1 2011

1.1 Land and capital

Consider a firm that uses optimally its three inputs: land, capital and labor. Argue, in your own
words (15 lines max!) why, in the optimal point, we must have equality between the marginal
productivity of land, capital and labor.

1.2 Mono and Duo

The firm “Mono” is a firm operating on a market with the following inverse demand function:

P (Q) = a − bQ.

The total cost function of Mono is

T C (q) = 10 + cq

where q is Mono’s output.

Assume that a > c > 0 and b > 0.

1. Compute Mono’s profit. (5 points; if you do not like letters, you can replace them by the
following numbers, but then you can score 4 points maximum only: a = 140, b = 2 and
c = 20);

2. Suppose another firm, “Duo”, with the same cost function, enters this market and competes
in quantities with Mono. Compute Mono’s profit in this Cournot competition game (5 points;
4 points if you replace the letters with the above numbers)

1.3 Techies

Consider an industry in which all firms use the same technology:

Q (K; L) = K 1/4 L2/3

1. Determine (using the appropriate definition) whether there are increasing, constant or de-
creasing returns to scale in this industry. (2.5 points)

2. Do you expect many or few firms to be present in this market? Why? Justify your answer.
(2.5 points)

1
2 2012

2.1 A Monopolist (2.5+2.5 points)

1 1
Suppose a monopolist produces using the following production function: F (K, L) = K 2 L 2 . The
price of capital and labor are given by r = 4 and w = 2. In the short-term the firm’s capital is fixed
at four units. K = 4.

1. Compute the firm’s short-term total cost function.

The market demand is given by: P = 120 − Q.

2. Compute the equilibrium quantity sold on this market and the monopolist’s profit. If you
could not do question 1 above, then assume that the total cost function of the firm is given
by T C (Q) = 4Q2 + 17.

2.2 Ben and Jerry

Ben and Jerry are two icecream producers using labor and capital to produce their output. Ben
produces vanilla icecream and Jerry produces chocolate icecream. Ben’s production function is
given by:
FB (K, L) = min [K, L] ,

whereas the production function of Jerry is given by:

FJ (K, L) = K + L.

Ben’s endowment of the two production inputs is (K, L) = (3, 5). Jerry’s endowment is (6, 3) .

1. Draw the capital-labor Edgeworth box with all the relevant information, together with the
initial inputs endowment point and the two producers’ isoquants that go through this point.
Use the squared space provided below.

2. Is there room for trades? If yes, explain why and darken the relevant area in the Edgeworth
box.

3. If there is room for trades, what is the after-trades point which is associated with the highest
total level of icecream production?

2
 4. If the two producers decided not to maximize their own objective function only (as we have
always assumed in the two lectures on general equilibrium) but actually decided to form a
team and act as a single producer which wants to maximize the total quantity of icecream
produced, regardless of the icecream flavors, how should they allocate their capital-labor
endowments between the two production plants to achieve this alternative goal?

Draw the Edgeworth Box in the following space (this 10 by 10 unit square is NOT the Edgeworth
box! You need to draw it yourselves in there!):

3 2013

3.1 Production

Consider a firm which produces using labor and capital. Capital is fixed in the short run at K0 .
Labor is variable even in the short run. The price that the firm has to pay for each unit of labor
it uses is w.

1. Derive the relationship which exists between the marginal product of labor and the firm’s
marginal cost in the short run. (2 points). Explain intuitively what you found. (2 points).

b. Let Q (K, L) be the production function. The price of capital and labor are r and w re-
spectively. Explain why in the long run the firm will always choose an input mix such that
MP K MP L
r = w , whereas in the short run this condition may fail to hold. (3 points)

c. Suppose Q (K, L) = KL and r = 1 and w = 2. What is the LAC curve of this firm? (3
points)

4 Monopoly and Duopoly

The market demand for slots on the brand new space station on Mars is: P = 100 − Q, where Q
is a slot on the station and P is expressed in millions of euros.
Initially, only one firm, Slate, offers such slots. Slate is thus a monopolist in this market. Slate’s
average cost function is given by:
100
AT C (Q) = Q +
Q

1. Determine the optimal (Q, P ) choice of Slate (4 points)

3
 Suppose now that a second firm, Laste, becomes active on this market. The total cost function
of Laste is given by:
T C (Q) = Q2 + 200

Because there are now two firms competing on the market and they both offer exactly the same
good, the market demand becomes: P = 100 − (QS + QL ), where QS is the number of slots offered
by Slate and QL is the number of slots offered by Laste.

