Q:

In the Colluding Refiners problem on the 2004 exam, is it possible to show MR on the graph?

A:

See the other posts on demand and marginal revenue.

Q:

Also on this problem, why is DWL $5 million rather than $10 million?

A:

I think you are right, in that the calculation should be 1/2 * ($2.50-$1.50)* 20 million. ($1.50 is the point on the supply curve at 100 million gallons.)

## Thursday, December 13, 2007

### Global Warming

Q:

In the Global Warming question on the 2005 exam, the answer to part d states:

"It would get 20 each from India and China and 80 from the rest of the world."

Why is this?

A:

So, the starting point is that China and India each has 120 permits and the rest of the world has 180. Furthermore, since the US pollutes 300 units, it would like to buy 120 permits if it can do so at a cost of $25 or less, since that is the minimum cost for the US to clean up. Now, China and India, if they clean up 100 units (which is the first "block" of marginal cost), each have 20 permits left over to sell. They will choose to sell these 20 permits each at a minimum price of $10 and $15 respectively, since that is what it cost to clean up rather than use them. The rest of the world, if it cleans up 100 units, still has 200 units of pollution and only 180 permits, so it needs to either buy permits or keep cleaning. The second block of cleaning has a MC of $20, and if they clean up this block then they have 80 permits to sell. They will sell the permits and clean if they can get a minimum price of $20.

In the Global Warming question on the 2005 exam, the answer to part d states:

"It would get 20 each from India and China and 80 from the rest of the world."

Why is this?

A:

So, the starting point is that China and India each has 120 permits and the rest of the world has 180. Furthermore, since the US pollutes 300 units, it would like to buy 120 permits if it can do so at a cost of $25 or less, since that is the minimum cost for the US to clean up. Now, China and India, if they clean up 100 units (which is the first "block" of marginal cost), each have 20 permits left over to sell. They will choose to sell these 20 permits each at a minimum price of $10 and $15 respectively, since that is what it cost to clean up rather than use them. The rest of the world, if it cleans up 100 units, still has 200 units of pollution and only 180 permits, so it needs to either buy permits or keep cleaning. The second block of cleaning has a MC of $20, and if they clean up this block then they have 80 permits to sell. They will sell the permits and clean if they can get a minimum price of $20.

### Congestion Again

Q:

The answer to part a of the congestion problem on the 2007 exam states:

"the trips cost society the rectangle A in private costs plus the triangles B

and C in externalities"

Can you please explain?

A:

Technically, areas A, B, and C are all costs of the externality in the free market. The total cost of an externality is the per unit cost times the number of units transacted, which gives the area A+B+C.

The answer to part a of the congestion problem on the 2007 exam states:

"the trips cost society the rectangle A in private costs plus the triangles B

and C in externalities"

Can you please explain?

A:

Technically, areas A, B, and C are all costs of the externality in the free market. The total cost of an externality is the per unit cost times the number of units transacted, which gives the area A+B+C.

### Shannon's Taxis

Q:

On part e of the Shannon's Taxis problem on the 2007 exam, the answer states:

They lose $1 x 1000 = $1000 of consumers surplus on the 1000 rides they take per day they take plus 1/2 x $1 x 20 = $10 on the 20 extra rides they would have taken had the price been $5 per ride instead of $6.

Why is there a 1/2 in the last part of the answer?

A:

if you draw the graph this should make sense. The $1000 is the rectangle of lost consumer surplus, and the $10 is the triangle of lost CS that comprises the upper part of the DWL triangle. Since the area of a triangle is 1/2 * base * height, you get the 1/2.

On part e of the Shannon's Taxis problem on the 2007 exam, the answer states:

They lose $1 x 1000 = $1000 of consumers surplus on the 1000 rides they take per day they take plus 1/2 x $1 x 20 = $10 on the 20 extra rides they would have taken had the price been $5 per ride instead of $6.

Why is there a 1/2 in the last part of the answer?

A:

if you draw the graph this should make sense. The $1000 is the rectangle of lost consumer surplus, and the $10 is the triangle of lost CS that comprises the upper part of the DWL triangle. Since the area of a triangle is 1/2 * base * height, you get the 1/2.

### Valley of the Locusts

Q:

In part c of the Valley of the Locusts question, if the total marginal value 160> total cost 100, it is a good thing, right? Why NO?

A:

The answer to this question is no because the market solution, i.e. the answers to parts a and b state that the consumption where marginal benefit equals 160 and marginal cost is 100 won't happen. In other words, the answers to parts a and b are not welfare maximizing.

In part c of the Valley of the Locusts question, if the total marginal value 160> total cost 100, it is a good thing, right? Why NO?

A:

The answer to this question is no because the market solution, i.e. the answers to parts a and b state that the consumption where marginal benefit equals 160 and marginal cost is 100 won't happen. In other words, the answers to parts a and b are not welfare maximizing.

### Internet Browsers Again

Q:

In the Internet Browsers problem on the 2006 exam, in part a, where does the $30 come from?

A:

A monopolist that is maximizing profit is going to produce at the quantity where MR=MC. In this case, MC is constant at $10. Marginal revenue has the same price intercept as demand and is twice as steep. The equation for this is MR=50-Q. So 50-Q has to equal 10 and Q is 40. The price in the demand equation such that quantity demanded is 40 is $30.

In the Internet Browsers problem on the 2006 exam, in part a, where does the $30 come from?

A:

A monopolist that is maximizing profit is going to produce at the quantity where MR=MC. In this case, MC is constant at $10. Marginal revenue has the same price intercept as demand and is twice as steep. The equation for this is MR=50-Q. So 50-Q has to equal 10 and Q is 40. The price in the demand equation such that quantity demanded is 40 is $30.

### Internet Browsers

Q:

Spring 2006 practice exam, part 3, question 1a (Internet Browsers): From the information presented in the problem, how do you know there are only two firms in the market?

A:

I admit that this is a confusing question. There aren't two firms in the market, the solution to the problem merely shows that IF there were two firms in the market that, given the market demand that they face, they couldn't both be profitable. This would imply that one of them would exit, leaving a monopoly. A natural monopoly is one where MC is always below ATC. In this example, the constant MC at $10 plus the fixed cost ensures that this will be the case.

Spring 2006 practice exam, part 3, question 1a (Internet Browsers): From the information presented in the problem, how do you know there are only two firms in the market?

A:

I admit that this is a confusing question. There aren't two firms in the market, the solution to the problem merely shows that IF there were two firms in the market that, given the market demand that they face, they couldn't both be profitable. This would imply that one of them would exit, leaving a monopoly. A natural monopoly is one where MC is always below ATC. In this example, the constant MC at $10 plus the fixed cost ensures that this will be the case.

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