Department of Economics
University of Pacific
Spring Semester 2010
ECONOMICS 53
Problem Set 7
Due before lecture on April 22
Part 1: Multiple Choice (30 Questions, 1 Point Each)
1. The four largest firms account for approximately 90% of U.S. beer sales. The U.S. beer industry
would be best classified as a(n)
A) perfectly competitive industry.
B) monopolistically competitive industry.
C) oligopoly.
D) monopoly.
2. The oligopoly model in which firms produce exactly the same results as would exist if a
monopolist controlled the entire industry is called the ________ model.
A) Cournot
B) Price leadership
C) Collusion
D) Prisoner’s Dilemma
3. Tacit collusion
A) is legal under the U.S. antitrust laws.
B) occurs when firms engage in formal agreements to reduce output and increase prices in
their industry.
C) is more likely to be successful in increasing industry profits when there are a few, similar
firms in the industry.
D) is more likely to effectively raise prices in the industry when demand is elastic.
4. In the Cournot model the final level of output falls between the output that would prevail if
the market were ________ and the output that would be set by a ________.
A) competitive; monopoly
B) oligopolistic; monopoly
C) monopolistic; cartel
D) monopolistically competitive; cartel
5) Product differentiation that makes the product better than a rivalʹs product from everyoneʹs
perspective
A) is known as vertical differentiation.
B) is known as horizontal differentiation.
C) always increases welfare.
D) makes the rivalʹs product obsolete.
6. Which of the following is not a characteristic of monopolistic competition?
A) A large number of sellers.
B) Sellers offer products that are, in some way, different from their competitors' products.
C) There is free entry into the market.
D) Firms are price takers.
Figure 1
7. Refer to Figure 1. Which of the graphs shown would be consistent with a firm in a monopolistically
competitive market that is earning a positive profit?
A) Panel a
B) Panel b
C) Panel c
D) Panel d
8. Refer to Figure 1. Which of the graphs shown would be consistent with a firm in a monopolistically
competitive market that is doing its best but still losing money?
A) Panel a
B) Panel b
C) Panel c
D) Panel d
9. Critics of advertising argue that advertising
A) highlights differences in products that might not exist.
B) serves as a barrier to entry
C) increases costs to consumers
D) All of the above are correct.
10. The largest source of revenue for the federal government is the
A) property tax.
B) sales tax.
C) corporate income tax.
D) individual income tax.
11. Refer to Table 12-2. Costa is a single person whose taxable income is $50,000 a year. What is his total
tax due in 2002?
A) $4,057.50
B) $6,426
C) $10,483.50
D) $14,000
12. Refer to Table 12-2. Costa is a single person whose taxable income is $50,000 a year. What is his
average tax rate in 2002?
A) 19.6%
B) 20.5%
C) 21%
D) 28%
13. Refer to Table 12-2. Costa is a single person whose taxable income is $50,000 a year. What is his
marginal tax rate in 2002?
A) 0%
B) 15%
C) 28%
D) 31%
14. Tax incidence refers to
A) the structure of the tax
B) how frequently the tax is collected
C) who bears the economic burden of the tax
D) the impact of the tax on price or wages
15.
A)
B)
C)
D)
Refer to Figure 8-5. Without a tax, the equilibrium price and quantity are
$16 and 300.
$10 and 300.
$10 and 600.
$6 and 300.
16. Refer to Figure 8-5. Without a tax, consumer surplus in this market is
A) $1,500.
B) $2,400.
C) $3,000.
D) $3,600.
17. Refer to Figure 8-5. Without a tax, producer surplus in this market is
A) $1,500.
B) $2,400.
C) $3,000.
D) $3,600.
18. Refer to Figure 8-5. Without a tax, total surplus in this market is
A) $3,000.
B) $4,800.
C) $6,000.
D) $7,200.
19. Refer to Figure 8-5. When a tax is imposed in this market, the price buyers effectively pay is
A) $10.
B) $16.
C) $22.
D) between $10 and $16.
20. Refer to Figure 8-5. When a tax is imposed in this market, the price sellers effectively receive is
A) $6.
