Microeconomics 2012-2013 IBA

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Problem set 4: Chapters 9 and 10

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CHAPTER 9: Perfectly competitive markets

Before making the exercises in this problem set, you should finish Homework Week 8,
Chapter 9 and Homework Week 9, Chapter 10 in WileyPlus.

Question 9.1
A market under perfect competition consists of 1000 identical firms. The market demand
curve for the product is given by Qd = 4800 P. Each firm has the same short run total cost
curve: STC = 200 + 100Q.
a) How much will any of these firms produce in the short run?
b) How much profit will a firm make?
c) In the long run, will there be more or less firms operating in this market, under constant
market conditions?

Question 9.2
The propylene industry is perfectly competitive and each producer has a long-run marginal
cost function MC(Q) = 40 12Q + Q. The corresponding long run average cost function is
AC(Q) = 40 6Q + Q/3. The market demand curve for propylene is D(P) = 2200 100P.
a) What is the long run market equilibrium price in this industry and how much would an
individual firm produce?
b) How many firms are in the propylene market in the long run competitive equilibrium?

Question 9.3
A profit maximizing firm has in the short run a fixed capital stock of 36 units. The production
function is given by Q( L, K ) 2 L K . The price of capital and labor are fixed at
respectively r = 3 and w = 12 and the market price for the good is $10.
a) Determine the optimal production quantity and the maximum profit in the short run.
b) Determine the long run optimal capital labor ratio (use the optimality condition).
c) Determine the long run total cost function once in terms of labor and subsequently in term
of output levels.
d) Are the long run marginal costs equal to the minimum of the short run average costs?
What does this mean?
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CHAPTER 10: Market equilibrium

and government intervention

Question 10.1
The market demand for DVD-players is given by D(P) = 40 P. Market supply is S(P) = 0.5P
5, with P the unit price of a DVD-player. The government will impose an excise tax of $6
on a DVD-player.
a) What is the market equilibrium price and quantity without government intervention?
b) What is the market equilibrium price and quantity with the government intervention?
c) Give a graphical representation of both situations (on 1 graph).
d) Determine the change in the consumer surplus due to the introduction of the excise tax.
e) Determine the change in the producer surplus due to the introduction of the excise tax.
f) What is the value of the benefit for the state (government income)?
g) What is the value of the excess burden (deadweight loss) of the excise tax?
h) What is the proportion of the tax incidence born by the consumers?
i) If the market demand were to change to D(P) = 70 2P, would the proportion of the tax
incidence born by the consumers become larger or smaller? Explain.

Question 10.2
Suppose the market for corn in Pulmonia is competitive and no imports and exports are
possible. The demand curve is Qd = 10 Pd, where Qd is the quantity demanded and when the
price consumers pay is Pd. The supply curve is

Qs

4 P s when P s

when P s

Where Qs is the quantity supplied (in millions of bushels) when the price producers receive is
Ps.
a) What are the equilibrium price and quantity?

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b) At the equilibrium, what is the consumer surplus, the producer surplus and the deadweight
loss? Show them graphically.
c) Suppose the government imposes an excise tax of $2 per unit to raise government
revenues. What will the new equilibrium quantity be? What price will buyers pay? What
price will sellers receive?
d) At this new equilibrium, what is the consumer surplus, the producer surplus, the impact on
the government budget and the deadweight loss? Show them graphically.
e) Suppose the government has a change of heart about the importance of corn revenues to
the happiness of Pulmonian farmers. The tax is removed and a subsidy of $1 per unit is
granted to corn producers. What will be the equilibrium quantity, the price the buyers pay
and the price (including the subsidy) the farmers receive?
f) At this new equilibrium, what is the consumer surplus, the producer surplus, the impact on
the government budget and the deadweight loss? Show them graphically.

Question 10.3
Demand and supply in the US corn market in 1985 (in millions of bushels) is given by:
D(P) = 240 - 150P
S(P) = -180 + 200P
a) Calculate the market equilibrium, the producer and consumer surplus and make a
graphical representation
b) Suppose that the government introduced a minimum price of 1.4 dollar per bushel.
Furthermore, it put into place a production quota to prevent a disequilibrium in the market
to occur.
1. What is the value of the quota?
2. Calculate the welfare effects of this measure.
c) Again, suppose that the government introduced a minimum price of 1.4 dollar per bushel.
To support this minimum price, the government however decided to commit to buying
corn of the market at the minimum price. To limit their costs, they simultaneously decided
to introduce a production quota of 80 million bushels.
1. How much corn did the government have to buy and how much did it cost it?
2. Calculate the changes in consumer and producer surplus, and the net effect on
welfare.
d) Later in time, the government decided to abandon the minimum price of corn and to give
corn producers a direct income subsidy to compensate them so they would feel indifferent
between the new situation and the situation under the minimum price with government
buying excesses and quota. Was this a sensible thing to do?
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Question 10.4
The demand for sugar in the EU is given by: D(P) = 13 - 2P. The supply of sugar is partly
provided by EU producers according to SE(P) = -3 + P and partly provided by foreign
producers (world producers) according to SW(P) = -12 + 4P. Demand and supply are
expressed in millions of tons and prices are in euros per ton.
a) Give the supply function of sugar in the EU.
b) Determine the equilibrium quantity and price on the total sugar market under free
competition.
c) How big is the European and foreign sugar supply in the market equilibrium?
d) Give a graphical representation of the equilibrium.
e) Suppose a European government imposes a global production quota of 4 million ton, of
which European producers can produce 1.5 million ton. How much is the market price for
sugar on the market with this production quota?
f) Add the situation under this production quota on the graph.
g) Determine the net welfare effect of the introduction of the production quota on the
European sugar market.