1. This long microeconomics question test the student's understanding of monopoly and the comparison of the monopoly result to the allocatively efficient outcome of perfect competition. In particular, the question addresses allocative efficiency in parts e-g.
(a) The profit-maximizing monopolist produces the output level at which marginal revenue (MR) equals marginal cost (MC). The price that consumers pay is found by going up to the demand curve at that output level.
(b) In this graph, the monopolist produces Q1 and charges price P5; see point B.
(c) The competitive market result is at point C where marginal cost equals price or crosses the demand curve. The price would be P4 and the output would be Q2.
(d) Consumer surplus represents the area showing the difference between "willingness to pay" (the demand curve ) and price that consumers actually pay, over the quantity of output produced. For the monopolist this area is P5AB. In the competitive industry the area is P4AC.
(e) Allocative efficiency occurs a the output level where marginal social benefit is equal to marginal social cost, or, in this case, where price (P) equals marginal cost (MC).
(f) The allocatively efficient level of output is Q2.
(g) The government should provide a per-unit subsidy to
the monopolist. The subsidy will lower marginal cost (or raise marginal
revenue) leading the monopolist to increase its output toward the allocatively
efficient level.
2. This question was principally aimed at finding the firm's profit-maximizing level of employment and assessing whether the firm was earning an economic profit. The first parts of the question tested whether the student realized that the firm, being a price taker and a wage taker, was operating in a competitive output market and in a competitive input market.
(a) The firm sells its output in a perfectly competitive market. The firm is a price taker with no control over the output price.
(b) The firm hires labor in a perfectly competitive input market. The firm is a wage (or price of labor) taker with not control over the input price.
(c) The profit-maximizing firm seeks to hire labor until the equality of the marginal revenue product of labor and the marginal factor cost of labor. In this case, the firm will hire five (5) labor or workers. At five workers, the marginal revenue product of labor ($12=4 units of output x $3 per unit) exceeds the marginal factor cost for labor ($11), so the fifth worker will be hired. For the sixth worker the marginal revenue product ($6) is less than the marginal factor cost ($11), so the sixth worker will not be hired.
(d) With 5 units of labor hired, the firm will produce 46 units of total output.
(e) The firm is making a positive economic profit of $73 since total revenues ($138=$3 x 46 units of output) exceed total costs ($65) of which total variable costs are $55 ($11 x 5 units of labor) and fixed costs are $10.
(a) The tariff is added to the marginal cost or supply price at each output level, shifting up (or in) the supply curve. Assuming a downward-sloping demand curve, the equilibrium price of imported shoes increases and the quantity decreases.
(b) With an increase in the price of the substitute good (imported shoes), the demand for domestically produced shoes shifts out. The equilibrium price of domestic shoes increases and the quantity increases.
(c) Since the demand for imported shoes is price elastic, the proportionate decrease in quantity exceeds the proportionate increase in price, and total expenditure on imported shoes falls.