B) $10.
C) $16.
D) between $6 and $10.
21. Refer to Figure 8-5. When a tax is imposed in this market, consumer surplus is
A) $600.
B) $900.
C) $1,500.
D) $3,000.
22. Refer to Figure 8-5. When a tax is imposed in this market, producer surplus is
A) $450.
B) $600.
C) $900.
D) $1,500.
23. Refer to Figure 8-5. When a tax is placed on this good, the quantity sold
A) is 600 and buyers effectively pay $10.
B) is 300 and buyers effectively pay $10.
C) is 600 and buyers effectively pay $16.
D) is 300 and buyers effectively pay $16.
24. Refer to Figure 8-5. When the government imposes a tax in this market, tax revenue is
A) $600.
B) $900.
C) $1,500.
D) $3,000.
25. Refer to Figure 8-5. The amount of the tax on each unit of the good is
A) $6.
B) $8.
C) $10.
D) $12.
26. Refer to Figure 8-5. Total surplus with the tax in place is
A) $1,500.
B) $3,600.
C) $4,500.
D) $6,000.
27. Refer to Figure 8-5. What happens to consumer surplus when a tax is imposed in this market?
A) It falls by $3,600.
B) It falls by $2,700.
C) It falls by $1,800.
D) It falls by $900.
28. Refer to Figure 8-5. What happens to producer surplus when a tax is imposed in this market?
A) It falls by $600.
B) It falls by $900.
C) It falls by $1,800.
D)It falls by $2,100.
29. Refer to Figure 8-5. What happens to total surplus in this market when a tax is imposed?
A) It increases by $1,500.
B) It increases by $3,000.
C) It decreases by $1,500.
D) It decreases by $,3000.
30. Refer to Figure 8-5. The tax results in a deadweight loss that amounts to
A) $600.
B) $900.
C) $1,500.
D) $1,800.
Part II: Short Answers (70Points)
Question 1: Cournot Model (18 Points)
Suppose that the 3-D glasses industry is composed of only two firms, Toshiba and Sony. Both Toshiba
and Sony have the same total cost and demand functions:
TC = 30Q (total cost function for both Toshiba and Sony)
P = 120 – Q (demand function for both Sony and Toshiba)
Where Q = number of 3-D glasses produced.
Additionally, the production of 3D glasses by Toshiba depends on the number of glasses Sony produces
and vice-versa. The reaction functions are as follows:
qT = 45 – 0.5qs (Reaction function for Toshiba)
qS = 45 – 0.5qT (Reaction function for Sony)
Where qS = quantity of 3D glasses produced by Sony; q T = quantity of 3D glasses produced by Toshiba
(a) If Sony produces 24 3D glasses, how many glasses will Toshiba produce? What will be the price that
Toshiba will charge for its glasses? Calculate Toshiba’s profits (or losses). (5 Points)
Plug in Sony’s production into Toshiba’s reaction function:
qT = 45 – 0.5(24) = 33
If Toshiba produces 33 glasses, we can find the price by substituting Q=33 into the demand function for
Toshiba. P = 120 – (33) = $87
To find profits we use the formula profits = total revenue – total costs
Total Revenue = P x Q = $87 x 33 glasses = $2871
Total Costs = 30(33) = $990
Profits = $1881
(b) Graph the reaction functions for Toshiba and Sony on the same graph. Put the quantity of glasses
produced by Toshiba on the y-axis, and the quantity of glasses produced by Sony on the x-axis. (5 Points)
(c) Solve for the best response equilibrium. At the best response equilibrium, how many 3D glasses will
Toshiba produce? At the best response equilibrium, how many 3D glasses will Sony produce? What will
be the price that each firm will charge for their glasses? What will be the profits or loss each firm will
realize? (8 Points)
We have the two reaction functions for the two firms.
qT = 45 – 0.5qs (Reaction function for Toshiba)
qS = 45 – 0.5qT (Reaction function for Sony)
We need to solve for 1 of the firms (it does not matter which one you solve for first).
In this example, we’ll solve for Toshiba’s best response equilibrium.
