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Class test 3 - ECON 221 memo final
Micro-economics / Mikroekonomie (North-West University)
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SECTION A: SHORTER THEORY QUESTIONS
[15]
Answer all the questions in this section.
Question 1
[3]
Consider each of the following concepts below and define them accordingly:
1.1
Intertemporal price discrimination.
(1)
Practice of separating consumers with different demand functions into different groups by
charging different prices at different points in time.
1.2
Market failure.
(1)
Situation in which an unregulated competitive market is inefficient because prices fail to
provide proper signals to consumers and producers.
1.3
Nash-equilibrium.
(1)
Set of strategies or actions in which each firm does the best it can, given its competitors’
actions
Question 1
[3]
Sin taxes are considered vital sources of government revenue, so much so, that
some have referred to as budget saviors. They are defined as excise taxes, levied
on goods and services whose consumption is regarded as morally questionable. As
such, the imposition of these policy tools and their burden is said to fall primarily on
the consumer with the objective to curtail the use of these services and goods
within economies.
Based on the statement above, illustrate the effect of the imposition of sin
2.1
taxes in a competitive market and explain based on elasticity considerations
why their application withholds a higher tax burden on consumers? (4)
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0.5mark correct axis named
0.5 mark for steeper demand curve
(named correctly)
0.5 mark for indication of tax burden
0.5 mark for flatter supply curve
(correctly named)
0.5 mark for correct price indication
(Pb, Ps & Po)
0.5 mark for Q1 and Q0 indication.
Consumer carry most of burden as
demand for sin taxed products (alcohol,
cigarettes) tends to be relatively more
inelastic than the supply of these
products. (1 mark)
Question 3
[2]
Monopolistically competitive and oligopolistic markets exist when there is imperfect
competition present within an industry or sector. Although these market structures are
closely related both attribute their own distinct features.
Compare the two market structures as highlighted above, clearly
3.1
highlighting the key differences between them whilst identifying an example
(2)
of each.
Monopolistic competitive markets
Market in which firms can enter freely, each producing its own brand or version of a
differentiated product, market power can be obtained. (0.5 mark)
Example: Retail markets (market for toothpaste, detergents, pharmaceuticals) (0.5 mark)
Oligopolistic market
Only a few firms competing in the market earning substantial profits in the long run due to
entry barriers. (0.5 mark)
Example: telecommunications, banking industry, automobile markets, steel, aluminum,
petrochemicals and electrical equipment. (0.5 mark)
Question 4
[6]
Rand Water serves as a critical natural monopoly bulk water provider to the Gauteng
region, the economic heartland of South Africa. It is the country’s largest water board and
acts in an agency capacity on behalf of the government in providing an essential
commodity to municipalities, the population, and to large industrial customers.
Various concerns though surrounding the provision of adequate and safe drinking water
supplies have arisen of late. Calls in this regard have come on the need for the
establishment of an independent water regulator and adequate regulation to halt the
abuse of taxpayers’ money and ensuring the efficient and effective utilization of such
resources.
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Considering its features as a natural monopoly, what price discrimination
strategy can Rand Water apply to improve consumer welfare and economic (2)
efficiency in the sector. Motivate your answer accordingly.
As a natural monopoly, application of secondary price discrimination in the market will
increase economic efficiency (1 mark). Incentivizing lower prices with larger purchases,
will make consumer better off as these markets illustrate declining average and marginal
costs (economies of scale) (1 mark).
4.1
4.2
Illustrate and explain the need for regulation in these types of industries?
How and why should regulation be imposed?
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(4)
0.5-mark correct axis
0.5-mark separate AR and MR curves
0.5-mark for AC and MC curves
0.5 mark Pm and Qm
0.5-mark Qc and Pc at MC = AR
0.5-mark for Pr and Qr at AC = AR
Without regulation firm produces high price
(Pm) and lower output Qm) (0.5 mark)
Regulation required at AR=AC to protect
consumer (lower prices, higher output) but
also to make production viable given
presence of economies of scale (0.5 mark)
SECTION B: Calculations
[15]
Answer All question in this section
Question 1
[4]
The domestic supply and demand curves for Cotton Wool are as follows: Supply: P =50 +Q
Demand: P = 200 -2Q. Where P is the price in cents per Rands and Q is the quantity in
millions of Rands. Botswana is the small producer in southern African Cotton wool’s market,
where the current price (which will not be affected by anything we do) is 60 cents per Rand.
government is considering a tariff of 40 cents per Rand.
