Question One

Suppose that Parliament is currently considering the imposition of a tax on distilled liquors. The tax would not apply to beer. The own-price elasticity of supply of liquor is 4, and the own-price elasticity of demand is -0.2. The cross-elasticity of demand for beer with respect to the price of liquor is 0.1.

1.If the new tax is imposed, who will bear the greater tax burden, liquor suppliers or liquor consumers? Why? Support your answer with an appropriate diagram.

2.How will the new tax affect the beer market, assuming that beer supply is perfectly/indefinitely elastic? Support your answer with an appropriate diagram.

Question Two

Suppose that the average revenue (demand) curve and the marginal revenue curve for a monopolist are as follows:

AR = P = 27 - (3/2)Q

MR = 27 - 3Q

Suppose further that the monopolist can produce at a constant marginal (and average) cost equal to $10.

1.What are the firm's profit maximizing output and price?

2.What is the firm's profit?

3.What would the equilibrium price and quantity be in a competitive industry?

4.What would the social gain be if this monopolist were forced to produce and price at the competitive equilibrium? Who would gain and lose as a result? Illustrate your answer with an appropriate diagram.

Question Three

Determine the "rule-of-thumb" price when for a monopolist who has a marginal cost of $25 and faces a price elasticity of demand of -3.0.

Question Four

Suppose a monopolist is deciding how to allocate output between two geographically separated markets (Dunedin and Auckland). Average revenue (demand) and marginal revenue for the two markets are:

P1 = 15 - Q1; MR1 = 15 - 2Q1

P2 = 25 - 2Q2; MR2 = 25 - 4Q2

Where 1 denotes the Dunedin market and 2 denotes the Auckland market. The monopolist's total cost is C = 5 + 3(Q1 + Q2), implying a constant marginal cost of $3.00.

1.What are the price, output, profits, marginal revenues, and deadweight loss if the monopolist can price discriminate?

2.What are the price, output, profits, marginal revenues, and deadweight loss if the monopolist is not allowed to charge different prices in the two cities?

Question Five

Stag's Leap winery sells wine in two sub-markets. In one market, the wine carries a distinctive Stag's Leap label and is bottled in a uniquely shaped bottle which receives a substantial price premium. The other sub-market is targeted toward more price conscious consumers who buy the wine in a standard bottle carrying the label "Misty Bay Table Wine". The retail price of the premium Stag's Leap wine is $21 per bottle, while the wine carrying the Misty Bay label sells for $12.50 per bottle. Market research indicates a price elasticity of demand for the higher priced wine of -2.0, and an elasticity of demand for the Misty Bay wine of -4.0. Moreover, the research suggests that both elasticities are constant over broad ranges of output.

1.Demonstrate that the winery's current prices are not optimal.

2.Management considers the $12.50 price necessary to meet competition. What price should the firm set for the Stag's Leap label to achieve and optimal price ratio?

Question Six

A monopolist can produce at a constant average (and marginal) cost of AC = MC = 5. The firm faces a market demand curve given by Q = 53 - P.

1.Calculate the profit maximizing price and quantity for this monopolist. Also calculate the monopolist's profit.

2.Suppose a second firm enters the market. Let Q1 be the output of the first firm, and Q2 be the output of the second firm. Market demand is now given by Q1 + Q2 = 53 - P. Assuming that this second firm has the same cost structure as the first, write the profits of each firm as a function of Q1 and Q2.

3.Suppose (as in the Cournot model) each firm chooses its profit-maximizing level of output under the assumption that its competitor's output is fixed. Find each firm's 'reaction curve' (eg, the rule that gives its desired output in terms of its competitor's output).

4.Calculate the Cournot equilibrium (eg. the value of Q1 and Q2 for which both firms are doing as well as they can given their competitor's output). What are the resulting market price and profits of each firm?