1.

The figure below shows all direct flights between Seattle and Ontario, California on
January 1st, 2023 that can be booked (as of 12/5/2022) as well as their prices. Only two
airlines serve this route, Alaska Airlines and Delta.

a. Your best friend, Lana, argues that Alaska and Delta are Cournot duopolists and
they are setting their price above the socially efficient level. Lana argues that the
government should regulate the price that these airlines charge. Use 250 or fewer
words to explain what Lana means and what evidence you would seek to support
Lana’s assertions. (5 points).

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b. Your second friend, Delia, argues that Alaska and Delta are Bertrand duopolists
caught in a Prisoner’s Dilemma and they cannot avoid setting price equal to their
marginal cost and thus should not be regulated. Use 250 or fewer words to
explain what Delia means and what evidence you would seek to support Delia’s
assertions. (5 points).

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c. Your third friend, Conor, argues that Alaska and Delta are engaged in
Monopolistic Competition and are earning exorbitant profits. Conor argues that
this condition is leading to an undersupply of airlines seats serving this route. Use
250 or fewer words to assess the validity of Conor’s assertions. (5 points).

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 d. Suppose you are persuaded by Lana that they are Cournot duopolists. After
studying the market, you are convinced that daily demand for this route can be
characterized by the following equation: Q = 1200 – 2P (or, equivalently, P = 600
– Q/2). You believe that the marginal cost of each passenger is $50 (i.e., this is
the cost of added jet fuel and snacks served on the flight).

i. Given these assumptions, what price should each airline set for seats on its
flights? Explain and show your work (9 points).

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ii. How much money would Alaska be willing to pay Delta to take over their
flights from Seattle to Ontario (i.e., so that Alaska would be a monopolist
for this route)? Would Delta accept the offer? Explain and show your
work. (7 points).

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iii. Should federal regulators allow Alaska to pay Delta to take over their
flights from Seattle to Ontario? Explain. (3 points).

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2. Marvelous Wood is the producer of a synthetic wood that has unusual properties
(strength, malleability, durability, etc.). Marvelous Wood (or “MW”) has a patent on
their production process and this patent gives MW the exclusive right to produce and sell
this synthetic wood. There are no other products similar to MW’s synthetic wood. The
following equations characterize the demand for MW’s synthetic wood and the cost of
producing it, where quantity is measured in cubic-feet:

Demand: P = 10,000 – 0.2Q

Cost: Cost = 4,000,000 + 100Q + 1.8Q2
Marginal Cost: MC = 100 + 3.6Q

a. How many cubic feet of MW’s synthetic wood will be sold? Show your work
(here and on subsequent questions). (3 points).

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b. What price will MW set for its synthetic wood? (2 points).

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c. How much profit will MW earn? (4 points).

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d. How much deadweight loss will there be in this market for MW’s synthetic
wood? (5 points).

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e. Congresswoman Patty Bonilla supports legislation for the federal government to

give Marvelous Wood a $100 subsidy for each cubic foot of synthetic wood that
they sell. Bonilla argues that this subsidy will improve economic efficiency. Is
Bonilla correct? Explain. (4 points).

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3. Perfect Competition – Long Run

a. In choosing how much capital and labor to use in the long-run, why will a profit-
maximizing firm set the marginal rate of technical substitution equal to the ratio
of w/r, where w is the wage paid to workers and r is the rental cost of capital?
Use 200 or fewer words to explain. (5 points).

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b. For a perfectly competitive firm, explain why P=MC=ATC in the “long-long-

run”. What does this imply about the firm's profit? Use 200 or fewer words to
explain. (5 points).

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4. In a given year, the short-run demand and supply for re-roofing houses in Seattle are
given by the following equations:

Qd = 2000-P/25
Qs = -2000 + P/5

Assume that these re-roofing services are supplied by perfectly competitive firms and
assume that each firm has identical costs of production.

a. Compute the initial equilibrium price, quantity, producer surplus, and consumer
surplus. (If you cannot solve this mathematically, do so graphically for fewer
points.) (7 points).

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b. For this market, what information would you need to know to compute an
individual firm’s short-run profit? (3 points).
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5. Suppose the government provided low-income households a subsidy which paid 20% of
their rent. Under this policy, the average low-income household’s rent is $600, of which
the government pays $120.

a. Explain how this policy produces economic inefficiency. (4 points)

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b. Suppose that the government considers replacing this subsidy with a $120 cash
payment to low-income households. How would this policy change affect the
average low-income household’s expenditure on rent and other goods? Explain
both substitution and income effects. (4 points)

Answer Here