2. a. Determine the new market equilibrium (Q∗S , Q∗L , P ∗ ) if both firms determine simultaneously
the number of slots they offer to the market, that is, they act as Cournot competitors (4
points);

2. b. What is the effect of the two firms’ fixed costs on their choice? Why? (2 points)

5 2014

5.1 General Equilibrium

Consider an exchange economy with two rational consumers: Anna (A) and Benny (B). There
are two consumption goods, clothing (C) and food (F ) . Let CA and FA denote Anna’s consump-
tion choices. Let CB and FB denote Benny’s consumption choices. Anna’s utility function is
1 3 1 1
UA (CA , FB ) = CA4 FA4 . Benny’s utility function is: UB (CB , FB ) = CB3 FB3 .
Anna’s endowment consists of 240 units of clothing and 240 units of food. Benny’s endowment
is made of 120 units of clothing and 120 units of food.

1. Explain why in the pareto optimal consumption point we must have that Anna’s marginal
utility per euro spent on clothing must be equal to her marginal utility per euro spend on
food. (4 points)

PC
2. compute the equilibrium price ratio to show that PF is eqaul to 21 , where PC is the price of
clothing and PF is the price of food. (6 points)

3. Compute the optimal consumption choices of the two consumers. (2 points)

5.2 Game Theory

Consider a game between two players, Piet and Klaas. They produce presents and surprises. The
payoffs to the two players are as follows:

4
 1. If both produce a present, Piet gets 3 and Klaas gets 4;

2. If Piet produces a present and Klaas produces a surprise, Piet gets 16 and Klaas gets 9;

3. If Piet produces a surprise and Klaas produces a present, Piet gets 9 and Klaas gets 16;

4. If both produce a surprise, Piet gets 4 and Klaas gets 3.

Suppose that Piet chooses what he produces first. Then Klaas chooses what to produce.
Questions:

1. Draw the corresponding extensive form representation of the game, the game tree. (2 points)

2. Write down all the strategies of Klaas and explain what the meaning of what you wrote. (2
points)

3. Derive and explain what is the subgame perfect equilibrium of the game. (4 points)

6 2015

6.1 Firm Behavior

1. Derive the production function of a firm that has the following isoquants:

5
 2. Suppose now the production function of a firm is 3L1/3 K 2/3 and the price of labor and capital
are given respectively by w = 1 and r = 2. Compute its long-run cost function.

3. Suppose the demand for this firm’s production is P = 25 − 3Q. Compute its optimum
production level and its profit.
(If you are unsure of your answer to question 2 above, you can assume that the firm’s cost
function is C(Q) = Q + Q2 , but you will lose one point for doing this.)

6.2 Monopoly and Duopoly

1. Suppose a monopolist can now produce using two different plants. The two plants’ respective
cost functions are C1 (Q1 ) = 4Q1 and C2 (Q2 ) = Q22 . How should the firm allocate optimally
the production of 4 units of its product across the two plants? Explain in your words why,
even though the optimal production mix is associated to different total costs across the two
plants, it is still the optimal mix to adopt.

2. Consider a Cournot duopoly for which the market demand is P (Q) = 90 − Q. Both firms
have marginal cost equal to 30. Derive the Nash equilibrium of this game.

7 2016

7.1 Question 1

Explain why, and whether or not, at the optimum production choice of a firm we must have that
the marginal product per euro of each input is equalised. In your answer, distinguish between
theshort (2 points) and the long run (2 points).

7.2 Question 2

Consider an exchange economy with two consumers, Donald (D) and Gene (G), and two goods,
chocolate (C) and hotdogs (H).
Let Xi be the consumption of good X by consumer i.
The preferences of the two consumers are given by:

1 3 2 1
UD (CD , HD ) = CD4 HD4 ; UG (CG , HG ) = CG3 HG3

6
 Suppose that Donald’s endowment is made up of 5 units of chocolate and 6 hotdogs whereas
Gene has 15 units of chocolate and 24 hotdogs.
Compute how many hotdogs Donald will consume in equilibrium. Show and explain all the
necessary derivations and computations.

