Name: ____Solutions_______
Cosumnes River College
Principles of Microeconomics
Problem Set 8
Due April 16, 2015
Spring 2015
Fall 2013
Prof. Dowell
Prof. Dowell
Instructions: Write the answers clearly and concisely on these sheets in the spaces
provided.
1.
The following graph shows the cost curves for a pizza parlor that operates in a
monopolistically competitive market:
Price
Monopolistic Competition
110
100
90
80
70
60
50
40
30
20
10
0
MC
ATC
0
2
4
6
8
10
12
Quantity
MR
14
16
18
D
20
a. Explain why the pizza parlor is probably operating in a market that is monopolistically
competitive. Give an example of a situation where a pizza parlor would not be in a
monopolistically competitive market.
They are probably operating in a monopolistically competitive market because there are
many firms, but the product is differentiated. If pizza were homogeneous, perfect
competition would prevail.
b. What is the quantity of pizza that will be sold and the price at which it will be sold?
Set MC=MR to get Q=8 and P=$60
c. What are the profits for the pizza parlor? Give the dollar amount and show it on the
graph as well.
Profits = TR – TC = *x60 – 8x32 = 8(60-32) = 8(28)=224
Principles of Microeconomics: Problem Set 8
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d. Explain what will happen in the long run. (You don’t need to give numbers, just
explain in words.)
Profits will lead to entry, shifting the individual firms demand curve down and to the lef
until profits are zero.
e. What do we mean by excess capacity? What quantity would the firm have to produce
to not have any excess capacity?
Excess capacity exits when we are not producing at the minimum of average total costs.
To eliminate excess capacity, the firm would have to produce 10 units of output.
2.
Chiaravelli and Fiegenshau are the only two dentists in Plainville. They have been
colluding, sharing the market and earning monopoly profits of $100,000 each for several
years. Fiegenshau is considering reducing his price. He estimates that if Chiaravelli
keeps his price at current levels, Fiegenshau would earn $150,00, although Chiaravelli’s
earnings would fall to $25,000. There is also the possibility that Chiaravelli would
compete against Fiegenshau. The resulting price war would reduce the earnings of each
to $40,000.
a. Represent this situation as a Prisoner’s Dilemma game.
Chiaravelli
Fiegenshau
cooperate
compete
cooperate πF=$100,000
πF=$25,000
πC=$150,000
πF=$150,000
πF=$40,000
πC=$40,000
πC=$100,000
compete πC=$25,000
b. What is the Nash equilibrium outcome? Explain the intuition behind this.
Both players compete. If Chiaravelli cooperates, then Fiegenshau can earn more by
competing ($150,000.$100,000). If Chiaravelli competes, again Fiegenshau earns more
by competing ($40,000.$25,000). The same is true for Chiaravelli, and both choose to
compete.
Principles of Microeconomics: Problem Set 8
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3.
The 500 mail-order computer equipment suppliers are (discretely) forming a cartel. The
market demand curve and the supply curve of a typical equipment supplier are given
below. The quantity represents the number of computers.
P
$1,000
900
800
700
600
500
400
300
200
Market Demand
Q
TR
300,000
300 mil.
400,000
360 mil.
500,000
400 mil.
600,000
420 mil.
700,000 4200 mil.
400 mil.
800,000
900,000
360 mil.
1,000,000 300 mil.
1,100,000 220 mil.
MR
-600
400
200
0
-200
-400
-600
-800
Firm’s Supply
P
Q
$1,000
4,000
900
3,500
800
3,000
700
2,400
600
2,000
500
1,600
400
1,000
300
500
200
100
Market Supply
P=MC
Q
$1,000
2 mil.
900
1.75 mil.
800
1.5 mil
700
1.2 mil.
600
1 mil.
500
800,000
400
500,000
300
250,000
200
50,000
a. Derive the marginal revenue for the computer equipment supplier market.
b. Add up the 500 individual firm supplies to derive the market supply.
c. Find the profit maximizing price for the cartel as a whole. How many computers will
be sold at this price? How many must each from sell to sustain this price?
Set MC=MR=400 => Q=500,000 and P=$800
Each firm will sell 500,000/500=-1,000 units
d. If the cartel charges the price computed in part c, how many units would the
individual firm like to sell?
3,000
e. Now suppose that all firms cheat, and the market becomes competitive. Find the
equilibrium price and quantity.
Find the price/quantity combination where demand equals supply.
P=$500 and Q=800,000
Principles of Microeconomics: Problem Set 8
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6.
Answer the following questions True or False and explain.
a. If a firm in monopolistic competition wants to sell one more unit of output, the
marginal revenue they receive as a result of the sale of that unit is equal to the
price of the product.
False. They face a downward sloping demand curve, meaning that increasing quantity
reduces the price on all units sold. This means that marginal revenue is less than the
price.
b. In the long-run, if a firm in monopolistic competition is earning a profit, new firms
enter and the firm’s demand curve will shift in.
True. In monopolistic competition there are no barriers to entry. As firms enter, the
market demand is divided up among more firms, shifting the individual firms demand
curve down or in.
c. The primary difference between perfect competition and monopolistic competition is
that in monopolistic competition the product is homogeneous.
False. The product is homogeneous in perfect competition and differentiated in
monopolistic competition.
d. A firm has excess capacity if they are operating at the minimum of the average total
cost curve.
False. They have excess capacity when they are not operating at the minimum of ATC.
e. The only time the market will give us an economically efficient (allocative and
productive) long-run equilibrium is if the market is perfectly competitive.
True. Allocative efficiency requires MC=MB (or MC=P) which only occurs under
perfect competition.
f. Price is equal to marginal cost in monopolistic competition.
False. The firm faces a downward sloping demand curve meaning that P>MC.
Principles of Microeconomics: Problem Set 8
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