MAE201 Competition and Industry Past Exam Paper

Answer all the questions below.

Question 1

A consumer spends their income between two goods, movies and music. Assume that they have well-behaved preferences in that their indifference curves are strictly convex.

Consider the figure below where the black line represents the consumers initial budget constraint and the red line represents the consumers new budget constraint following a change in the prices and/or income.

Scenario A: If the seventh digit of your Deakin student ID number is even (that is, it is either 0, 2, 4, 6 or 8), then assume that the consumer has a relatively strong preference for movies and that the price per unit of movies has gone up at the red budget line relative to the black one.

Scenario B: If the seventh digit of your Deakin student ID number is odd (that is, it is either 1, 3, 5, 7 or 9), then assume that the consumer has a relatively strong preference for music and that price per unit of movies is lower at the red budget line relative to the black one.

Based on this information, answer the following questions:

(i)

Write down the seventh digit of your Deakin student ID number. Which scenario applies to you? Based on this, answer the parts below.

(ii)

Based on your scenario, provide an example of a direction of change in the price per unit of music and/or the consumers income which can logically contribute to the budget line shifting from the black line to the red line and explain your answer. [NOTE: We are not expecting numerical values of new prices or income level but rather an example of a pattern of change(s) that can be logically consistent with the shift in the budget line from the black position to the red position as shown in the diagram.]

(iii)

Will the shift from the black budget line to the red budget line always trigger a substitution effect? Will such a shift always trigger an income effect? Explain your answer. [Note: You do not need to draw a diagram for this part.]

(iv)

Reproduce the diagram in the question on a white paper or electronically in a neat manner and make sure to keep the crossing point between the red and black budget lines near the centre of the black line as shown above.

Having reproduced the diagram, do further work on it to show how a consumers optimal bundle may change in light of the shift in the budget line from the black to the red position when both income and substitution effects are at play.

In doing so, make sure to touch upon the following:

• Show a hypothetical initial optimal bundle on the black budget line that is consistent with the scenario you are examining and briefly explain its

• Show how the substitution effect will impact the consumers choice and briefly explain your work.

• By making necessary assumptions and stating them clearly, show how the income effect will impact the consumers Briefly explain your work.

• Show and mention a hypothetical location of the new optimal bundle which is consistent with your work above.

[Make sure to scan and insert your diagram for part (iv) alongside your typed explanations in the answer sheet word document prior to submitting your work].

Question 2

This question has two versions. You need to attempt only ONE version depending on the value of the third digit of your Deakin student ID number.

If the third digit of your Deakin student ID number is even (that is, it is either 0, 2, 4, 6 or 8), then attempt Version A.

If the third digit of your Deakin student ID number is odd (that is, it is either 1, 3, 5, 7 or 9), then attempt Version B.

Version A

Suppose that:

A firms long run production function involves two inputs, labour (L) and capital (K) which are perfect substitutes of each other. You are informed that an input bundle involving only 25 units of capital and no labour is able to produce an output of 200 units. You are also told that an input bundle involving only 50 units of labour and no capital is able to produce 500 units of output. Based on this, answer the following questions:

(i)

Work out the firms production function given the information above and show your working.

(ii)

Suppose you are told that labour is twice as expensive as capital to hire and labour is kept on the horizontal axis while capital is kept on the vertical axis. What will be the absolute gradient of the isocost family? Using the production function in part (i), determine the absolute gradient of an isoquant.

Version B

Suppose that a firms production function involves two inputs, labour (L) and capital

(K) which are perfect substitutes of each other. You are informed that an input bundle involving only 60 units of labour and no capital can produce an output of 180 units. You are also told that an input bundle involving only 20 units of capital and no labour can produce 40 units of output. Based on this, answer the following questions:

(i)

Work out the firms production function given the information above and show your working.