8 2017

8.1 Optimal production bundle

Consider a firm that produces jeans. It uses three inputs: cotton (C), labour (L) and capital (K):
Y = Q (C, K, L). In the short run, capital is a fixed input whereas the other two inputs are variable.
The per-unit prices of the three inputs are pC , pK and pL . Let M PX denote the marginal product
∂Q(C,K,L)
of input X: M PX = ∂X , where X = C, K, L.
Questions:
In the short run equilibrium, what can you tell about:

M PC M PL
1. the relationship between pC and pL ? (1.5 points)

M PC M PK
2. the relationship between pC and pK ? (1.5 points)

8.2 General equilibrium in a closed exchange economy

Consider an exchange economy with two rational agents, Alexander (A) and Georgina (G), and
two goods, Bananas (B) and Fish (F). Denote agent i’s consumption of good X by Xi . The utility
1 1
function of Alexander is: UA (BA , FA ) = (BA ) 2 (FA ) 2 and that of Georgina is: UG (BG , FG ) =
1 1
BG3 FG3 . Initially A has 2 Bananas and 8 Fish, while G’s endowment is 4 Bananas and 4 Fish.
Denote the prices of B and F by PB and PF .
Question:
Compute how many bananas and fish G consumes in equilibrium. (7 points)

8.3 Profit maximisation when producing with two plants

A monopolist produces using two distinct production plants. The demand for its product is given
by P = 84 − Q. Let Q1 be the production level of plant 1 and Q2 that of plant 2. Let Q = Q1 + Q2 .
The total cost function of plant 1 is T C(Q1 ) = (Q1 )2 + 4Q1 . The total cost function of plant 2 is
(Q2 )2
T C(Q2 ) = 4 + 11Q2 .

7
Questions:

1. Write down the monopolist’s total profit function. (3 points)

2. Compute the profit maximising production pair (Q∗1 , Q∗2 ). (7 points)

9 2018

9.1 Perfect competition (12 points)

Consider the market for corn. This is a perfectly competitive market. In the short run, 1200 firms
are active on this market.
The short run cost function of each firm is given by C (qi ) = 5 = 400qi2 + 1, where qi is the
amount of corn produced by firm i.
The market demand for corn is given by QD (P ) = 200 − P, where Q is the total amount of
corn demanded on the market.

1. Compute the short run profit of each firm. Explain what you do.

2. Suppose the long run cost function is also given by C (qi ) = 5 = 400qi2 + 1. Compute the
number of firms that will be active on this market in the long run. Explain what you do.

√
3. Suppose the long run cost function becomes C (qi ) = qi + 1, for example because of some
technological innovation. Is this new cost function consistent with perfect competition? Ex-
plain the reasoning behind your answer.

4. The firms must buy their inputs K and L. Explain why, in the long run, we must have the
M PK M PL
following equality: PK = PL .

9.2 T-shirts for Students and Profs (12 points)

A firm produces EUR’s university t-shirts. There are two types of clients: students and professors.
The students’ demand for university t-shirts qs = 60 − P. The demand of professors is qp = 80 − 12 P.
The firm can identify students at no cost and offers them a special purchasing price.
The firm’s cost functrion is given by: C (qs , qh ) = 1
2 (qs + qp )2 .

1. Compute the equilibrium values of qs and qp . Explain what you do.

8
2. Explain what is the key difference between second and third degree discrimination (in general,
this question does NOT refer specifically to the problem above).

9
10 Answers 2011

Land and capital:

(Here we look at the production side of the firm only. if you want to look at the whole profit
function of the firm, then you want the firm to choose the point where the marginal productivity
of an input per euro is equal to that of other inputs). Suppose this is not the case. For example,
suppose that the marginal productivity of labor is greater than that of capital and land. This
implies that employing an extra worker yields more output to the firm than using an extra unit
of capital or land, and also more than compensates the loss in production if we reduce the use of
capital and land to use more labor.

