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Berkeley ECON 100A - Econ 100A Midterm 2 Solutions

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Econ 100A Midterm 2 Solutions 1. A straightforward response to this question would have utilized a graph, as above. The graph shows the before-tariff demand curves DUS, DE, DT for US, European, and world demand, respectively, where the world demand is the horizontal sum of US and European demand. Supply is upward-sloping, as given in the problem. The initial price is P0 for the entire world, with quantities Q0_US, Q0_E, and Q0_T denoting initial quantities sold in the US, Europe and the world. The demand in Europe shifts down by a distance t due to the specific tariff. This new demand is drawn in a heavier line and labeled D’E. The new world demand is also drawn in a heavier line and is labeled D’W. The Asian suppliers shift their deliveries between the two sectors until the price they receive is equal in both sectors (shown as P1_US). US customers pay a lower price P1_US, while European customers pay a higher price P1_US+t which is also drawn as P1_E when compared to the no-tariff case. US quantity increases, European quantity decreases, and total quantity decreases. 9 points for a clear explanation and graph 6 points for correctly identifying quantity and price changes2. The government sets a biding price support for soybeans at $5. The government will buy as many bushels as farmers want to sell at that price. (The government destroys the crop it buys.) Label the equilibrium point e1; and show the equilibrium price p1, and equilibrium quantity, Q1. How much output does the government buy? Now suppose that technological progress causes the original supply curve, S1, to shift to the right to S2. Show the new equilibrium e2. What happens to consumer surplus (if it changes, show how it changes)? How does the amount of output the government buys change? Solution: Initially market quantity is where demand intersects the original supply equation S1. When the government imposes a price support equal to $5, the quantity demanded falls to Qd. The equilibrium point is e1. The quantity supplied rises to Qs1. The difference between quantity supplied and quantity demanded is government purchases (G1). Consumer surplus (CS) has not changed – it is the triangle above the price support (i.e. the price paid) and below the demand curve. After the technological shift but still with the government price support, quantity demanded does not change. Quantity supplied increases to Qs2. The difference between quantity supplied and quantity demanded is government purchases (G2). Notice that G2-G1 = (Qs2-Qd) -(Qs1-Qd)= (Qs2-Qs1)>0. Consumer surplus is the same since the demand curve and the price paid by consumers do not change. Price support P S1 D Qd Q S2 Qs1Qs2p1=$5 e1=e2 CS G1 G23. A monopoly produces a life-saving medicine at a constant cost of $10 per dose. The demand for this medicine is perfectly inelastic if the price is less than the $100 per day for the 100 patients who need to take this drug daily. Patients will not (cannot) pay more than $100 per day. A. Show the equilibrium price and quantity, the consumer surplus, and producer surplus, and the deadweight loss in a graph. First consider how demand looks. 100 patients are each willing to pay up to $100 per day for one unit of the good. Hence for prices up to $100, 100 units of the good are demanded in aggregate. For price higher than that, no units are demanded. What should the firm produce, and how should it price it? Recall the heuristic rationale that brought us to the MR=MC rule. If an extra unit increases the firm’s revenue by more than it costs to produce, the firm should produce it. 100 patients are each willing to pay up to $100 for a unit of the good, hence for any price below that cutoff point, the firm can sell up to one hundred units. If it’s selling at a price above $10, which is its marginal cost, then it can sell up to one hundred units. It has no reason to sell below 100 units, because all customers all willing to shoulder $100 per dose. Moreover, it can set prices, and as long as it keeps them at or below $100, all customers are willing to buy. Hence, seeking to maximize its profit, it will charge $100. There is therefore no deadweight loss. All 100 units that society values are being produced. If the drug was produced competitively, then 100 units would be sold at a price of $10, equal to the marginal cost and minimum average cost. Competition, in the form of entry in the market, would eat away firm profits. The only difference here is that it is the firm making all the surplus, and the customers left with no consumer surplus. Hence PS=A+B, CS=0, DWL=0. $ $100 Equilibrium A A $30 Equilibrium B B $10 MC 100 QB. The government imposes a price ceiling of $30. Show the new equilibrium. What is the change in consumer and producer surplus? What is the deadweight loss (if any) from this price control? By establishing a price ceiling of $30, the government limits the price the firm can charge. It will still give the drug to all 100 patients, since the sale of the drug to each patient does not affect the price it can charge to previous patients, and marginal cost always remains below the highest marginal revenue it can have, which is $30. Hence now PS=B and CS=A. There is no deadweight loss from this price control, as it did not affect agents’ behavior, it merely redistributed surplus between producer and consumer groups. 4. A profit maximizing monopolist sets marginal revenue equal to marginal cost. We can figure out the marginal cost function by differentiating the cost function. However, we’re only given the profit maximizing price and price-elasticity of demand. We can rewrite the marginal revenue function as MR=p(x)*[1+1/e] where e is the price-elasticity of demand. MC=10+2*q Thus setting MR=MC and plugging in the price and elasticity, we can solve for q. 40*(1+1/(-2))=10 +2q 20=10+2q q=5 5. What are the effects on price, quantity, deadweight loss, and profit of a lump-sum tax on a monopoly? There are a number of different ways to answer this question. Any form of explanation that a lump-sum tax has no effect on marginal revenue or marginal


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Berkeley ECON 100A - Econ 100A Midterm 2 Solutions

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