1.1 Find the domestic price of cotton wool that will result if the tariff is imposed.
50 + Q =200 -2Q or QEQ =50 (Million rands)
(4)
(0,5 mark)
Substitute QEQ = 50 into either the supply or demand equation to determine price:
PS = 50 + 50 = 100 and PD =200 – (2)(50) =100
( 0,5 mark)
Thus, the equilibrium price P is R1 (100 cents). However, Southern African market price
is 60
cents. At this price, the domestic quantity supplied is 60 =50 -Qs or Qs =10,
and domestic demand is 60 =200 – 2QD or QD = 70 (1 mark). Imports equal the
difference between domestic demand and supply, or 60 million rands. (1 mark)
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If Government imposes a tariff of 40 cents, the effective price of imports increases a tariff
to R1. At R1, domestic producers satisfy domestic demand and Imports fall to Zero. (1
mark)
Question 2
2.1
[4]
The following shows the demand curve facing a monopolist who produces at
constant marginal cost of R10.
Pri
ce
27
24
21
18
15
12
9
6
3
0
Quan
tity
0
2
4
6
8
10
12
14
16
18
2.1.1
Calculate the firm’s marginal revenue curve.
(1)
To find the marginal revenue curve, we first derive the inverse demand curve. The
intercept of the inverse demand curve on the price axis is 27. The slope of the
inverse
demand curve is the change in price divided by the change in quantity. For example,
a
decrease in price from 27 to 24 yields an increase in quantity from 0 to 2. Therefore,
the
slope is – 3/2 and the demand curve is
P = −27- 1.5Q (0,5 mark)
The marginal revenue curve corresponding to a linear demand curve is a line with the
same intercept as the inverse demand curve and a slope that is twice as steep.
Therefore, the marginal revenue curve is
MR = 27 - 3Q. (0.5mark)
2.1.2
What are the firm’s profit-maximizing output and price? And What is its profit? (2)
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The monopolist’s maximizing output occurs where marginal revenue equals marginal
cost. Marginal cost is a constant $10. Setting MR equal to MC to determine the profitmaximizing quantity:
27 - 3Q = 10, or Q = 5.67 (0,5 marks)
To find the profit-maximizing price, substitute this quantity into the demand equation:
P =27− (1.5) (5.67) = R18 .5. (0,5 marks)
Total revenue is price times quantity:
TR = (18 .5) (5.67) = R104 .83. (0,5 marks)
The profit of the firm is total revenue minus total cost, and total cost is equal to
average cost times the level of output produced. Since marginal cost is constant,
average variable cost is equal to marginal cost. Ignoring any fixed costs, total cost is
10Q or 56.67, and profit is 104.83 – 56.67= R48.17 (0,5 marks)
2.1.3
what would the equilibrium price and quantity be in a competitive industry?
(1)
For a competitive industry, price would equal marginal cost at equilibrium. Setting the
expression for price equal to a marginal cost of 10:
27 − 1.5Q =10
⇒ Q = 11 .3 (0,5 mark)
⇒ P = 10 .(0,5 mark)
Question 3
[5]
A monopolist is deciding how to allocate output between two geographically separated
markets (East Coast and Midwest). Demand and marginal revenue for the two markets are:
P1  15  Q1 MR1  15  2Q1
P2  25  2Q2 MR2  25  4Q2
The monopolist’s total cost is C  5  3(Q1  Q2). What are price, output, profits, marginal
revenues, and deadweight loss.
3.1
Choose quantity in each market such that marginal revenue is equal to marginal cost.
The marginal cost is equal to 3 (the slope of the total cost curve). The profitmaximizing quantities in the two markets are:
15  2Q1  3, or Q1  6 on the East Coast, and (0,5 mark)S
25  4Q2  3, or Q2  5.5 in the Midwest (0,5 mark)
P1 =15 - 6 = $9 (0,5 mark), and P2 =25 - 2(5.5) = $14.(0.5 mark)
π= 9(6) + 14(5.5) - [5 + 3(11.5)] = $91.50. (0,5 marks)
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the monopoly deadweight loss is DWL =(0.5)(QC - QM)(PM - PC ),(0,5 mark)
DWL1 = (0.5)(12 - 6)(9 -3) = $18. (0,5 mark), and DWL2 =(0.5)(11 - 5.5)(14 - 3)
=$30.25.(0,5 mark)
The total deadweight loss for two markets is $48.25. (0,5 mark)
Question 4
[2]
Suppose the government, concerned about the high price of doorstops, sets a maximum
price at $27.
4.1
How does this affect price, quantity, consumer surplus, and DD’s profit?
27 = 55 - 2Q, or Q = 14. (0,5 mark)
CS = (0.5)(55 - 27)(14) = $196. (0,5 mark)
p = (27)(14) - (100 - (5)(14) + 142) = $152. Profits (0,5 marks)
4.2
What is the resulting deadweightloss
(0.5)(15 - 14)(27 - 23) = $2 (0,5 mark)
TOTAL MARK 30
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