Mono and Duo:

10.1 Answer

1. Profit is given by:

π = P (Q) Q − T C (Q)

= (a − bQ) Q − 10 − cQ

The optimal production point is given by:

a−c
a − 2bQ = c → Q∗ =
2b

and thus profit is given by:  

a+c a−c a−c
− 10 − c
2 2b 2b

2. Cournot profit functions:

(a − b (q1 + q2 )) q1 − 10 − cq1

(a − b (q1 + q2 )) q2 − 10 − cq2

Firm’s best response functions:


 a − bq2 − 2bq1 = c
 a − bq − 2bq = c
2 1

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 imposing symmetry and rational expectations:

a−c
a − bqi − 2bqi = c → qi∗ =
3b

and thus profit of each firm is given by

 
a + 2c a − c a−c
− 10 − c
3 3b 3b

Techies:

1. Applying the definition in the course slides: For any α > 1:

(αK)1/4 (αL)2/3 = α1/4 K 1/4 α2/3 L2/3

1 2
1 2 α 4 + 3 <α
= α 4 + 3 Q (K; L) < αQ (K; L)

and thus this production function exhibits decreasing returns to scale.

2. DRS → small firms in terms of production → quite many firms on the market to be able to
service demand.

10.2 Answers 2012

Monopolist:

1. As capital is fixed at 4, the short run production function is given by:

√
F (4, L) = 40.5 L0.5 = 2 L;

Then for every unit of labor used, the firm can produce
√ Q2
(Q = 2 L ⇔ L =)
4

units of output. Thus the firm’s short-run total cost function is given by:

Q2 Q2
w +4∗r = + 16.
4 2

2. The marginal cost function of the monopolist is:

11
 The equilibrium condition is thus:

Q = 120 − 2Q ⇔ Q∗ = 40 → P ∗ = 80

and thus the monopolist’s profit is equal to:

402
(120 − 40) 40 − − 16 = 2384.
2

Ben and Jerry

1. Capital-labor Edgeworth box:

2. Room for trades is the bluewish triangle

3. the after-trades point which is associated with the highest total level of icecream production
is such that Ben should give to Jerry the two units of labor he has and currently cannot use.
this maximizes production because 1) the production function of Ben is perfect complements
and thus two of the five units of labor ben has are not productive 2) Jerry’s production
function is perfect substitutes and thus every unit of input produces one unit of output. this
trade is Pareto acceptable and leads to a total production of 3 + 11 = 14 units of icecream.

4. here, because of the two production function’s characteristics (see answer to q3 above) only
Jerry should produce as he would then produce 17 units of icecream in total.

12
11 answers 2013

Problem 1:

1. As wages are fixed and labour is the only variable input, then V C = wL and thus

∂ (wL) ∂L 1
MC = =w =w
∂Q ∂Q MP

Thus the more productive at the margin labor is, the lower will be the marginal cost of
increasing output, given any wage level.

2. See your textbook

MP K MP L L K
3. r = w implies 1 = 2 ⇔ K = 2L thus
r
2 Q
Q (2L, L) = 2L ⇔ L (Q) = ,
2

and thus also r

Q p
K (Q) (= 2L (Q)) = 2 or 2Q
2
Then

T C (Q) = (2 ∗ L (Q) + 1 ∗ K (Q))

r r r
Q Q Q p
= 2∗ +1∗2 =4 or 8Q.
2 2 2

Finally, r
T C (Q) 4 8
LAC (Q) = =√ or .
Q 2Q Q

Problem 2:

11.1 Answers

1. Profits of Slate are given by

π = (100 − Q) Q − Q2 − 100

thus the FOC (M R = M C condition) is

100 − 2Q − 2Q = 0 ⇔ Q∗ = 25

⇔ P ∗ = 100 − 25 = 75

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 (a) Under Cournot competition the profits of the two firms are (I use labels q1 and q2 )

π1 = (100 − q1 − q2 ) q1 − q12 − 100 for firm 1, and

π2 = (100 − q1 − q2 ) q2 − q22 − 200 for firm 2.

