CALCULATION IN MICRO ECONOMICS

QUESTION
Instructions

Economics Department
School of Economics and Finance

Additional Tutorial Exercises ‐ Set 3
313658 Microeconomics 300
Semester 2 2012

Dr Julian Inchauspe, Unit UC & Lecturer

Due on: Your Assigned Tutorial Session in Week 12
 Fill the empty gaps on this page.
 Use the answer sheet on page 6 to answer the multiple choice questions.
 Handwritten answers are acceptable.
 Submit your answers by giving a hard copy of your answers to your Tutor during your assigned
Tutorial session.
 Plagiarism or cheating will not be tolerated and may lead to a mark of 0 (zero) and further
disciplinary actions.

First Name:……………..……………………………………………………………………………
Last Name:.…………………………………………………………………………………………..
Signature:……………………………………………………………………………………………..
Tutor:……………..…………………………………………………………………………………….
Day and Time of Tutorial:……………………………………………………………………..

MARK:                /100
Microeconomics 300 ‐ Semester 1, 2012                                                                Additional Tutorial Exercises – Set 3

1.  Suppose  that  there  are  two  airlines  operating  a  particular  route  in  Australia.  You  have  been  asked  by
the  Australian  government  to  research  what  would  happen  under  different  hypothetical  situations  or
scenarios.  Your  report  will  be  corroborated  with  further  data  at  a  later  stage.  The  information  available
to you now is
as follows:
Demand:  550 50

,

Firm 1 Cost Function:

50

Firm 2 Cost Function:

50

(Units: : $/ticket,
: hundreds of passengers per week)

Now, proceed as follows to prepare a full report on the different scenarios:
2
(a)  The  government  is  concerned  about  the  implications  of  price  setting  under  extreme  circumstances.
For  this  reason,  your  report  will  have  to  consider  a  price  war  scenario  and  a  cartel  scenario.
The
government is also concerned about the possibility that Firm 1 may become a monopolist in the market,
so  this  constitutes  a  third  scenario.  Estimate  the  quantities,  prices  and  profits  in  each  scenario.
Represent  your  answers  graphically.  To  better  explain  the  price  war  and  cartel  scenarios,  represent  the
profits  in  a
game‐theory  bi‐matrix.  Hint:  Assume  that  when  the  prices  set  by  each  firm  are  equal,
consumers  buy  50%  from  Firm  1  and  50%  from  Firm  2.  Otherwise,  consumers  buy  from  the  cheapest
supplier.
(b) The government also thinks that it is likely that the two firms are competing with
each other by
setting  quantities (i.e. trying to attract a number of costumers) as opposed to setting the price.
Calculate the output in this scenario and represent your answer in a graph.
(c) A fifth scenario contemplates the possibility that Firm 1 may be a quantity leader. Calculate the
output
in this scenario and represent your answer in a graph.
(d) To complete your overview on different scenarios, fill the empty boxes in the following table:
Bertrand Price
Competition
Monopoly by
Firm 1
Cartel
Cournot
Simultaneous quantity decisions
Stackelberg
Leader/Follower quantity dec.

Total

Total
(1) DWL

(2) CS
(3) PS
Total (1)+(2)+(3)
Notation: DWL: Deadweight losses; CS: Consumers’ Surplus; PS: Producers’ Surplus (Firm 1 + Firm 2).
(e) To conclude your report, do you have any specific policy recommendations?
Microeconomics 300 ‐ Semester 1, 2012                                                                Additional Tutorial Exercises – Set 3

2. Suppose that an economy is composed by two sectors:
Country A: Endowed with an agriculture good (Good 1).
Country B: Endowed with a technology good (Good 2).
Given this information and assuming convex preferences and perfect competition, use appropriate
graphs and formulae to answer the following questions:
(a) How would
Countries A and B benefit from a pure exchange? Define Pareto‐improvement and depict
a contract curve for these two countries.
(b) Explain how prices would determine the equilibrium in this model.
(c) Assume that the economy is delimited by the production possibility frontier:

10
1,500, preference are convex and that  after some adjustments, the economy converged
to a competitive equilibrium associated with the price system

3
∗
5 and

∗
1. At this equilibrium,
farmers are consuming
10 and
30. Given this information, calculate the level of
consumption for each country and represent your answer in a graph.

