WINTER BREAK WORK (MICROECONOMICS)
Complete ALL of the following Questions. Be careful to clearly explain your
reasoning and to provide clear labels to all graph axes and curves.
1. Assume the following about the market for cigarettes.
 Cigarettes are sold in a competitive market.
 Cigarettes have no close substitute.
 The demand for cigarettes is price inelastic.
Suppose now that the government imposes a per unit excise tax on producers of cigarettes.
A. Using a correctly labeled graph, show the impact of the excise tax on each of the following
in the cigarette market:
i.
Price.
ii. Output.
iii. The area of tax revenue collected by the government.
iv.
Dead weight loss from the tax.
B. Given that demand for cigarettes is price inelastic, will consumer spending on cigarettes
increase, decrease, or remain constant? How do you know?
2.
Two rival firms operate in an oligopoly and, once a year, choose an advertising strategy. The firms
can choose between an expensive television and radio advertising campaign (costly ads) or an
inexpensive direct mail advertising campaign (cheap ads). Television and radio cost more, but
reach more potential customers. Each firm decides their advertising strategy independently on
January 1, 2007 and, once chosen, cannot alter the decision until January 1, 2008. The table below
summarizes the profits each firm would earn given their own, and their rival's strategy. Use this
matrix to answer the following questions.
A. Suppose Firm 1 chooses Costly Ads and Firm 2 chooses Cheap Ads.
i.
Identify the profit for Firm 1.
ii. Identify the profit for Firm 2.
B. It is now January 1, 2007 and each firm must independently make the advertising strategy
decision. Is there a dominant strategy in this game? Explain how you know.
C. If each firm chooses the advertising strategy independently without collusion, what is the
outcome of this game?
D. Is the outcome of this game an example of “prisoners’ dilemma”? Explain your answer.
4. Bob's Beans is a perfectly competitive soybean producer. The short-run price of soybeans is
currently below average total cost, but above Bob's shut-down point.
A. Using two correctly labeled graphs, show the soybean market side-by-side with Bob's
Beans. Clearly indicate which graph represents the market and which represents Bob's
Beans. In your graphs, identify:
i.
Price and quantity in the soybean market.
ii. Price and quantity for Bob's Beans.
iii. The area of economic profit or loss for Bob's Beans.
B. In a new set of side-by-side graphs for both the market and Bob's Beans, show the longrun
adjustment in each of the following:
i.
Price and quantity in the soybean market.
ii. Price and quantity for Bob's Beans.
C. Suppose now that Bob's Beans is a monopoly producer of soybeans. In a correctly labeled
graph, show a profit-maximizing monopolist and indicate each of the following:
i.
Price and Output
ii. The area of economic profit or loss for Bob's Beans.
iii. Dead Weight Loss and Consumer Surplus