The FOCs are

100 − 2q1 − q2 − 2q1 = 0

100 − 2q2 − q1 − 2q2 = 0

as the FOCs are symmetric in equilibrium we must have q1∗ = q2∗ = q ∗ which is the
solution to:
100 − 2q ∗ − q ∗ − 2q ∗ = 0 ⇔ q ∗ = 20

(b) Fixed costs do not matter as they do not affect a firm’s profit at the margin and thus
should not be taken into account by the firm when it decides whether or not and how
much to produce.

12 Answers 2014

General equilibrium:
1. If this were not the case then it would mean that Anna would be better off increasing her
consumption for the good that is characterised by a higher marginal utility/price ratio, as this
would allow her to increase her utility compared to the current situation. Thus Anna will stop
reallocating her income between the two consumption goods when the last euro spent on each good
yields the same marginal utility
2. Anna’s consumption maximisation problem is:
1 3
CA4 FA4 s.t. 240PC + 240PF = PC CA + PF FA ,

The corresponding FOCs yield:

FA PC
3CA = PF

and inserting these in the budget constraint yields:

∗ = 240PC +240PF 3(240PC +240PF )

CA 4PC and FA∗ = 4PF

14
 Similarly (and quite obviously as Benny values the two goods equally!), the optimal consumption
choices for Benny are given by:

∗ = 120PC +120PF (120PC +120PF )

CB 2PC and FB∗ = 2PF

Market clearing for clotting requires:

∗ + C ∗ = 360 <=> 240PC +240PF 120PC +120PF

CA B 4PC + 2PC = 360

which can be rewritten as

240PC + 240PF + 240PC + 240PF = 1440PC <=> 480PF = 960PC

PC 1
and thus PF = 2

QED

PC 1
3. Replace PF = 2 in the optimal consumption choices above to get the values of these
consumption choices. This yields:
PF
∗ = 240 +240PF 360PF
CA 2
4PC = 4PC = 180
PF
3(240 +240PF ) 3(120+240)
FA∗ = 2
4PF = 4 = 270
PF
∗ = 120 +120PF 180PF
CB 2
2PC = 2PC = 180

and FB∗ = 90,

∗ = 2F ∗ given the preferences of Benny and the fact that PC

as we must have that CB B PF = 21 !.
Game theory
1. The game tree is given by the figure below.
2. Klaas has two contingencies, two points in the game where he may be asked to play, thus his
strategies are pairs of actions. There are 4 such pairs (the first action in each pair is what Klaas
does after Piet has chosen to produce a present, the second is what Klaas does after Piet has chosen
to produce a surprise): (surprise, surprise) , (surprise, present), (present, surprise) and (present,
present).
3. We use backward induction. In the subgame of Klaas after Piet has chosen to produce a
present, Klaas chooses to produce a surprise as this yields him a payoff of 9 which is greater than
4. In the subgame of Klaas after Piet has chosen to produce a surprise, Klaas chooses to produce
a present as this yields him a payoff of 16 which is greater than 3. Knowing this, Piet is better of

15
choosing to produce a present as this yields him a payoff of 16 which is greater than 9. Thus the
outcome of the game is that Piet produces a present and Klaas produces a surprise.
The subgame perfect EQUILIBRIUM though is that 1) Piet produces a present and 2.1) Klaas
chooses to produce a surprise if Piet has chosen to produce a present and 2.2) Klaas choses to
produce a present if Piet has chosen to produce a surprise. Indeed, equilibria are about strategies,
not outcomes!
A possible shorthand notation for this equilibrium is thus: (present, (surprise, present)) where the
first term refers to the strategy of Piet and the pair of two terms refers to the strategy of Klaas.

13 Answers 2015

Problem 1:

1. Leontief: 5min[K, L] (2 points overall, 1 for recognising that it is a Leontieff func-

tion; 1 for getting the function right)

2. if the production function is 3 ∗ L1/3 K 2/3 and the price of labor and capital are given
 

MP K MP L
respectively by w = 1 and r = 2, then: The long run cost function is defined by r = w .

