Revised (typos corrected)

EC 113 Spring 2003 Final Exam May 16, 2003

1. Suppose (y) denotes the price elasticity of demand when y is the level of demand. Suppose a monopolist has a cost function c(y) which is increasing in y. Prove that if | ()| < 1, then y cannot be a prot y maximizing level of output for the monopolist. Hint: show that there is a certain change of output from y which would increase prot. [15 points] 2. Suppose the demand curve for Japanese cars is given by Q = 150 P where Q is the aggregate quantity (in thousands of cars) and P is the price in thousands of dollars. Suppose the cars are produced under competitive conditions with a constant returns to scale technology so that the supply schedule is horizontal at a price of $18,000. What is the equilibrium price and quantity? Suppose, under pressure from the domestic manufacturers, the U.S. government imposes an import tax of $2,000 on each Japanese car. What is the new price and quantity in equilibrium? How much revenue does the government collect? What is the loss in consumers surplus? Suppose the Japanese auto makers agree to limit their shipment to 130,000 cars and the U.S. government agrees to lift the tax. (The auto makers are free to set their price). Compare the resulting equilibrium to the case in which there was an import tax, in terms of the price paid buy U.S. consumers, quantity bought, and consumers surplus. Which of these two policies (import tax or voluntary export restraint by the Japanese) would you recommend to the U.S. government? [25 points] 3. The aggregate demand curve for the output in an industry is given by P = 210 Y , where P is the price and Y is aggregate output. The cost of production is 0 for all levels of output.

(a) Suppose there are m rms in this industry. What is the output of each rm and its prot in a Cournot Nash equilibrium? (Your answers should be some function of m). (b) Suppose the industry is has a single rm to begin with and the government decides to break-up the monopoly and to create an industry with an equal number of n rms. Suppose the proposal is to set n = 6. Based on your answer to part (a), what is the prot of each of the 6 rms in a Cournot-Nash equilibrium? Suppose one of these, say rm 1, is prohibited from merging with any other rm but the other 5 rms are allowed to merge. (If they do merge the industry will be a duopoly). Assume that if rms 2,3,4, 5 and 6 merge, each of the original partners will share equally in the prot of the new merged rm, which behaves like a duopoly (along with rm 1). In other words, if the merged rm earns a prot x, the prot of each of the members is x/5. What are the (Cournot-Nash) equilibrium prots of each of the new duopolists if such a merger takes place? What are corresponding prots of each of the (original) rms 2, 3, 4, 5 and 6? Compare these to their prots in the 6 rm Cournot oligopoly. Do rms 2, 3, 4, 5 and 6 have an incentive to merge? Does rm 1 prefer to see them merge? Repeat this entire analysis for the case in which n = 4. (As before, compute the equilibrium with 4 rms and then the prots when rms 2, 3 and 4 merge. Assume that when rms 2, 3 and 4 merge, they share the prot of the merged rm equally: if the merged rm earns x, each member gets x/3). Explain the qualitative dierence if any between the case n = 6 and the case n = 4. [30 points] 4. Suppose there is an exchange economy, E, with two consumers, A and B, and two commodities x and y. The utility functions and endowments as follows: uA (xA , yA ) = (xA )2 yA , A = (90, 0), uB (xB , yB ) = xB (yB )2 , [Subscripts refer to consumers]. Compute the demand functions of each consumer in terms of prices and their incomes, mA and mB . Express their incomes in terms of prices to derive the demands as functions of prices. Compute the competitive equilibrium. 2 B = (0, 90).

What must be true about the marginal rates of substitution of the two consumers at a Pareto optimal allocation? Compute the locus of Pareto ecient allocations for this economy. Sketch an Edgeworth box with the competitive allocation and the Pareto optimal allocations. [20 points] 5. In an exchange economy with consumers A and B there are n commodities. Suppose the market prices are (p1 , p2 , . . . , pn ) where each price is strictly positive, i.e., pi > 0 for all i = 1, . . . n. Suppose each consumer has strictly monotonic preferences, and the demands of the two consumers are xA = (x1 , . . . xn ) and xB = (x1 , . . . xn ). Prove that: A A B B
i i If xi + xi = A + B for all i = 2, . . . n, then it must be the A B 1 2 case that x1 + x1 = A + B . (In other words, if (n 1) A B markets clear, all markets must clear).

Is this result valid in an economy with more than 2 consumers? Explain. [10 points]