ECON 201 EXAM

1

• ECON 201 EXAM 2 OUTLINED ANSWERS
• Demand Decrease Organic Raisin Question
• The following graph depicts the initial long-run
  equilibrium conditions
• Zero Econ Profit P ATC
• No incentive for firms to enter/exit industry.
• Firms max profits producing at P (MR) MC
• Producing at lowest ATC--min. per unit costs
• No incentive to change plant size, ATC at output
  where P MC
• Industry Adjustment to decrease Demand
• Market Demand falls and thereby Price falls to
  P2
• Lowers firms demand MR (P2d2 MR2)
• Firm lowers output to q2 (new P2 MR2 MC)
• P2 lt ATC, so negative profits (area xyzP2) means
  firms exit industry.
• Exit of firms reduces market supply (S2) ,
  raising P
• This raises firms demand MR
• P rises, putting upward pressure on profits
  until 0 econ profits earned
• Long-run equilibrium achieved P MC Min ATC
  and firms earn zero economic profits
• New equilibrium market quantity is lower.
• New equil. price returns to initial level (Though
  this depends on effects of entry on firm costs.)

2

MARKET
S1

FIRM
S2
D1
D2
MC
a

• x

y
ATC
P1
d1 MR1, d3 MR3,
P1
A
P2
P2
d2 MR2
z
q2
q1
Q
3

• Resource Allocative/Productive Efficiency
  Question
• In long run equilibrium, competitive markets
  result in an efficient outcome described as
  follows
• Resource Allocative Efficiency
• Profit max leads to allocative efficiency
• Firms produce at MR MC
• Since MR P, then P MC
• Marginal Benefit (demanders) Marginal Cost (to
  suppliers of using societys resources)
• Societys marginal value of resources equals
  Societys opportunity costs of resources
• Productive Efficiency
• Firms produce at lowest ATC in long-run
• Firms economizing on resource use
• Goods produced at lowest unit opportunity costs

4

• Monopoly Question
• A) The characteristics of a monopoly market are
  as follows One seller in the market No close
  substitutes are available Extremely high
  barriers to entering the market.
• B) In a competitive industry, the market
  price/quantity is determined by market demand and
  market supply (which is summation of all firms
  MCs). In the graph, the competitive output
  would be QC and price PC. But the monopoly
  restricts Q, maximizing profit at QM where MR
  MC since it faces the downward-sloping MR curve.
  Thus, the monopoly results in less Q and higher
  P.
• C) Consumer are worse off by the loss in
  consumer surplus (ie., the difference between
  consumers willingness to pay and the actual
  price paid) of the area (PMBDPC) .

B
PM
D
A
PC
MCATC
DMarket
MR
QM
QC
5

• D) The problem with a monopoly is the Monopoly
  Welfare Cost, interpreted as follows
• Area (PMBDPC) Lost Consumer Surplus from the
  higher P.
• Area (PMBAPC) Monopoly Profit redistributed
  from consumer in the form of higher P (this is
  not part of welfare cost)
• Area (BAD) Welfare Cost, or resource
  misallocation. Another way to view it is that at
  any Q less than QC, P gt MC (meaning Societys
  Marg. Benefit of output gt Societys Marg. Cost of
  using resources to produce it)
• Area (PMBAPC) Monopoly Profit subject to
  rent-seeking--an additional component of welfare
  cost

B
PM
D
A
PC
MCATC
DMarket
MR
QM
QC
6

• Marginal Revenue Curve for a Single-Priced
  monopolist
• Monopoly has the same basic rule as competitive
  firm
• Max profit at Q where MR MC
• However, since monopoly only firm, its output
  impacts market price and so its MR. If it
  raises P, then it still sells product but not as
  many
• So it searches for the price to sell output that
  maximizes profits Monopoly faces down-sloping
  market demand
• Its Price influences quantity demanded
• So it must lower price to sell another unit Not
  just on last unit sold, but all previous units
  also. So, the MR (of selling another unit) is
  less than its Price. In turn, this means that
  the firmsMR doesnt equal Market Price

7
Monopolists MR lies below Demand(graph
explanation from class

• Lost revenue from lowering Price for preceding 3
  units (6)

• Must lower P from 10 to 8 to sell 4th unit
• Gains 8 from selling a 4th good
• But loses 2 for each of 3 units couldve sold
  for 10
• MR 4th unit 8-6 2

Gained revenue from selling 4th unit (8)
10
8
DMarket
2
MR
Q
3
4