Plug in qs into Toshiba’s reaction function
qT = 45 – 0.5[45 – 0.5qT]
qT = 45 – 22.5 + 0.25qT
0.75qT = 22.5
qT = 30
Toshiba’s best response equilibrium would be 30 glasses.
We can easily see that if Sony knows that Toshiba will always produce 30 glasses then they should
produce: qs = 45 – 0.5(30) = 30
Sony should also produce 30 glasses.
Both firms will charge P = 120 – 30 = $90
Profits for both firms will be
Total Revenue = P x Q = $90 x 30 = $2700
Total Costs = 30Q = 30(30) = $900
Profits = $1800
Question 2: Anti-Trust Policy: Herfindahl-Hirschman Index (9 Points)
Suppose that the airline industry contains only five firms. The table below shows the market share of
each firm in the market.
Percentage Share of Industry:
United Airlines
American Airlines
Southwest
Delta
Jet Blue
25
30
15
25
5
(a) Calculate the Herfindahl-Hirschman index for this industry. (3 Points)
HHI = 252 + 302 + 152 + 252 + 52 = 2400
(b) Suppose that Southwest and JetBlue want to merge into one combined airline called SouthBlue. Will
the Justice Department allow this merger to take place? Show your work to justify your answer. (3
Points)
After the merger the HHI will be HHI = 252 + 302 + 252 + 202 = 2550
The post-merger industry will have an HHI that is 150 greater than the HHI originally. The pre-merger
HHI was 2400 which meant the industry was already considered concentrated Recall the rule that the
Justice Department will reject any merger that increases HHI by more than 50 after a merger in a
concentrated industry. Therefore this merger will be rejected.
(c) What if Southwest wanted to merge with Delta instead of JetBlue. Will the Justice Department allow
this merger to take place? Show your work to justify your answer. (3 Points)
After the merger the HHI will be HHI = 252 + 302 + 402 + 52 = 3150
By the same reasoning above in (b) the government will strongly reject this merger.
Question 3: Taxes (21 Points)
The market for cases of Johnnie Walker Scotch Whiskey is represented by the following demand and
supply curves.
Qd = 80 - P (demand curve)
Qs = 0.5P – 10 (supply curve)
(a) Graph the demand and supply curves together in one graph. In your graph be sure to label the axes
and the curves. Clearly indicate where the demand curve crosses the axes (find the X and Y intercepts).
(4 Points) Using algebra calculate the equilibrium price and quantity in this market. (4 Points)
To find equilibrium just set QS = Qd or 0.5P – 10 = 80 – P
90 = 1.5P or P = 60. If P = 60, then Q = 20 since Q = 80 – (60) = 20
Thus the equilibrium price will be $60, the equilibrium quantity will be 20 units.
(b) Calculate the consumer surplus, producer surplus and total surplus of this market. (3 Points)
Consumer surplus is the area below the demand curve and above the price paid by consumers.
Consumer surplus = ½(20)(20) = $200
Producer surplus is the area above the supply curve and below the price received by producers
Producer surplus = ½(40)(20) = $400
Total surplus = Consumer + Producer surplus = $200 + $400 = $600
(c) A new political party called the Temperance Party takes control of the state legislature. The main goal
of the Temperance Party is to discourage alcoholic consumption. Towards that end, they passed a law
imposing a $6 tax per case consumed of Johnnie Walker’s Scotch Whiskey directly on consumers.
Calculate the new demand curve that would result from this tax. Draw this demand curve in your graph
from Part (a). (Hint: The price consumers ultimately will pay will be different from the market price of
the whiskey). (4 Points)
New Demand Curve: Price consumers pay (Pc) = P + tax
Qd = 80 – (P + 6) = 74 – P
The new quantity demanded is Qd =74 – P
(d) Using algebra, calculate the new equilibrium price and quantity after the tax has been imposed. (2
Points)
Qd =74 – P
Qs = 0.5P – 10
QS = Qd or 0.5P – 10 = 74 – P
84=1.5P
P = $56
Q = 18
(e) Calculate the consumer surplus, producer surplus, government revenue, and total surplus associated
with this tax. (4 Points)
At equilibrium price of $56, consumers will have to pay $62. $56 market price plus the tax of $6. The
consumer surplus will be the area above the price that consumers actually pay ($62) but below the
original demand curve.
