You Have 50 Minutes to Answer All Four Questions. Good Luck

Economics 101

Third Exam

Instructor Dermot Hayes

You have 50 minutes to answer all four questions. Good Luck

Question 1 (20 points)

Firms that operate under monopoly-like (or monopolistic) competition often face problems when new substitute brands emerge.

(a)Show the impact of a new substitute brand on the demand curve faced by a monopsonist.

(b)Draw the average total cost curve on this diagram and show what happens to profits when the substitute brand emerges.

(c)Assume for simplicity that the monopsonist continues to charge the same monopoly price as before the introduction of the new brand. Show the output level where the monopsonist earns zero economic profit.

Question 2 (20 points)

(a)Explain the hands-up game we used in class (or the prisoners dilemma game in the text)

(b)Describe the Nash equilibrium and the cooperative equilibrium.

(c)Explain why the cooperative equilibrium can emerge and lead to price fixing even when the companies involved are not allowed to communicate.

Question 3 (20 Points)

Assume that oil is a non-renewable natural resource and that interest rates are at 10%.

(a)Show the demand curve for oil and make sure that the choke price is $110 per barrel.

(b)Show the supply curve for oil in each of the two years prior to full depletion.

(c)Show the equilibrium price and quantity in each of these two years. Note that you can round prices to the nearest $10

Question 4 (20 Points)

Assume that a lot of people decide to become involved in some professions such as teaching or production agriculture and that as a result earnings in this sector are very low.

(a)Now assume that the government decides to help the individuals in this sector with a law that mandates a higher wage for those in this type of employment. Show how this higher wage will change the number of people who decide to join this profession.

(b)Now hold fixed the new number of people in the profession and show the equilibrium wage for this industry if the mandate is removed by the government (or because people cheat.)

Question 5 (20 Points)

Assume that your parents have just discovered that a new freeway will be built and that they have decided to take advantage of this information by making an investment. They are considering two options. The first option involves investing in a construction company located near the new freeway and the second involves an investment in land near the proposed freeway. Suppose that your parents are interested in “doing well” over the next few decades on this investment.

(a)Write a letter to your parents explaining the concept of economic rents (or producer surplus).

(b)Use the letter to explain why one of these investment decisions will meet their criteria better than the other.