Microeconomics Exam
Q1) NOTE: THIS QUESTION NO LONGER APPLIES TO CLASS. PLEASE IGNORE. DeBeers introduced the "A Diamond is Forever" slogan to keep people from selling their old jewelry (and Grandma's too). Suppose this campaign had the desired effect.
a) Draw a "stock" diagram showing the market before and after the campaign. What happens to prices?
b) Draw a "flow" diagram showing the market before and after the campaign. What happens to prices?
Q2) Under current US law, organs (lungs, kidneys, livers, etc.) may not be sold. They must be given for free. We will evaluate changes in this law and the price of those changes. Suppose that under current law, demand for kidneys is 10,000 per year and supply is 8,000 per year.
a) What is the current cost of kidney transplants in the US?
b) Continuing with the assumptions from (a), suppose that insurers, Medicaid and Medicare (government insurers) are required to pay for kidney transplants regardless of the expense, so that demand for kidneys is completely inelastic. Also suppose that supply is upward sloping, so that as the price for a kidney increases, more people are willing to donate kidneys either while living or after death.
Now assume that kidneys are allowed to be bought and sold, and assume that all kidneys are sold at the same price. Draw a supply and demand graph for the kidney market, labeling quantities, intercepts and prices with the information you have. Try to make the graph as clean and accurate as possible. Shade the area that represents the cost to insurers, Medicaid and Medicare of purchasing kidneys. How does this cost depend on the elasticity of kidney supply?
As the supply of kidneys becomes more elastic, the expense to insurers and the government (circle one): INCREASES or DECREASES.
c) Suppose the government undertook a program advertising that organs donated at death would be sold at market rates, with the revenue from the sale going to the estate of the deceased (for example, to pay for the funeral). Re-draw the graph from (b) with both the old supply and new supply curve. Please be as accurate as possible.
d) Motorcycle accidents are a large source of donated organs. Suppose the government passes a law requiring people to wear helmets while riding a motorcycle. How will this affect the expense to insurers and the government from the organ market? How does this depend on the elasticity of supply of organs?
After the new law is passed, the expense to insurers and the government from the organ market (circle one): INCREASES or DECREASES
This effect is (circle one): LARGER or SMALLER when supply is more elastic.
e) Is the financial return on the government's advertising campaign described in (b) higher or lower after the law described in (d) is passed?
The return on the government's advertising campaign is (circle one): HIGHER or LOWER after the law requiring motorcyclists to wear helmets is passed.
Q3) Suppose annual demand for L-Star brand lycra shorts is D(p) = 1,000,000 × (40 - p) and the annual cost for L-Star of making these shorts is TC(q) = FC + 10q + q2/1,000,000, where FC is fixed cost.
a) What price should L-Star charge for shorts? How many will it sell?
b) What is the maximum value of annual fixed costs such that L-Star is still earning a positive profit at the price you found in (a)?
c) Suppose L-Star can lease a different production facility that reduces its marginal cost by $10. Suppose that leasing the new facility costs $85,000,000 per year more than the current facility. Should L-Star lease this facility?
Q4) Delta Airlines is deciding how to price seats on its flights from RDU to Atlanta. Suppose there are business customers, who are willing to pay up to $600 for a first class seat and $300 for a coach seat, and there are household customers, who are willing to pay $400 for a first class seat and $200 for a coach seat. Suppose that Delta cannot directly observe the difference between the two groups, and that for any given flight there are 70 potential household customers and 40 potential business customers.
a) Suppose that an airplane holds 100 seats (coach and first class seats take up the same amount of space) and that the marginal cost of selling a seat is $0. What is the optimal price to charge for coach and first class seats? If Delta would prefer not to sell one or the other type of seat, write NA for the optimal price. How many coach and first class seats should a plane contain? Assume that if both business customers and households want to purchase the same seat, the business customers will get the seat. That is, if you wish to sell 50 coach seats and demand from business customers is 40 and demand from households is 40, then 40 business customers and 10 households will purchase the seats.
b) Now suppose a plane can hold up to 110 coach seats, but that a first class seat is twice the size of a coach seat. For example, adding 10 first class seats to the airplane would require removing 20 coach seats. What is the optimal price to charge for coach and first class seats? If Delta would prefer not to sell one or the other type of seat, write NA for the optimal price. How many coach and first class seats should a plane contain?
c) What is the opportunity cost of a first class seat given the prices you found in (b)?
Q5) For each question, circle the correct answer.
a) Suppose only 15 oranges are for sale at the supermarket and they are sold in an auction to the highest bidder. Buyers will tend to overpay for the oranges. TRUE or FALSE
b) Membership fee pricing is more profitable when customers are more homogenous: TRUE or FALSE
c) The optimal price when charging membership fees is typically equal to marginal cost. TRUE or FALSE
d) When markets are more competitive, a smaller fraction of industry-wide cost increases are passed through to consumers in the form of higher prices. TRUE or FALSE
e) Suppose farmers can freely use groundwater to irrigate crops. We should expect groundwater to be depleted over time. TRUE or FALSE
f) It is always possible to increase profit via indirect price discrimination. Simply offer products of varying quality and charge more for higher quality products. TRUE or FALSE
g) If policymakers desire to increase the use of low emission technologies to generate power, it is usually better to tax production methods with high emissions than subsidize production methods with low emissions. TRUE or FALSE
h) When selling a product in multiple markets, demand in one market should never affect the firm's price in the other market. TRUE or FALSE
i) When a CEO sets up a "Profit & Loss" statement for divisions of the firm she manages, she only gets an accurate picture of the performance of each division if she allocates fixed costs to each division in proportion to each division's contribution to revenue. TRUE or FALSE