**Econ 460 Final Exam Questions **

**Length of Answers:** Please keep your answers brief but compete (preferably no more than 1 page for each of the 6 questions). Write your answers on a Word file.

- Assume these four-firm concentration ratios (CR4) and advertising-to-sales ratios (A/S) for the following industries. Both ratios are measured in percent for the country as a whole.

**Industry**** ****CR****4**** **** A/S**

Brewing 90 10.0

Construction Machinery 81 0.2

Autos 80 2.5

Cement 34 0.5

- Define the Dorfman-Steiner condition and use it to provide a likely reason why A/S is high in brewing and low in construction machinery.
- The Dorfman-Steiner condition implies that market power (and, therefore, concentration) influences A/S. How could causality go the other way – advertising affects concentration?
- Section 2 of the Sherman Act (1890) makes an unregulated monopoly illegal.
- The original Sherman Act was designed to address issues of static inefficiency that are associated with market power. How might dynamic considerations overturn this viewpoint?
- Define the Lerner index of monopoly power. Why would the Lerner index provide an inaccurate measure of market power in a dynamic setting?
- Assume that an unregulated, profit-maximizing monopolist uses linear pricing and faces the following demand and cost conditions.

Inverse Market Demand: p=16-Q,

Firm Total Cost: TC=4q,

where p is price and q is firm output (which is the same as industry output, Q). (Note that marginal cost is 4 and marginal revenue at the industry level is: MR=16-2Q.)

- Calculate the numerical value of the allocatively efficient level of output (
*Q**EFF*). - Calculate the numerical value of the monopolist’s profit maximizing price (
*p**) and quantity (*q**). - At
*p**and*q**, calculate the numerical values of:

- i) consumer surplus (CSA),
- ii) producer surplus (PSA),

Econ 460 Final Exam Questions

iii) deadweight loss associated with the monopoly outcome (DWLA)

- Assume that an unregulated, profit-maximizing monopolist perfectly price discriminates (i.e., non-linear pricing) and faces the following demand and cost conditions.

Inverse Market Demand: p=16-Q,

Firm Total Cost: TC=4q.

- Calculate the numerical value of the lowest price that the monopolist will charge, pB.
- Calculate the numerical value of total quantity of output that will be produced and consumed in the market, QB.
- At this outcome, calculate the numerical values of:

- i) consumer surplus (CSB),
- ii) producer surplus (PSB),

iii) the deadweight loss (DWLB).

Econ 460 Final Exam Questions

- Assume that a profit-maximizing monopolist faces the following demand and cost conditions.

Inverse Market Demand: p=16-Q,

Firm Total Cost: TC=4q.

In this case, the government decides to regulate the firm, using the following two-part rule:

- The government sets a price ceiling of p (i.e., the firm cannot charge a price above the ceiling price). Assume that p must be a counting number (i.e., 1, 2, 3, 4,… 16).
- The firm is allowed to perfectly price discriminate at prices at or below p.

- Identify a value of p that leads to an increase in both CS and PS (compared to CSA and PSA) and leads to less DWL (compared to DWLA).
- Verify your answer by calculating the numerical value of:

- consumer surplus (CSC),
- producer surplus (PSC).
- Calculate the numerical value of the deadweight loss associated with this monopoly outcome (DWLC).

Econ 460 Final Exam Questions

**Note – question 6 is difficult. Don’t panic if you cannot answer every part of the question. It is simply designed to challenge you; it’s the type of question you might see in graduate school. **

- Assume a market with two firms (1 and 2) that compete in output (
*q**1*and*q**2*). The demand and cost conditions are:

Inverse Market Demand: p=a-Q,

Firm *i*’s Total Cost: TCi=cqi,

where *a* > 0 and *c* = 0 for simplicity. Firm profit equations are:

1=aq1-q12-q1q2,

2=aq2-q22-q2q1.

The first-order condition of profit maximization for each firm is:

1q1=a-2q1-q2=0,

2q2=a-2q2-q1=0.

- Calculate each firm’s best-reply function (solve for q2 in both cases), q2BR1 and q2BR2.
- Calculate the Nash equilibrium values of output for each firm, q1* and q2*.
- Now assume that the owner of firm 1 is overconfident – the owner overestimates the demand parameter by ϵ>0. That is, the owner incorrectly believes that its demand parameter is a+ϵ (instead of a). (Note that firm 2 is aware of this overconfidence.)

- i) Calculate firm 1’s new best-reply function.
- ii) Is it possible that firm 1’s overconfidence actually increases firm 1’s profit? (At this point, you might assume that parameter
*a*takes a specific value, such as 100.)

iii) How would firm 2’s profit be affected by firm 1’s overconfidence? (Again, you might assume that parameter *a* takes a specific value, 100.)

- iv) How can you explain this result?

Econ 460 Final Exam Questions