(1 point for this or anything that means this)

6F (K,L) 3F (K,L)
Here, M P K = 3K and M P L = 3L .
6F (K,L) 3F (K,L)
As w = 1 and r = 2, the optimal input mix condition yields: 6K = 3L or K = L.
(1 point for this or anything that yields this)

16
 Q
This implies in turn that L(Q) = K(Q) = 3. (1 point for this or anything that yields
this)
Q
But then T C(Q) = wL(Q) + rK(Q) = 3 + 2 Q3 = Q. (1 point for this or anything that
yields this) (4 points overall)

3. The profit function of the firm is (25 − 3Q)Q − Q. (1 point for this or anything that
yields this) The first order condition is 25 − 6Q = 1 (1 point for this or anything that
yields this) which yields Q∗ = 4 and thus P ∗ = 25−12 = 13 (1 point for this or anything
that yields this) which implies that profit is given by: π ∗ = 13 ∗ 4 − 4 = 48.(1 point for
this or anything that yields this) (4 points overall)

Problem 2:

 4 = 2Q2
1. The firm’s problem is to solve the following system: (2 points for getting
 Q +Q =4
1 2
and explaining how to get to this system)
which yields Q∗2 = 2, Q∗1 = 2.(1 point for this or anything that yields this)
Equalizing marginal costs implies that you are minimising total costs, unless using one plant
only to produce is better (which is not in this specific case!). (1 point for this or anything
that yields this) (4 points overall)

2. The two firms maximise profits simultaneously, taking the production of the other firm as
given. (1 point for this or anything that means this) In equilibrium beliefs about the
other firm’s choice must be correct. (1 point for this or anything that means this)
The profits of each firm are given by πi = (90 − (qi + qj ))qi − 30qi . (1 point for this or
anything that yields this) The FOC to each firm’s problem yields the following system of
best responses:

 90 − 2qi − q¯j = 30
. (1 point for this or anything that yieldss this)
 90 − 2q − q¯ = 30
j i

In equilibrium, by symmetry as the two firms face the same problem, we must have that
qi∗ = q¯i = qj∗ = q¯j (1 point for this or anything that means this) and thus the system
yields the NE: qi∗ = qj∗ = 20. (1 point for this or anything that yieldss this) (6 points
overall)

17
14 Answers 2016

First problem
M PL w
Long run: yes, we require: M PK = r, as otherwise the firm would have an incentive to use
more of the input that is more productive per euro spent. By doing this it would save money while
keeping the production level constant.
Short run: it cannot as one of the inputs is fixed. Then it has to adjust mechanically the use
of the variable input to meet any production target.
Second problem
2HG HD
The M RS of Gene is given by: M RSG = CG . The M RS of Donald is M RSD = 3CD .

Gene’s income is (normalising the price of chocolate to 1) MG = 15 + 24pH . Donald’s income

is MD = 5 + 6pH .

In equilibrium the two M RS’s must coincide (to be on the contract curve) and must be equal
to equilibrium prices pC /pH .

Market clearing on the hotdogs market requires: HG + HD = 30. Market clearing on the
chocolates market requires CD + CG = 20.

Normalize pD to 1. Then, Gene’s consumption problem implies CG = 2pH HG . Donald’s

pH HD
consumption problem implies CD = 3 .

Inserting these conditions into each consumer’s budget constraint allows us to get their demands
of hotdogs as a function of pH :

pH HD
2pH HG + pH HG = 15 + 24pH and + pH HD = 5 + 6pH
3

which implies that

15 + 18pH 15 + 24pH
HD = and HG =
4pH 3pH
Using the market clearing condition for hotdogs yields:

15 + 18pH 15 + 24pH
+ = 30 → 45 + 54pH + 60 + 96pH = 360pH → pH = 1/2
4pH 3pH
∗ = 15+18/2
and thus HD 4/2 = 12.

18
15 Question 3 (8 points)

A monopolist uses labour and capital to produce. Its production function is F (K, L) = K 1/2 L1/2
and the price of the two inputs are w = 18 and r = 2. In the short run capital is fixed at 9 units.

1. Derive its short run (1 point) and long run (2 points) total cost functions.

Q
2. Suppose the demand facing this monopoly is P = 112 − 10 . Use the long-run cost function
you just computed (if you are not sure what you did is correct, then use the following cost
function, but it will cost you 1 point over the two following questions: LT C(Q) = 32Q).