SOLUTION

Q1

The demand function is given by

p=550 – 50Yt

Yt= Y1 + Y2

Firm1 Cost Function: C1=50Y1

Firm2 Cost Function: C2=50Y2

a)     In the price war scenario the prices will be less and thus the impact will be on the cost function which will be on the higher side.  Also in case of price war scenario the firm with lower price they will capture the market.  Thus there will be three cases

I The Price of firm 1 is less than price of firm 2

II The Price of firm 2 is less than price of firm 1

III The price of both the firms are equal

In the case I the whole market will be captured by Firm 1, In case of case II the whole market will be captured by Firm 2 and in case III the market share will be divided.

Thus in case I the price will be 550 -50Y1 as the quantity demanded will be Y1. Thus the profit will be 550-100Y1. There will be no market share for Firm 2. In this case the profit will be zero as the price will be set equal to the cost to gain the market share.

Similarly in case II the price will be 550 -50Y2 as the quantity demanded will be Y2. Thus the profit will be 550-100Y2. There will be no market share for Firm 1

In case III the price will be 550 – 50(Y1+Y2) or 550 – 100Y and the cost function for the two firms will be same which will be 50Y. Thus the profit for both the firms will be 550-150Y.

In case of cartel the market share of both the firms will be there and nobody will take the others market share contrary to the case in perfect competition where the share was distributed and the share of one firm will be taken up by the other in case of price difference. Thus in any case the price will be 550-50Y1 and the cost function will be 50Y1. Thus the profit for both the firms will be 550-100Y1 and 550-100Y2.

In case of monopoly the marginal revenue will be equal to marginal cost thus it can be said that 550-50Y1=50Y1 or 550 = 100Y1 or Y1=5.5. Thus the condition in the market will be that firm 1 will have the control over the market and in the long run the cost will be equated to revenue. The market share of the other firm will not be impacted as it will be very low.

b)     In case the strategy is to capture the market based on the quantities, the case will be that either the market share of firm1 will be 100% or the market share of firm 2 will be 100%. Thus the price in case of firm 1 having the market share as Y1=Yt will be 550 – 50Yt and in case firm 2 has the market share of Yt=Y2 thus the price will be 550 – 50Y2

c)     In the fifth scenario the case 2 in the above part will not be there and thus the price will be set based on the market share of firm 1 which will be 550 – 50Y1

d)     The table has been compiled as shown below:

e)     The government must consider the value of competition in the market. Thus take steps in order to maintain the competitive nature of the market so that the cost function and the demand is always in the positive direction so as to benefit the consumer

Question 2

a)     Given below is the data showing the details of the products produced by the two countries. As it is seen the Country 1 specializes in product P1 whereas country 2 specializes in product P2.

The Graph can be plotted for the above data and it can be interpreted that the two countries when in Autarky produced total of 68 units of product P1 and 56 units of Product P2. This is autarky as both the countries are devoting four hours in the production of both the products. Thus in order to take advantage the country 1 that has efficiency in production of P1 devotes more hours in that and country 2 devotes more hours in production of P2. This will result in more production of of P1. This has been shown in table 2. Thus it can be said that the overall production of the economy has increased by contributing more to the products that devote more time production of goods in which they specialize and thus creating trade surplus in the economy. As seen above after contributing more hours to product P1 the total production has increased by 0.67 units which is beneficial for the economy.

b)     The prices in such a market would determine the equilibrium in the market as the demand of one product in one country will depend on the price of the product in another country. Thus if the output is increased in one country the prices of the commodity wilkl change which will depend on the demand of another product and thus this will have to be compensated.

c)     The given consumption is given by

(X1)^A=10 and

(X2)^A=30

Thus from the above two equations we get

(X1)=(10) ^1/A and

(X2)=(30) ^1/A

The above is substituted in the production equation as in equilibrium both consumption value and production value will be same

Thus we get

(10) ^2/A +10 *(30) ^1/A = 1500

Solving the above equation for A we get A = 0.74.

By substituting the values for A in the above equations to get X and X2 we get

X1=22 and X2=99

LA20

Please  Click on the  below links to Chat Now  or fill the Order Form !