-There are 100 points in total. Points for each question are indicated.
-Show all your calculation, and clearly mark the correct answer.
-Write clearly and legibly, and fully label all graphs!
1.Concepts and short answer questions (20 points)
a.[5 points] Define and explain the difference between the concepts economies of scale and returns to scale.
b.[5 points] The Lerner Index provides a measure of market power. Provide the mathematical formula for this index, and explain its meaning in words. Also explain why this index provides a reflection of market power.
c.[5 points] Provide a graphical illustration of the indifference curve diagrams for the following two preference descriptions.
1.Erik likes his fries with mayo, and adds exactly two spoons of mayo on every portion of fries.
2.Tommy likes all kinds of milk. His marginal rate of substitution between full-fat milk and skimmed milk does not vary with the quantities of full-fat and skimmed milk he consumes.
d.[5 points] Explain the basic differences between monopoly, oligopoly and monopolistic competition.
2. Consumer choice (15 points)
Florian’s preferences for Burgers (B) and Sushi (S) can be represented by the following utility
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function: ( , ) = 3 3. He has an annual budget of 1080€, which he can spend on burgers and sushi. Prices are PB = 10€ per burger and PS = 15€ per box of sushi, respectively.
a. [2.5 points] Write down Florian’s budget constraint, and use it to illustrate how many boxes of sushi he can still afford in case he would buy 48 burgers.
b. [5 points] Identify Florian’s optimal consumption of burgers and sushi. (round off at two digits after the comma if needed)
c. [2.5 points] Imagine now that the price of burgers decreases PB = 8€ per burger. How much money would Florian be left with if he sticks to his consumption bundle as calculated under point b?
d. [5 points] Calculate Florian’s optimal consumption of burgers and sushi after this price change, and graphically illustrate the income and substitution effect arising from this price change. (Make sure your graph is clearly drawn!)
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3. Producer theory (10 points)
The London Review of Books (LRB) produces a magazine of books reviews (surprise!) with
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the following production function ( , ) = 3 4 4 (where L is labour and K is capital).
a. [3 points] How many units of labour does the LRB require to produce 48 magazines (i.e. one per week with a 4-week summer-break) when they have 16 units of capital available?
b. [7 points] What is the marginal product of K? what is the marginal product of L? What is the marginal rate of technical substitution between L and K?
4. Competitive markets (30 points)
a. [10 points] Graphically illustrate the deadweight loss that arises when a government imposes a price ceiling (Pmax) set below the market-clearing price (P0)? Clearly explain the various changes in consumer and producer surplus that arise from this government intervention.
NOTE: Make sure to clearly label all elements of your graph:
-Label the market-clearing quantity and price as Q0 and P0, respectively.
-Label the quantity and price under the price ceiling as Q1 and Pmax, respectively.
b. [5 points] Nettbuss AS offers long-distance bus travel, and has the following short-run total cost function: C(q) = 2q3 – 8q2 + 12q + 4 (with q measuring output in kilometers of travel). Would you advise in favour or against Nettbuss offering bus trips (i.e. q>0) when the price level P per kilometer of travel equals 3? Explain your answer!
The market for rental snowboards in Geilo is perfectly competitive. With P representing the price in NOK/hour and Q the quantity in terms of snowboard rentals (per hour), the market is described by the following (inverse) supply and demand functions:
Demand: P = 200 – 5Q
Supply: P = 4Q – 70
c. [5 points] What is the equilibrium price and quantity? What is the size of the consumer surplus at the equilibrium price and quantity?
d. [5 points] The government is concerned about the number of snowboarders racing down the slopes and decides to impose a cap on the number of snowboard rentals at Q = 20. What will the new equilibrium price be that consumers have to pay? How much does the size of the consumer surplus change due to this government intervention?
e. [5 points] Would your answer change if the government’s cap on the number of snowboard rentals instead was set at Q = 60? Explain concisely why this is the case.
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5. Monopoly, Market power and Oligopoly (25 points)
a. [5 points] Explain the idea behind first-degree price discrimination. Graphically illustrate how the quantity supplied by a monopolist firm under first-degree price discrimination (to be labelled as QPD) differs from the quantity supplied by a monopolist firm that can only set
one price (to be labelled as QMON).
(Note: The optimal price of the non-discriminating monopolist can be labelled as PMON).
Bounce Inc. is a monopolist in the market for travel-size trampolines, and faces an inverse market demand curve given by = 99 ‒ 3 (where P is the price in NOK, and Q is the quantity). Its total cost function is given by TC = 9Q.
b. [5 points] Calculate Bounce Inc.’s profit-maximizing price, quantity and profit.
c. [10 points] Suppose a second firm – Leap Ltd – with a MC = 15 and no fixed costs enters the market. Assume that both firms compete in quantities (i.e. this is a Cournot oligopoly). First write down the reaction functions (also known as best-response functions) for Bounce Inc. and Leap Ltd. Then use these functions to calculate the equilibrium quantities produced by both firms. Finally show the resulting market price and the profits of each firm. (round off at TWO digits after the comma if needed)
d. [5 points] Draw the best response functions in a diagram with the quantity produced by Bounce (QB) on the vertical axis and the quantity produced by Leap (QL) on the horizontal axis. Indicate the Nash equilibrium point on your graph! (Clearly indicate all elements in your graph: axes, intercepts, best response functions,…)