Consumer Surplus (CS) = ½($80-62)(18) = $162
Producer surplus is the area below the price that firms receive ($56) but above the supply curve.
Producer Surplus (PS) = ½($36)(18) = $324
Government Revenue = tax x Quantity Sold = $6 x 18 = $108
Total Surplus with tax = Consumer surplus + Producer Surplus + tax
$162 + $324 + $108 = $594
(f) Calculate the deadweight loss to society from this tax. (4 Points)
Compare the total surplus before the tax ($600) with the total surplus after the tax ($594). Since total
surplus after the tax went to $594, the deadweight loss is $6.
Alternatively, you can measure the area of the triangle to the left of the new quantity.
DWL = $6(2)(1/2) = $6
Question 4: Game Theory (14 Points)
The United States is considering imposing trade sanctions on China. The imposition of trade sanctions by
the United States would likely trigger a retaliatory measure by China who would impose its own trade
sanctions on the United States. The potential economic consequences of trade sanctions are outlined
below:

If the United States imposes trade sanctions and China does not impose trade sanctions then the
U.S. trade balance will be $140 billion, while China’s trade balance will be $5 billion.

If the United States imposes trade sanctions and China also imposes trade sanctions, then the U.S.
trade balance will be $65 billion, while China’s trade balance will be $75 billion.

If the United States does not impose trade sanctions but China imposes trade sanctions then the
U.S. trade balance will be $35 billion, while China’s trade balance will be $285 billion.

If the United States and China both decide not to impose trade sanctions, then the U.S. trade
balance will be $130 billion, while China’s trade balance will be $275 billion.
(a) Represent the above situation above in a payoff-game matrix. (5 Points)
(b) Does the United States have a dominant strategy? Explain (3 Points)
What should the US do if they think that China would impose sanctions? If the US put their own
sanctions then they would get $65 billion, while if they did not put sanctions they would only get $35
billion. Thus imposing sanctions would be their best strategy. What should they do if they thought that
China would not impose sanctions? If the US imposed sanctions they would get $140 billion while if they
did not impose sanctions they would only get $130billion. Thus imposing sanctions is their best strategy.
The United States dominant strategy is to impose trade sanctions.
(c) Does China have a dominant strategy? Explain (3 Points)
Follow the same reasoning as in part (b). If China thought the U.S. would impose sanctions their best
response would be to impose trade sanctions. If China thought the U.S. would not impose trade
sanctions their best response would also be to impose trade sanctions. Thus China’s best strategy would
be to impose trade sanctions regardless of what the United States chooses to do.
China has a dominant strategy to impose trade sanctions.
(d) Find the Nash Equilibrium of this situation. (3 Points)
Nash equilibrium is the likely outcome that would result if both players play their best strategy given
what the other player is going to do. We know that both U.S. and China will impose trade sanctions since
that is their best strategy, thus the Nash Equilibrium is that the U.S. and China will impose trade
sanctions.
Question 5: Graphical Analysis of Monopolistically Competitive Market (8 Points)
The firm below sells its output in a monopolistically competitive market.
(a) Show the firm's profit-maximizing level of output and price. Is the firm earning a profit or a loss?
Show your answer on the graph. (3 Points)
(b) What will happen in the long run to this monopolistically competitive firm? Explain in words and
show graphically in the figure above. (5 Points)
In the long run since there is no barriers to entry, new firms will enter the industry to take advantage of
the above normal profits. Although, the new firms will not make the exact same product, they will
produce goods that are very similar to this particular firm. Some of the existing firm’s customers will
switch to the new good, and thus the demand curve (and hence marginal revenue curve) will shift to the
left. This will continue until profits are eliminated. The graphing portion of the question is eliminated,
but your graph should have shown new demand and marginal revenue curves that are to the left of the
originals.