(a) find its profit maximising choice and the profits if it cannot practice any discrimination
(2 points);

(b) find its profit maximising choice and the profits if it knows the market is made of 10
identical consumers and it can price discriminate (3 points);

15.1 Answers
Q2
1. In the short run, the prod function is given by Q = F (9, L) = 3L1/2 . This implies L(Q) = 9 .
Q2
Thus the short run total cost function is given by ST C(Q) = 9 ∗ 2 + 18 ∗ 9 = 18 + 2Q2 .
Q Q
In the long run all inputs are chosen optimally, which requires 2wL∗ = 2rK ∗ or L∗ = r
wK
∗ =
K∗ ∗ ∗ 1/2 K ∗ 1/2 = K ∗ .


9 . Thus F (K , L ) = K 9 3
wQ
Thus LT C(Q) = 3rQ + 3 = 6Q + 6Q = 12Q.

2. Basic profit maximisation with market demand (what is between “( )” is the answers using
LT C(Q) = 32Q).
Q
M R = M C → 112 − 5 = 12 (32) → Q∗ = 500 (400) → P ∗ = 112 − 50 = 62 (112 − 40 = 72).
Profits are given by 500∗62−500∗12 = 500∗50 = 25000 (400∗72−400∗32 = 400∗40 = 16000)

3. For each consumer, or the whole market (that’s the same), a two part tariff with P =
M C(Q) = 12 and fee equal to whole consumer surplus. For P = 12 (32), Q = 1000 via demand (800)
thus qi = 100 (80). Individual demand curve: P = 112 − qi . Thus max membership fee is
(112−12)∗(1000−0)
2 = 5000 (80 ∗ 80/2 = 3200). Profits are given by 1000 ∗ 12 − 1000 ∗ 12 + 5000 ∗
10 = 50000 > 25000 (3200 ∗ 10 = 32000 > 16000).

Bottom line: discriminate if you can!!

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16 Answers 2017

First problem

1. both inputs are variable, thus the firm will set its use of them optimally (1/2 point); namely
M PC M PL
such that pC = pL (1/2 point); indeed, if this equality does not hold it means that the
M PX
firm can reallocate some of its funds from the input for with pX is lower to the input for
M PX
which pX is higher and thus produce (perhaps even more output) at a lower cost. This
M PC M PL
reallocation of funds continues until pC = pL (1/2 points).

M PK
2. As capital is fixed, pK is fixed and the firm cannot influence it, thus the exact value of
M PK
pK (strictly positive of 0 depending on how you interpret the meaning of fixed input) and
M PC
thus the relationship with pC is immaterial to the firm (1 point; if a student states that
M PK
pK = 0 because M PK = 0 given that K is a constant, then the relationship is obviously
M PC M PK M PK
pC > pK ; if a student states that pK evaluated at the fixed level of K is a positive
number that depends on the actual value of K, then the relationship can go either way; both
answers are OK provided the student is constant in their answer), which has to focus on
buying optimally C and L only (1/2 point).

Second problem
In equilibrium, the two consumers’ MRS must be equal to relative prices (1/2 point). We must
Fi PB PB
thus have for i = A, G: Bi = PF , so Fi = PF Bi . (1 point).
Only relative prices matter in equilibrium. We can thus set PF as the numeraire: PF = 1. So
Fi = PB Bi . (choosing the other price to be the numeraire is fine too)
Putting this into the budget constraint we obtain for A that FA + PB BA = 2PB BA = 2PB + 8.
PB +4
This gives BA = PB (1 point; a similar formula with the other price as numeraire is fine too;
focusing on good F is fine too)
2PB +2
Similarly we obtain for G that BG = PB . (1 point; a similar formula with the other price as
numeraire is fine too; focusing on good F is fine too)
PB +4 2PB +2
In equilibrium the market clears (1 point): BA + BG = 2 + 4, so PB + PB = 6, and thus
6 = 3PB . PB = 2. (1.5 points; a similar formula with the other price as numeraire is fine too;
focusing on good F is fine too)
4+2
Using this we can find BG , BG = 2 = 3 and FG = PB BG = 2 × 3 = 6. (1 point)
So G consumes 3 Bananas and 6 Fish in equilibrium.

