resembles
individual demand curve? What would happen to the quantity of output of
a monopolist if we increase the price?

Answer: Because monopolist is the only firm in the market that supplies good so quantity
supply of and demand for specific good in the market is the same. Therefore, it makes
sense to just use one curve to represent both demand and supply (and price). If we increase
the price, quantity of output decreases, as consumers would want less of the products.

2. For each of the following characteristics, say whether it describes a perfectly

competitive firm, a monopolistically competitive firm, both, or neither.
a. sells a product differentiated from that of its competitors
 b. has marginal revenue less than price
c. earns economic profit in the long run
d. produces at the minimum of average total cost in the long run
e. equates marginal revenue and marginal cost
f. charges a price above marginal cost

Answer: a. monopolistic competitor.

b. monopolistic competitor.
c. neither
d. perfectly competitive firm.
e. both
f. monopolistic competitor.

3. Assume that only one firm produces and sells soccer balls in the United States, and
international trade in soccer balls is prohibited. The following equations describe
the monopolist’s demand, marginal revenue, total cost, and marginal cost:

Demand: P = 10 – Q
Marginal Revenue: MR = 10 – 2Q
Total Cost: TC = 3 + Q + 0.5Q2
Marginal Cost: MC = 1 + Q,
where Q is quantity and P is the price measured in US dollars.
 a. How many soccer balls does the monopolist produce? At what price are
they sold? What is the monopolist’s profit?
b. One day, the US government decrees that henceforth there will be free
trade—either imports or exports—of soccer balls at the world price of
$6. The firm is now a price taker in a competitive market. What happens
to domestic production of soccer balls? To domestic consumption? Does
US export or import soccer balls?

Answer: A. Q = 3, P = 7, Revenue = 21, TC = 10.5, Profit = 10.5

𝑀𝑅 = 𝑀𝐶
→ 10 − 2𝑄 = 1 + 𝑄
→ 3𝑄 = 9 → 𝑄 = 3
𝑃 = 10 − 𝑄 → 𝑃 = 7
𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 𝑃 ∗ 𝑄 = 3 ∗ 7 = 21
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 = 3 + 3 + 0.5 ∗ 3! = 10.5
𝑃𝑟𝑜𝑓𝑖𝑡 = 21 − 10.5 = 10.5

B. The domestic production of soccer balls decreases; domestic consumption

increases; the US will import soccer balls.

4. You and a classmate are assigned a project on which you will receive one combined
grade. You each want to receive a good grade, but you also want to avoid hard
work. In particular, here is the situation:
• If both of you work hard, you both get an A, which gives each of you 40
units of happiness.
• If only one of you works hard, you both get a B, which gives each of you 30
units of happiness.
• If neither of you works hard, you both get a D, which gives each of you 10
units of happiness.
• Working hard costs 25 units of happiness.
 a. Fill in the following payoff matrix

15 30

15 5

5 10

30 10

b. What is the likely outcome? Explain your answer.

c. If you get this classmate as your partner on a series of projects throughout
the year, rather than only once, how might that change the outcome you
predicted in part (b)?

Answer: B. You both just shirk the responsibility and both get 10 unit of happiness
because you realize that if you shirk the duties, regardless of what your partner
chooses to do (work hard or shirk), you will maximize your benefits. In addition,
you believe that your partner is likely thinking similarly like you are.

C. Game Theory predicts that if you play a game infinite times, the outcome
is likely to change, and you both are more likely to cooperate and work-hard.