Exam 1 review
 study homework and inclass problems
 try problems at the end of each chapter and throughout the book
Chapter 1: What is IO
1. Understand market power
Chapter 2: Basic Micro Review
1. Understand the key differences between perfect competition (PC) and Monopoly (M).
That is, efficiency, price and quantity differences and short-run and long-run
consequences.
2. Understand how to calculate Profits = (q) = R(q) – C(q)
profit = total revenue (typically P*Q) – total costs
3. Understand how to find the profit maximizing quantity. Profit-maximizing firms produce
where their marginal revenue equals marginal cost. (ALL FIRMS); MC(q*) =
MR(q*)Differentiate C(q) with respect to q and set equal to derivative of R(q) with
respect to q. dC(q)/dq = dR(q)/dq
4. Understand, identify (on a graph) and be able to calculate consumer, producer and total
surplus. (TS = CS + PS, where CS = WTP – P and PS = P – MC)
Chapter 3: Market Structure and Market Power
1. Know CRN and HHI (be able to calculate or at least set up the problem). Be able to
identify which is more concentrated based on different CRN and HHI numbers.
2. Understand the measurement problems with CRN and HHI.
3.
Know how to define a market.
4. Know how to measure market power. You won’t have to derive the Lerner Index from
monopoly profit maximization. (Lerner Index  L = 1/d = (Pm – MC(Qm))
Pm
5. Be able to relate market power to HHI (LI same as above but now it is equal to HHI/d).
Understand the problems with LI (and how it may overstate/understate market power).
6. Know Price elasticity of demand. That is, be able to calculate, interpret and relate it to
market power.
Chapter 4: Technology and Costs
1. Key costs concepts Cost curves  C(q) = A + bq2 + q
A is fixed cost (cost that you pay regardless of whether you produce or not).
AVC(q) = VC/q = (bq2 + q)/q : cost that vary with quantity produced
AC(q) = C(q)/q : Average cost (which is AVC in the long-run)
MC(q) = dC(q)/dq : Marginal cost
Sunk costs.
2. Relate output and whether to produce decisions to the cost curves. That is, AC lets a firm
know whether or not to produce (relating AC to P) and MC tells a firm how much to
produce. Sunk costs tell a firm whether to enter or not in the first place.
3. Know economics of scale, diseconomies of scale, and constant returns to scale. Be able to
identify the minimum efficient scale (MES).
4. Be able to use the Scale economy index to find areas of EOS, CRS, and DES. To measure
economies of scale: S(q) = AC(q)/MC(q). Be able to find ranges for Q in which
economies of scale exist.
5. Be able to solve problems to see if economies of scope exist.
Sc 
C (q1 ,0)  C (0, q 2 )  C (q1 , q 2 )
C (q1 , q 2 )
Chapter 5: Price Discrimination – Monopoly and Linear Prices
1. Necessary conditions to PD.
2. Be able to graph and calculate a “kinked” industry demand curve (without PD). Be sure
to identify Price ‘kink’ occurs as well as quantity.
3. 3rd Degree segment the market between groups of consumers with differing demands.
Higher prices will be charged to groups with a lower price elasticity of demand. Be able
to solve numerically, identify, and know the impact on economic efficiency (CS, Profits,
as well).
4. Be able to calculate the impact of PD on total surplus (and what you use to determine it;
be able to calculate CS, PS, TS). You will need the kinked demand curve to do this.
Chapter 6: Price Discrimination – Monopoly and Nonlinear Prices
1. 1st Degree  firm extracts all of the surplus from every buyer and from every unit
purchased. First-degree price discrimination is also Pareto optimal. Be able to solve
numerically, identify, and know the impact on economic efficiency (CS, Profits, as well)
for personal prices, two-part pricing, and block pricing. NOTE: for the 2-part pricing
the outcome is to P = MC for all groups (we merely did the case in class with P > MC to
show that the firm could make more money by P = MC)
2. 2nd Degree  menu pricing. Here a firm cannot identify individual consumers, so must
construct pricing schemes, which are the same for all consumers. Since some consumers
will purchase more than others, however, average prices and marginal prices may differ
among consumers. Know the overall implications for low demanders and high
demanders in creating a “menu” or package of pricing. Make sure you understand the
incentive compatibility and participation constraints. You will not have to calculate
anything.
3. Overall understand the impact of different degrees of price discrimination on CS, Profits,
Q, and Welfare.
4. Have a good understanding of the degrees and types of price discrimination and what this
implies for efficiency.
Chapter 7: Product Differentiation
1. Know the difference between vertical and horizontal differentiation.
2. Understand why firms differentiate their products.