Unit 9 Review Problems
1. Suppose the book-printing industry is competitive and begins in a long-run equilibrium.
a. Draw a diagram describing the typical firm in the industry.
b. Hi-Tech Printing Company invents a new process that sharply reduces the cost of printing books. What happens to Hi-Tech’s profits and price of books in the short run when Hi-Tech’s patent prevents other firms from using the new technology?
c. What happens in the long run when the patent expires and other firms are free to use the technology?
2. Suppose there are 1,000 hot pretzel stands operating in NYC. Each stand has the usual U-shaped ATC curve. The market demand curve for pretzels slopes downward, and the market for pretzels is in the long-run competitive equilibrium.
a. Draw the current equilibrium, using graphs for the entire market and for an individual pretzel stand.
b. The city decides to restrict the number of pretzel-stand licenses, reducing the number of stands to only 800. What effect will this action have on the market and on an individual stand that is still operating? Draw graphs to illustrate your answer.
c. Suppose that the city decides to charge a fee for the 800 licenses, all of which are quickly sold. How will the size of the fee affect the number of pretzels sold by an individual stand? How will it affect the price of pretzels in the city?
d. The city wants to raise as much revenue as possible, while ensuring that all 800 licenses are sold. How high should the city set the license fee? Show the answer on your graph.
3. Which of the following goods and services are sold by firms in monopolistic competition? Explain.
a. Cable Television Service
b. Wheat
c. Athletic shoes
d. Soda
e. Shaving cream
f. Toothbrushes
g. Ready-mix concrete
4. Suppose 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.
5. The Placebo Drug Company holds a patent on one of its discoveries.
a. Assuming that the production of the drug involves rising marginal cost, draw a diagram to illustrate Placebo’s profit maximizing price and quantity. Also show Placebo’s profits.
b. Suppose that the government imposes a tax on each bottle of the drug produced. On a new diagram, illustrate Placebo’s new price and quantity. Compare diagram to answers in part (a)?
c. In your diagram, the tax reduces Placebo’s profit. Explain why this is true.
d. Instead of the tax per bottle, suppose that the government imposes a tax on Placebo of $10,000 regardless of how many bottles are produced. How does this tax affect Placebo’s price, quantity and profits? Explain.
6. 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 and its cost curves, show the price and quantity combinations favored by each of the three partners. Explain.
7. What are the three types of barrier to entry that can create a monopoly? Provide an example of each type. Why cannot barriers to entry simply be torn down so that all markets become competitive?
8. Hawaii Cable Television is a natural monopoly.
a. Sketch a demand curve, a marginal revenue curve, an average total cost curve, and a marginal cost curve that illustrate Hawaii Cable’s situation
b. If Hawaii Cable is unregulated and maximizes profit, show in your graph the price, quantity, economic profit, consumer surplus, and deadweight loss.
c. If Hawaii Cable is regulated in the public interest, show in your graph the price, quantity, economic profit, consumer surplus, and deadweight loss.
d. If Hawaii Cable is subject to a price cap regulation that enables it to earn normal profit, show in your graph the price, quantity, economic profit, consumer surplus, and deadweight loss.
e. What would happen if the regulator set the price cap for Hawaii Cable too low for the firm to earn normal profit?
9. List four goods or services that you have purchased that were produced by an oligopolist. Why are these industries oligopolistic, rather than monopolistically competitive?
10. BONUS: Bob and Tom are two criminals who have been arrested for burglary. The police put Tom and Bob in separate cells. They offer to let Bob go free if he confesses to the crime and testifies against Tom. Bob also is told that he will service a 15-year sentence if he remains silent while Tom confesses. If he confesses and Tom also confesses, they will each serve a 10-year sentence. Separately, the police make the same offer to Tom. Assume that if Bob and Tom both remain silent, the police only have enough evidence to convict them of a lesser crime and they will serve 3-year sentences.
a. Use this information to write a payoff matrix for Bob and Tom.
b. Does Bob have a dominant strategy? If so, what is it?
c. Does Tom have a dominant strategy? If so, what is it?
d. What sentences do Bob and Tom serve? How might they have avoided this outcome?