Michigan State University - EC 201 Sample Quiz #11   Ec 201                                                                                                            Spring, 2009 Michigan State University                                                                              L

Sample Quiz #11

Ec 201                                                                                                            Spring, 2009

Michigan State University                                                                              L. Martin

I.  Multiple choice

1. A group of firms seeking to coordinate their price and output decisions to maximize group profits is called an

1. oligopoly;
2. monopoly;
3. cartel;*
4. monopsony;
5. monopolistically competitive industry.

2. Natural monopolies are characterized by

1. high marginal cost and low fixed cost;
2. high fixed cost and low marginal cost;*
3. high average cost and low marginal cost;
4. low average cost and high marginal cost;
5. constant cost.

3.  Suppose that firms in an oligopoly promise to charge the monopoly price and share the market.  Furthermore, they promise to continue monopoly pricing as long as all firms do similarly.  If lower prices are observed, the firms promise to revert to aggressive price competition.  This implicit agreement is called a

            a.  prisoner’s dilemma game;

            b.  battle of the sexes game;

            c.  trigger strategy;*

            d.  natural monopoly;

            e.  barrier to entry.

4.    Public utilities, such as electric power and water are examples of

1. monopolistic competition;
2. oligopolies;
3. cartels;
4. perfect competition;
5. natural monopolies.*

5.  When firms offer to match the lowest price available,

1. consumers gain because prices are lower;
2. average price is higher because firms have less incentive to lower price;*
3. firms make losses and must exit the market;
4. barriers to entry are created;
5. firms make normal returns on invested capital.

2. Problems

1.  In Little Rapids storms often fell large trees.  One of the city’s residents has a large chipper, which could dispose of the felled trees for a marginal cost of $5 each.  The fixed cost (allowing for a normal rate of return on capital)  associated with this chipper is $2,000 and the demand is given below.

Price    Quantity          Revenues         Marginal          Total Cost       Average cost

                                                            Revenue

$25      100

$20      200

$15      300

$10      400

$5        500

$0        600

a.  Find the profit maximizing price and quantity.

Price                ___$15______  

Quantity          ____300_____ 

b.  Find the efficient price and quantity.

Price                ___$5______  

Quantity          ___500____ 

c.  Compute total and average cost and enter in the table.

d.  Find the price and quantity that would just allow the chipper firm to make a normal return.

Price                ____$10_____  

Quantity          ____400____ 

2.  (2 points) Three dentists Dr. Payne, Dr. Love and Dr. A. Gony want to collude to fix prices for treatments.  They are the only dentists in Blackwater.  The following data applies. 

Monopoly profits per firm = $100,000

Cheating profits = $250,000

Profits with aggressive price competition = $0

Discount factor = 0.8

a.  Can this oligopoly sustain a collusive agreement to charge the monopoly price?  Show the calculation and explain. 

Collusion can be sustained if the present value of the cooperative profits exceeds the current value of the cheating profits.

($100,000 - $0) x (b + b² + b³ + . . . ) > $250,000 - $100,000

$100,000 x (b/(1-b) > $150,000

Substituting b = 0.8,

$100,000 [.8/(1-.8)} = $100,000 x 4 = $400,000 > $250,000.

Yes.