practice free response questions. 1) assume that a profit-maximizing firm in a monopolistically...
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Practice Free Response Questions
1) Assume that a profit-maximizing firm in a monopolistically competitive industry is in long-run equilibrium.
(a) Draw a correctly labeled graph that shows the profit-maximizing firm’s price and output.i. Difference between a competitive output, price & profit
MCATC
D
MRQty
P
Q1
P1A
------------
B
Quantity0
Price
P = MC P = MR(demand
curve)
P = MC P = MR(demand
curve)
Perfectly Competitive Firm
MCMCATCATC
Quantity produced =Efficient scale
Quantity produced =Efficient scale
B
(b) The city eliminates the business license fee (a fixed cost) for all firms in this industry. How does the elimination of the license fee affect:
i) Output/Price does NOT change
WHY: a ∆ in fixed costs
does not ∆ marginal costs ormarginal revenue.
i. Output ii. Profit iii. Modify Graph
MCATC
D
MRQty
P
Q1
P1A
MCATC
D
MRQty
P
Q1
P1A
MCATC
D
MRQ
P
Q
P
ii) As fixed costs ↓ ATC
Shifts downward => profits ↑ (from zero to shaded Area)
c) In long run this would attract more competition-Demand would shift left-Profit would = ZERO-Quantity would fall
ATC1EconomicProfits
(c) continued
i. Output ii. Profit iii. Modify Graph
A
D
MR
-----------------
Unit ElasticElastic range
Inelastic Range
●
Demand Curve & Elasticity
1) Firms Operate in Elastic Portion of Demand
2) Elasticity = 1 when MR = 0
Practice Free Response Question #2
Watsonia
Marginal Cost
Average Total Cost
Demand
Marginal Revenue
ATTENDANCEQ1 Q2 Q3 Q4 Q5 Q6 Q70
P1
P2
P3P4P5
P6
PR
ICE
/CO
ST
1. There is one art museum on the island of Watsonia. The museum’s demand and cost curves are shown in the graph above. The museum currently relies on an admission charge for some of its funding. Its directors are debating about how to set the admission charge.
Marginal Cost
Average Total Cost
Demand
Marginal Revenue
ATTENDANCEQ1 Q2 Q3 Q4 Q5 Q6 Q70
P1
P2
P3P4P5
P6
PR
ICE
/CO
ST
a) Identify the price and quantity associated:
i) The museum maximizes its profit. P5 Q2
Marginal Cost
Average Total Cost
Demand
Marginal Revenue
ATTENDANCEQ1 Q2 Q3 Q4 Q5 Q6 Q70
P1
P2
P3P4P5
P6
PR
ICE
/CO
ST
ii) The museum maximizes its total revenue P3 Q4
Marginal Cost
Average Total Cost
Demand
Marginal Revenue
ATTENDANCEQ1 Q2 Q3 Q4 Q5 Q6 Q70
P1
P2
P3P4P5
P6
PR
ICE
/CO
ST
iii) The museum maximizes the sum of consumer and producer surplus (total welfare)
P4 Q3
Marginal Cost
Average Total Cost
Demand
Marginal Revenue
ATTENDANCEQ1 Q2 Q3 Q4 Q5 Q6 Q70
P1
P2
P3P4P5
P6
PR
ICE
/CO
ST
iv) The museum maximizes its attendance, as long as it breaks even.
P2 Q5
Marginal Cost
Average Total Cost
Demand
Marginal Revenue
ATTENDANCEQ1 Q2 Q3 Q4 Q5 Q6 Q70
P1
P2
P3P4P5
P6
PR
ICE
/CO
ST
b) When the attendance is Q1, is the demand price elastic, inelastic, or unit elastic? Explain.
Demand is elastic at Q1.MR is greater than zero; Q1 is left of the mid-point
or in the upper half of the demand.
Elastic
Inelastic
Marginal Cost
Average Total Cost
Demand
Marginal Revenue
ATTENDANCEQ1 Q2 Q3 Q4 Q5 Q6 Q70
P1
P2
P3P4P5
P6
PR
ICE
/CO
ST
c) Assume that the price is set at P2. Assuming the existence of an opportunity cost, indicate whether the museum’s accounting profits would be positive, negative, or zero. Explain why.
Accounting profits are positive.
Marginal Cost
Average Total Cost
Demand
Marginal Revenue
ATTENDANCEQ1 Q2 Q3 Q4 Q5 Q6 Q70
P1
P2
P3P4P5
P6
PR
ICE
/CO
ST
c) Assume that the price is set at P2. Assuming the existence of an opportunity cost, indicate whether the museum’s accounting profits would be positive, negative, or zero. Explain why.
Economic profit is zero and opportunity costs exist.
Marginal Cost
Average Total Cost
Demand
Marginal Revenue
ATTENDANCEQ1 Q2 Q3 Q4 Q5 Q6 Q70
P1
P2
P3P4P5
P6
PR
ICE
/CO
ST
c) Assume that the price is set at P2. Assuming the existence of an opportunity cost, indicate whether the museum’s accounting profits would be positive, negative, or zero. Explain why.
Economic profit is zero and ATC includes opportunity costs.Or--
Marginal Cost
Average Total Cost
Demand
Marginal Revenue
ATTENDANCEQ1 Q2 Q3 Q4 Q5 Q6 Q70
P1
P2
P3P4P5
P6
PR
ICE
/CO
ST
d) Assume that the government decides the museum should charge no admission and agrees to subsidize the museum for any losses.
i) Using the labeling in the graph, identify the museum’s attendance under that circumstance. Q7
http://www.youtube.com/watch?v=azNo8ttSCiY
Innovation in Schools
Marginal Cost
Average Total Cost
Demand
Marginal Revenue
ATTENDANCEQ1 Q2 Q3 Q4 Q5 Q6 Q70
P1
P2
P3P4P5
P6
PR
ICE
/CO
ST
d) Assume that the government decides the museum should charge no admission and agrees to subsidize the museum for any losses.ii) Would the outcome be allocatively efficient? Explain.
Outcome is NOT allocatively efficient.
Marginal Cost
Average Total Cost
Demand
Marginal Revenue
ATTENDANCEQ1 Q2 Q3 Q4 Q5 Q6 Q70
P1
P2
P3P4P5
P6
PR
ICE
/CO
ST
d) Assume that the government decides the museum should charge no admission and agrees to subsidize the museum for any losses.ii) Would the outcome be allocatively efficient? Explain.
MC > P or MSC > MSB
isgreater
than