COR2100 Economics and Society

Homework 2 – chapter 2
Due: Friday 21/02/2020. Submission box in SOE level 5 lift lobby.
Note: pls write your section number clearly on your HW to facilitate easier sorting.

Costs, Profit maximization

1. You have the information shown in the accompanying table about a firm’s costs. Complete the
missing data.

Quantity TC FC VC MC ATC AVC

0 200 ? ? - - -
25 ? ? ? 20 ? ?
50 ? ? ? 10 ? ?
75 ? ? ? 16 ? ?
100 ? ? ? 20 ? ?
125 ? ? ? 24 ? ?

2. Larry, Curly, and Moe run the only saloon in town. Larry wants to sell as many drinks 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 saloon’s demand curve (downward-
sloping curve) and its cost curves (general cost curves), show the price and quantity combinations
favored by each of the three partners. Explain.

Market structures

3. Bob produces DVD movies for sale, which requires a building and a machine that copies the original
movie onto a DVD. Bob rents a building for $30,000 per month and rents a machine for $20,000 a
month. Those are his fixed costs. His variable cost per month is given in the accompanying table.

a. Calculate Bob’s average variable cost, average total cost, and marginal cost for each quantity of
output.
b. Assume that DVD production is a perfectly competitive industry. For each of the following questions,
explain your answers.
i. What is Bob’s break-even price? What is his shut-down price?
ii. Suppose the price of a DVD is $2. What should Bob do in the short run?
iii. Suppose the price of a DVD is $7. What is the profit-maximizing quantity of DVDs that Bob should
produce? What will his total profit be? Will he produce or shut down in the short run? Will he stay in
the industry or exit in the long run?
iv. Suppose instead that the price of DVDs is $20. Now what is the profit-maximizing quantity of DVDs
that Bob should produce? What will his total profit be now? Will he produce or shut down in the short
run? Will he stay in the industry or exit in the long run?

4. Consider an industry with the demand curve (D) and marginal cost curve (MC) shown in the
accompanying diagram. There is no fixed cost. If the industry is a single-price monopoly, the
monopolist’s marginal revenue curve would be MR. You can take the MC curve as the supply curve
for this industry. Answer the following questions by naming the appropriate points or areas.

a. If the industry is perfectly competitive, what will be the total quantity produced? At what price?
b. Which area reflects consumer surplus under perfect competition?
c. If the industry is a single-price monopoly, what quantity will the monopolist produce? Which price
will it charge?
d. Which area reflects the single-price monopolist’s profit?
e. Which area reflects consumer surplus under single-price monopoly?
f. Which area reflects the deadweight loss to society from single-price monopoly?
g. If the monopolist can price-discriminate perfectly, what quantity will the perfectly price-
discriminating monopolist produce?

5. The movie theater in Collegetown serves two kinds of customers: students and professors. There are
900 students and 100 professors in Collegetown. Each student’s willingness to pay for a movie ticket
is $5. Each professor’s willingness to pay for a movie ticket is $10. Each will buy at most one ticket.
The movie theater’s marginal cost per ticket is constant at $3, and there is no fixed cost.
a. Suppose the movie theater cannot price-discriminate and needs to charge both students and professors
the same price per ticket. If the movie theater charges $5, who will buy tickets and what will the movie
theater’s profit be? How large is consumer surplus?
b. If the movie theater charges $10, who will buy movie tickets and what will the movie theater’s profit
be? How large is consumer surplus?
c. Now suppose that, if it chooses to, the movie theater can price-discriminate between students and
professors by requiring students to show their student ID. If the movie theater charges students $5 and
professors $10, how much profit will the movie theater make? How large is consumer surplus?
6. In France, the market for bottled water is controlled by two large firms, Perrier and Evian. Each firm
has a fixed cost of €1 million and a constant marginal cost of €2 per liter of bottled water (€1 = 1 euro).
The following table gives the market demand schedule for bottled water in France.

a. Suppose the two firms form a cartel and act as a monopolist. Calculate marginal revenue for the car-
tel. What will the monopoly price and output be? Assuming the firms divide the output evenly, how
much will each produce and what will each firm’s profit be?
b. Now suppose Perrier decides to increase production by 1 million liters. Evian doesn’t change its
production. What will the new market price and output be? What is Perrier’s profit? What is Evian’s
profit?
c. What if Perrier increases production by 3 million liters? Evian doesn’t change its production. What
would its output and profit be relative to those in part b?
d. What do your results tell you about the likelihood of cheating on such agreements?

