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EC1000 Question Sheet 3 Week 8

1. Three managers of a beer producing company are discussing a possible increase in

production. Each suggests a way to make this decision.
H: We should examine whether our companys productivity (gallons of beer per worker)
would rise or fall.
R: We should examine whether our average cost would rise or fall.
T: We should examine whether the extra revenue from selling the additional beer would be
greater or smaller than the extra costs.
Whose opinion would you support?

2. The Clean Springs Water Company has a monopoly on bottled water sales in California. If
the price of tap water increases, what is the change in Clean Springs' profit-maximizing levels
of output, price, and profit? Explain in words and with a graph.

3. Jimmy Jazz and the Repercussions (a band from Tadcaster) have just finished recording
their first CD. Their record company's marketing department determines that the demand for
the CD is as follows:

Price Number of CDs

24 10,000
22 20,000
20 30,000
18 40,000
16 50,000
14 60,000

The company can produce the CD with no fixed cost and a variable cost of 5 per CD.
a. Find total revenue for quantity equal to 10,000, 20,000, and so on. What is the marginal
revenue for each 10,000 increase in the quantity sold?
b. What quantity of CDs would maximize profit? What would the price be? What would the
profit be?
c. If the band had an agent, and if you were the band's agent, what recording fee would you
advise them to demand from the record company? Why?

4. Larry, Curly, and Moe run the only saloon in town. Larry wants to sell as many drunks as
possible without losing money. Curly wants the saloon to bring in as much revenue as
possible. Moe wants to make the largest possible profits. Using a single diagram of the
saloons demand curve and its cost curves, show the price and quantity combinations
favoured by each of the three partners. Explain.

5. Paul is the manager of Alpha Company, a firm that has a monopoly in the market for
bicycle breaks thanks to a patented innovative technology. The owner of the firm, David,
hires a consulting company to estimate the price elasticity of bicycle brakes. The consultants
find that a 10% increase in the price would decrease demand by 5%. As a result, David
decides to fire Paul and hire a new manager. Why? If you were Paul, what could you argue to
convince David not to fire you?
EC1000 Question Sheet 3 Week 8

6. Consider two products, 1 and 2, and two consumers, A and B. Company Alpha has a
monopoly over both products. Products are indivisible and consumers buy at most one unit of
each. The products are independent (that is, neither substitutes nor complementary). Both
products have a unit production cost equal to 2. The following table gives the willingness to
pay for the two products:

As willingness to pay Bs willingness to pay

Product 1 10 8
Product 2 8 10

a. What is the monopoly price and the monopoly profits if the two products are sold
b. What happens if the firm bundles the two products and sell them as a single product?

7. Your cousin Vinnie owns a painting company with fixed costs of 200 and the following
schedule for variable costs:

Quantity of Houses 1 2 3 4 5 6 7
Painted per Month
Variable Costs 1 20 40 80 160 320 640

Calculate average fixed cost, average variable cost, and average total cost for each quantity.
What is the efficient scale of the painting company?

8. You go out to the best restaurant in town and order a lobster dinner for 40.
After eating half of the lobster, you realize that you are quite full. Your date wants you to
finish your dinner, because you cant take it home and because youve already paid for it.
What should you do? Relate your answer to the notion of sunk and recoverable costs.

9. Singer Britney Spears has monopoly over a scarce resource: herself. She is the only person
who can produce a Britney Spears concert. Does this fact imply that the government should
regulate the price of her concerts? Why or why not?

10. Suppose that you and a classmate are assigned a project on which you will receive one
combined grade. You each want to receive a good grade, but you also want to do as little
work as possible. The decision box and payoffs are as follows:
EC1000 Question Sheet 3 Week 8

Your decision
Work Shirk
You get A, no fun You get B, fun
Your classmates Classmate gets A, no fun Classmate gets B, no fun
decision You get B, no fun You get D, fun

Classmate gets B, fun Classmate gets D, fun

Assume that having fun is your normal state, but having no fun is as unpleasant as receiving a
grade that is two letters lower.
a. Write out the decision box that combines the letter grade and the amount of fun you have
into a single payoff for each outcome.
b. If neither you nor your classmate knows how much work the other person is doing, what is
the likely outcome? Does it matter whether you are likely to work with this person again?
Explain your answer.