(ii)

Suppose you are told that labour is half as expensive as capital to hire and labour is kept on the horizontal axis while capital is kept on the vertical axis. What will be the absolute gradient of the isocost family? Using the production function in part (i), determine the absolute gradient of an isoquant.

Question 3

Suppose that you have the following data on a perfectly competitive firm which is currently producing an output level of 100:

Assume also that AC, AVC and MC curves are U shaped.

The market price that the firm faces is given by the following formula:

Market price = 1 + third digit of your Deakin student ID + seventh digit of your Deakin student ID

Based on the above information, answer the following questions. (i)

What is the third digit of your Deakin student ID number? What is the seventh digit of your Deakin student ID number? Using these, calculate the market price the firm is facing.

(ii)

Based on your calculated market price, determine the best course of action for the firm if it wants to maximise profit and explain your answer.

[1 + 4 = 5 marks

Question 4

Suppose that a single price monopolists inverse demand curve is P = 350 Q.

If the seventh digit of your Deakin student ID number is even (that is, it is either 0, 2, 4, 6 or 8), then Scenario A applies so that the monopolists marginal cost curve is MC = 50 + 2Q.

If the seventh digit of your Deakin student ID number is odd (that is, it is either 1, 3, 5, 7 or 9), then Scenario B applies so that the monopolists marginal cost curve is MC = 40 + 3Q.

Based on the above information, answer the following questions: (i)

What is the seventh digit of your Deakin student ID number and therefore which of the above scenarios apply to you? Based on this scenario, answer all the parts below.

(ii)

Diagrammatically represent the monopolists demand, MR, and MC curves. Note: YOU MUST MAKE USE OF THE EQUATIONS WHEN DRAWING YOUR DIAGRAM AND APPROPRIATELY MARK THE LENGHTS OF RELEVANT INTERCEPTS.

(iii)

Calculate the monopolists profit maximising price and quantity, and show them on your diagram for part (ii). Show your workings. Given the information in the question, what assumption will you have to make to be able to calculate the monopolists profit at this price and quantity? Under that assumption, show (on your diagram for part (ii)) and also calculate the profit the firm would make. Show your workings.

(iv)

Calculate the deadweight loss at the monopolists profit maximising price and quantity and show it on your diagram for part (ii). Show your working.

(v)

Suppose that the government decides to impose a price ceiling of $240 to regulate the monopolist. Show this price ceiling on your diagram from part (ii). Show and calculate the monopolists chosen quantity after the imposition of the price ceiling and explain your answer. Will this price ceiling eliminate deadweight loss? Explain your answer.

Question 5

Two firms, Firm 1 and Firm 2 are considering whether to enter a market and if so, whether to charge a high price ($15) or a low price ($5).

Hence each firm needs to choose from the following three strategies:

Not enter (N), Enter and charge a high price (E H), or Enter and charge a low price (E L)

A firm incurs some fixed cost for entering the market which is as follows:

If the third digit of your Deakin student ID number is even (that is, it is either 0, 2, 4, 6 or 8) then Scenario A applies so that the cost of entry is $30 for Firm 1 and $50 for Firm 2.

If the third digit of your Deakin student ID number is odd (that is, it is either 1, 3, 5, 7 or 9), then Scenario B applies so that the cost of entry is $200 for Firm 1 and $210 for Firm 2.

In addition to the above fixed cost, the average variable cost per unit of output sold is $3.

The quantity of output each firm is able to sell is as per the following table.

(i)

What is the third digit of your Deakin student ID number? Which scenario applies to you? Use this scenario to answer all the parts below.

(ii)

Using the information about quantity sold and firms costs, present the normal-form representation of the game via a payoff matrix assuming each firm cares only about the profit it makes. Show the working behind your payoff calculations for a sample pair of strategies (i.e. a strategy profile).

(iii)

For each firm determine if a dominant strategy exists and if there are any dominated strategies. Explain your answer.

(iv)

Identify all Nash equilibria of the above game, show your working and comment if the market is a natural monopoly.

END OF EXAMINATION