ECON 4301A

Mid-term Exam
February 2018

Last Name:

First Name:

Student ID:

Instructions

1. Read carefully before you provide your answers

2. Show all your work. Random guesses will receive NO credit

3. Budget your valuable time

Good Luck

Question Points
1
2
3
4
5
6
Total

1
 Question 1: answers

a. The average and marginal cost functions are

TC 9
AC(q) = = +2+q (1)
q q
dTC
MC(q) = = 2 + 2q (2)
dq

The scale-economies index at the assumed output levels is

AC(3) 8
q = 3 : S(3) = = =1 (3)
MC(3) 8
(4)

b. The minimum efficient scale corresponds to the output level for which the scale-economies index
is 1. It is also the output level that minimizes AC

dATC 9
= 0 ⇒ − 2 + 1 = 0 ⇒ qmes = 3 (5)
dq q

3
 Question 2: answers

a. In the case of 3rd-degree price-discrimination, the monopolist equates marginal revenue with
marginal cost in each market

M RA = MC ⇒ 10 − Q A/5 = 1 ⇒ Q∗A = 45 ⇒ PA∗ = 10 − Q∗A/10 = $5.5 (6)

M RS = MC ⇒ 5 − Q S /15 = 1 ⇒ Q∗S = 60 ⇒ PS∗ = 5 − Q∗S /30 = $3 (7)

b. The necessary condition for 3rd-degree price discrimination to increase welfare relative to
non-discriminatory pricing is an increase in total output.

c. The Lerner indices are as follows

L A = (PA∗ − MC)/PA∗ = 4.5/5.5 = 0.82 (8)

LS = (PS∗ − MC)/PS∗ = 2/3 = 0.67 (9)

Note: An alternative way to solve (a), as some of you did, is to proceed as follows

M R = 10 − Q A/5 ⇒ Q A = 50 − 5M R (10)
M R = 5 − Q S /15 ⇒ Q S = 75 − 15M R (11)

Summing horizontally the MR curves we obtain

Q A + Q S = 125 − 20M R (12)

Q = 125 − 20M R ⇒ M R = 125/20 − Q/20 (13)

Optimality implies

M R = MC ⇒ 125/20 − Q/20 = 1 ⇒ Q∗ = 105 (14)

We can now find the quantities and prices in each market

Q∗A = 50 − 5M R = 45 ⇒ PA∗ = 10 − Q∗A/10 = $5.5 (15)

Q∗S = 75 − 15M R = 60 ⇒ PS∗ = 5 − Q∗S /30 = $3 (16)

6
 Question 3: answers

a. The monopolist should charge a price equal to marginal cost and a fixed fee equal to the consumer
surplus implied by marginal-cost pricing

P1∗ = 20 ⇒ Q∗1 = 80 − 20 = 60 ⇒ CS1∗ = Q∗2

1 /2 = $1, 800 (17)
P2∗ = 20 ⇒ Q∗2 = 60 − 20 = 40 ⇒ CS2∗ = Q∗2
2 /2 = $800 (18)

Therefore, the monopolist should charge a per-unit price of $20, a fixed fee of $1,800 to customers
of type 1 and $800 to customers of type 2.

b. The monopolist should charge a fixed fee equal to the willingness to pay (WTP) for the quantity
bought with marginal-cost pricing. Therefore, we now have

Q∗1 = 60 ⇒ WT P1∗ = 80Q∗1 − Q∗2

1 /2 = $3, 000 (19)
Q∗2 = 40 ⇒ WT P2∗ = 60Q∗2 − Q∗2
2 /2 = $1, 600 (20)

9
 Question 4: answers

Since the cool and very cool t-shirts are produced at a ratio of 2:3, we have q1 = λ1 q = 0.4q and
q2 = λ2 q = 0.6q. The RAC is then given by

C(λ1 q, λ2 q) 3, 200 + 0.1(0.4q) + 2(0.4q)2 + 0.2(0.6q)

RAC(q) = =
q q
3, 200 + 0.16q + 0.32q2
= (21)
q

11
 Question 5: answers

ai. When MaxSoft prices each program separately, it maximizes its profit by charging $90 for its
word processor and $90 for its spreadsheet. In both cases, it only sells to three consumers. MaxSoft
earns 3 × 90 = 270 from each program and, hence, $540 in total profit.

aii. MaxSoft should charge $150 for the bundle for a total profit of $600 with all consumers buying
the bundle.

b. With mixed bundling, MaxSoft can charge $200 for the bundle and $120 for each program
separately capitalizing on the high reservation prices of consumer A for the word processor and
consumer D for the spreadsheet. It also takes advantage of the high reservation prices of consumers
B and C for the bundle. Consumers B and C buy the bundle, consumer A buys only the word
processor and consumer D buys only the spreadsheet.

MaxSoft now earns $640 = 2 × 200 + 120 + 120 in profit, which exceeds its profit with stand-alone
pricing and pure bundling.

14
 Question 6: answers

a. The monopolists face the following demand functions

Q N = 30 − (PN + PB ) (22)
Q B = 30 − (PN + PB ) (23)

The inverse demand curves are

PN = (30 − PB ) − Q N (24)
PB = (30 − PN ) − Q B (25)

The corresponding MR curves are

M RN = (30 − PB ) − 2Q N (26)
M RB = (30 − PN ) − 2Q B (27)

Profit maximization then implies

30 − PB
M RN = MC ⇒ Q N = (28)
2
30 − PN
M RB = MC ⇒ Q B = (29)
2

We then have

30 − PB
PN = 30 − PB − Q N = (30)
2
30 − PN
PB = 30 − PN − Q B = (31)
2

We find the equilibrium by solving the following system of linear equations

2PN + PB = 30 (32)
PN + 2PB = 30 (33)

Using PN = 30 − 2PB from the 2nd equation and plugging in the 1st, we get

2(30 − 2PB ) + PB = 30 ⇒ PB∗ = 10 (34)

17
 PN∗ = 30 − 2PB∗ = 10 (35)

b. The implied equilibrium quantities Q∗N and Q∗N are

Q∗N = 30 − PN∗ − PB∗ = 10 (36)

Q∗B = 30 − PN∗ − PB∗ = 10 (37)

The implied equilibrium profit values ΠN∗ and ΠB∗ are

PiN∗ = PN∗ × Q∗N = $100 (38)

PiB∗ = PB∗ × Q∗B = $100 (39)

18