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Third problem:

1. The total profit function of the monopolist is the difference between total revenues and the
sum of the total cost functions of the two plants (1 point), namely:

(Q2 )2
π (Q) = (84 − Q) Q − (Q1 )2 − 4Q1 − − 11Q2
4
(Q2 )2
= (84 − (Q1 + Q2 )) (Q1 + Q2 ) − (Q1 )2 − 4Q1 − − 11Q2 (2 points)
4

 84 − 2 (Q1 + Q2 ) − 2Q1 − 4 = 0 (2 points)
2. The associated FOCs are:
 84 − 2 (Q + Q ) − Q2 − 11 = 0 (2 points)
1 2 2

 Q1 = 20 − Q2 (1 point; focusing on Q2 as a function of Q1 is fine too)
2
These yield
 84 − 2 (Q + Q ) − Q2 − 11 = 0
1 2 2

 Q1 = 9
and thus (1 point per correct quantity)
 Q = 22
2

(Using Cramer’s rule to solve the system also yields 3 points.)

Alternative solution: the monopolist will always choose its production levels such that M R =
M C. In this specific case, this requires to equate to marginal cost curves to each other and one of
them to the marginal revenue curve. 1 point for mentioning M R = M C and 1.5 points for getting
Q2
the M R (84 − 2 (Q1 + Q2 )) and M C curves (2Q1 + 4 and 2 + 11) right (1/2 point per derivation,
thus).
Thus the system to solve is

 
 84 − 2 (Q1 + Q2 ) − 2Q1 − 4 = 0 (1 point)  84 − 2 (Q1 + Q2 ) − Q2 − 11 = 0 (1 point)
2
or
Q2 Q2
 2Q + 4 =
1 + 11 (1 point)
2
 2Q + 4 = + 11 (1 point) 1 2

This yields (1/2 point for either system):

 
73
 Q2 = 40 − 2Q1  Q1 = 2 − 54 Q2
or
 2Q + 4 = Q2 Q2
1 2 + 11  2Q + 4 =
1 2 + 11

or:


 Q1 = 9
(1 point per correct quantity)
 Q = 22
2

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17 Answers 2018

First problem

1
1. Profit maximization requires P = M Ci (qi ), which means P = 800qi , or qi = 800 P . As
1200 3
this must hold for eacxh firm, QS = 800 P = 2 P. The market equilibrium is then such
that QS (P ) = QD (P ) . This yields 3
2P = 200 − P → P ∗ = 80, and qi∗ = 0.1. Then
πi = qi P − 500qi2 = 80 ∗ 0.1 − 400 ∗ 0.01 − 1 = 8 − 4 − 1 = 3.

2. In the long run we must have P = min LAC. (1 point) LAC (q) = 400q + 1q . The FOC yields
1 1 1
q 2 = 400 = 400


→ q = 20 . LAC 20 20 + 20 = 40 = P → Q = 200 − 40 = 160. Finally,
160
n= 1 = 160 × 20 = 3200.
( 20 )

3. No. Indeed, the MC decreases with q. This implies that the bigger a firm is the more efficient
it is → natural monopoly.

4. Suppose this is not the case. Then the more productive input per euro should be used even
more as it allows the firm to produce more cheaply. Thus we must have the above condition
in equilibrium.

Second problem
1) The profit function is given by: πt (qs , qp ) = (60 − qs ) qs + (160 − 2qp ) qp − 1
2 (qs + qp )2 .
Explanations are expected here.
60−qp 160−qs
The two FOCS are then qs = 3 and qp = 5 .
This yields qs = 10 and qp = 30.
SActually, the firm can do even better than this if it wants to offer students a really special price:
two-part tariff on the profs and use the proceeds of that to reduce further the price asked to student
while making sure it gets the same level of profits as when it follows the standard selling on two
markets strategy...
2) Third degree allows the firm to differentiate between groups as it can identify these groups.
Under second degree this differentiation is not possible.

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