Efficiency, exchange, and equity

Chapter 7: Efficiency, exchange, and equity

1. In a perfectly competitive market there is a donut shop that sells 1,200 donuts daily. Each donut sells for the market price of $0.75 and they sell out every day. Assume that this company has labor costs of $275 and materials costs of $400.

1. At what price would this donut shop shutdown in the short run?
2. Using only variable costs, what is the donut shop’s daily profit?

The owner is thinking of adding a second location downtown. The capital investment required is $4,000. The normal rate of return is 5%.

1. If the new shop could operate under the same conditions as the original location is it a good business decision to expand?
2. What would be the new shop’s daily profit?

2. Explain the concept of economic rent and how it is different than economic profit.

3. The government of Islandia imports heating oil at a price of $2 per gallon, but makes it available to citizens at a price of $1 per gallon. If the demand curve is given by P = 6-Q, where Q is in millions of gallons, How much economic surplus is lost as a result of the government policy?

4. Price controls are often put in place because the market equilibrium may not fairly distribute goods and services. Using the concepts of efficiency, equality, and dead weight loss, explain when price controls are good/bad for society.

Chapter 8: Imperfect Competition

1. TotsPoses Inc., a profit-maximizing business, is the only photography business in town that specializes in portraits of small children. George, who owns and runs TotsPoses, expects to encounter an average of eight customers per day, each with a reservation price (shown in the following table). Assume George has no fixed costs, and his cost of producing each portrait is $12.
2. How much should George charge if he must charge a single price to all customer? At this price, how many portraits will George produce each day? What will be his economic profit?
3. How much consumer surplus is generated each day at this price?
4. If George is very experienced and knows the reservation prices of each customer, how many portraits will he produce each day and how much economic profit will he earn?
5. Assume George charges only 2 different prices. He know that customers with reservation prices above $30, will never use coupons and the customers with reservation prices below will always use coupons. What price should George charge for portraits and what discount should he offer on the coupon?
6. What is the socially efficient number of portraits?

2. Consider the market for coffee in Claremont.

QD =  105 – 4P

QS = 75 + 2P

1. What is the Marginal Revenue function in this market?
2. If there was only one coffee firm in this market, solve for the monopoly equilibrium price and quantity.
3. Draw a graph showing this market, including Supply, Demand and MR.
4. What is the deadweight loss if this market operates as a monopoly?

3. Serena is a single-price, profit-maximizing monopolist who sells her own patented perfume (shown in the graph below).
   1. What is the equilibrium price and quantity under monopoly conditions?
   2. If instead Serena had to operate like a competitive firm, what would be the equilibrium price and quantity?
   3. What is the deadweight loss and total loss to consumer surplus when Serena operates as a monopoly?
   4. How much surplus would Serena have if she could act as a perfectly price-discriminating monopolist?

4. Explain where market power comes from and how high prices can go when there is limited or no competition.

5. Explain the features of the 4 market structures we have covered so far (#of buyers/sellers, market power, etc.).

Chapter 9: Game Theory

1. Consider the following game, called matching pennies, which you are playing with a friend. Each of you has a penny hidden in your hand, facing either heads up or tails up. You know which way the penny is facing in your own hand. On the count of three, you simultaneously show your pennies to each other. If the face-up side of your coin matches your friends, you get to keep both pennies. If they do not match, your friend gets to keep both.
   1. Who are the players in this game? What are each player’s strategies?
   2. Construct a payoff matrix for this game.
   3. Does either player have a dominant strategy? Explain
   4. Is there a Nash equilibrium? Explain.

2. Consider the following game where two players have to decide if they want to buy a movie ticket or a baseball ticket. They have the highest payoffs when they both buy tickets to the same activity, but must decide simultaneously what to buy without knowing what the other person will do.
   1. Does either player have a dominant strategy?
   2. How many equilibria does this game have?
   3. Is this an example of a prisoner’s dilemma? Explain.
   4. What will be the outcome if your friend buys their ticket first and you can observe their choice?

3. Describe credible threats and cheap talk. Explain the advantage that credibly communicating with another player might give you and if/how it could change the outcome of the game.

4. Suppose Proctor & Gamble (PG) and Johnson & Johnson (JNJ) are simultaneously considering new advertising campaigns. Each firm may choose a high, medium or low level of advertising.

1. What are each firm’s best responses to its rival’s strategies?
2. Does either firm have a dominant strategy?
3. What is the Nash equilibrium in this game?