Microeconomics FRQ Practice 1 Key
1.(a)(i) MR=MC is the profit-maximizing quantity. 4.
(ii) Go to demand curve from MR=MC. $40.
(iii) Allocative efficiency is typically where P=MC. 8.
(b) Economies of scale exist when your costs keep going down the more you produce. Increasing
returns to scale. The idea is that the fixed costs keep getting spread out so that your overall
production costs keep going down. In this case, this monopolist isn’t experiencing economies of
scale (nor diseconomies of scale). The LRATC curve is straight across, equal to both MC and the
SRATC. The straight line means that the rate of increase is constant, not increasing nor decreasing.
To experience economies of scale, there’d have to be a downward sloping LRATC curve tangent
with the SRATC curve at some point.
(c) This section is explicit. If you didn’t show your math here, even if you got the right answer, you
would not have gotten a point. At the same time, if you ignored the prompt about production 10
units, you’d get everything wrong.
(i) The “economic” in “economic profit” is designed to throw you off between this and accounting
profit. Accounting profit refers to total revenue minus total explicit costs. Economic profit refers
to total revenue minus total explicit and implicit costs. For this FRQ, that’s the profit rectangle.
Since we’re producing at 10 units, 10 is Q, P = $10, ATC is $20. What they’re trying to psych you
out on here is producing at 10 units which would cause a deliberate loss. Combine that with the
graph and they’re trying to confuse you. Stick to the math.
Profit = (P – ATC)(Q)
= ($10 - $20)(10)
= (-$10)(10)
= -$100
(ii) Consumer surplus is the difference between what we’re willing to pay vs. what we actually pay
times the quantity. In this case, the max we’re willing to pay is $60, but what we actually pay is $10.
Q is still 10.
CS = ½ (b)(h)
= ½ ($60 - $10)(10)
= ½ ($50)(10)
= ½ ($500)
= $250
(iii) DWL at 10 units is a bit off to where we normally see DWL. DWL is actually the triangle
found between MC and D curves at 10 units, above the D curve. From there it’s finding the area of
the triangle. The amount of extra units is 2, as opposed to 8 at allocative efficiency (10 – 2), The
market price vs. the price paid would be $20 minus $10 ($10).
DWL = ½ (b)(h)
= ½ ($20 - $10)(10 – 8)
= ½ ($10)(2)
= ½ ($20)
= $10
(d) Use the total revenue test to find it. TR spikes at 6 ($180). Anything before and after decreases.
Unit elastic is at 6.
(e) Requires you to understand that under perfect price discrimination, there is no consumer surplus
as the producer surplus (profit) eats it up. The producer is able to charge a different price for every
customer. That also means no DWL.
(i) Profit = ½ (b)(h)
= ½ ($60 - $20)(8)
= ½ ($40)(8)
= ½ ($320)
= $160
(ii) 0. No consumer surplus in perfect price discrimination.
3.(a) The graph is pretty straight forward—a simply demand and supply graph, labeled for P and Q,
and then respective equilibriums. However, if you didn’t draw in the elasticities correctly with the
prompt, then the rest of the FRQ will be problematic. Demand should be steeper than supply
because of its inelasticity.
(b) The $2 tax on producers means the supply graph shifts up by the same amount across the
board. The rest of this is just labeling.
(i) PB is found at the new equilibrium.
(ii) P2 is found straight below Pb on the previous supply curve.
(iii) QT is found straight below PB and PS
(c) When it says to use the labeling from your graph, you can literally use the labeling to explain
how to find tax revenue. No words are even necessary. (PB – PS)(QT)
(d) Tax incidence is determined by inelasticity. Whoever is more inelastic will bear the burden of
the tax. That’s the consumer in this case. Additionally, if you did your graph correctly, you can read
it from that.
Question 1
Question 3