7. Philip Morris and R.J. Reynolds spend huge sums of money each year to advertise their tobacco
products in an attempt to steal customers from each other. Suppose each year Philip Morris and R.J.
Reynolds have to decide whether or not they want to spend money on advertising. If neither firm
advertises, each will earn a profit of $2 million. If they both advertise, each will earn a profit of $1.5
million. If one firm advertises and the other does not, the firm that advertises will earn a profit of $2.8
million and the other firm will earn $1 million.
a. Use a payoff matrix to depict this problem.
b. Suppose Philip Morris and R.J. Reynolds can write an enforceable contract about what they will do.
What is the cooperative solution to this game?
c. What is the Nash equilibrium without an enforceable contract? Explain why this is the likely out-
come.
Further practice (not for submission)

1. The following table gives you information on the total cost of Mac’s ice cream production

a. Is Mac producing ice cream in the short run or the long run? Explain.
b. Compute the average total cost at each level of output.
c. Compute the marginal cost at each level of output.
d. Suppose that Mac runs his business is in competitive market, and that the current market price for ice
cream is $5/litre. What is the profit-maximizing quantity that Mac should produce? What is Mac’s profit
at this output quantity?

2. Suppose a firm is described by the following: Market demand is P = 50 − Q; MR = 50 – 2Q; ATC =

20 + 4Q; and MC = 30 + 5Q.
a. Find the profit maximizing price and quantity.
b. What is the firm’s profit?
c. Suppose that the firm incurs additional costs and now needs to produce at the quantity where price
equals ATC. Calculate the new price and quantity.

3. The following diagram shows the market demand and market supply for sweaters. Calculate
consumer surplus, producer surplus, and social surplus in this market.
4. A monopolist producing with a constant average cost and marginal cost of $6 has the following
demand for its product.
Price Quantity
$10 1
$9 2
$8 3
$7 4
$6 5
a. Calculate total and marginal revenue for each output level.
b. Find the optimal output and price.
c. Determine the profit or loss as this output.

5. The following graph shows the demand, marginal revenue, and marginal cost curves in a monopoly
market.
(Hint/recall: the MC curve can be taken to be the supply curve of the market)

a. Identify the profit-maximizing price and quantity for this monopolist.

b. What are the values of the consumer surplus, producer surplus, and deadweight loss in the market?
c. How would consumer surplus change if this market were competitive?

6. Suppose Russia is deciding to Invade or Not Invade its neighbor Ukraine. The United States has to
decide to Be Tough or Make Concessions. They will make their decisions simultaneously. Their payoffs
are as follows:
United States/ Russia Not Invade Invade
Be Tough United States gets 5 United States gets 7
Russia gets 4 Russia gets 3

Make Concessions United States gets 3 United States gets 1

Russia gets 5 Russia gets 9

a. What is the United States’ best response when Russia chooses Not Invade?
b. What is the United States’ best response when Russia chooses Invade?
c. What is Russia’s best response when the United States chooses Be Tough?
d. What is Russia’s best response when the United States chooses Make Concessions?
e. What is the Nash equilibrium of this game?
7. Make three copies of the following diagram and label them (i), (ii) and (iii). Add three different
demand curves faced by a firm: (i) very steep (inelastic), (ii) relatively flat (elastic), and (iii) horizontal
(perfectly elastic). Draw the demand such that the firm earns positive economic profit.

a. Which sketch corresponds to a firm that faces perfect competition?

b. Which sketch, without actually representing perfect competition, is close to perfect competition in
terms of the price and quantity?
c. Which sketch corresponds to a firm that is most likely to earn super-normal profit even in the long
run?