New Managerial Economics Midterm Practice MATH & ESSAY PORTION

The market price in a perfectly competitive industry is $24. Firm A has a marginal cost given by MC = 2Q. What is the marginal revenue of Firm A if it sells 20 units?

A. 20

B. 12

C. 24

D. 40

24

On a competitive market, consumers demand 112 units and producers supply 5 units at a price of 5. When price increases to 10, consumers demand 62 units and producers supply 45 units. By how much did the market shortage decrease because of this price increase?

90

When the price of widgets is 9, the quantity demanded of widgets is 37 and the quantity supplied of widgets is 67. What is the surplus on this market?

30

At the current price, there is a shortage of 52 units on the market and consumers demand 93 units. What is the quantity supplied by producers?

41

The market demand is given by the following function: P = 200 - Q. The market supply is given by the following function: P = 50 + 2Q. Calculate the shortage that occurs on the market if the market price is 50. Round your answer to 2 decimal places, if needed.

150.00

The market demand is given by the following function: P = 561 - 4Q. The market supply is given by the following function: P = 68 + 2Q. Calculate the equilibrium quantity. Round your answer to 2 decimal places, if needed.

82.17

A perfectly competitive firm with total cost function TC = 200 + 20Q + Q² and marginal cost function MC = 20 + 2Q is competing on a market where the market price is $89. What is the firm's profit if it chooses to produce optimally?

990.25

A monopolist with total cost function TC = 382 + 20Q and marginal cost MC = 20 is faced with consumers described by the demand function P = 201 - 2Q. What is the profit this monopolist will earn if it chooses its quantity and price optimally?

3713.13

A perfectly competitive firm with total cost function TC = 200 + 20Q + Q² and marginal cost function MC = 20 + 2Q is competing on a market where the market price is $87. What is the firm's profit if it chooses to produce optimally?

922.25

A monopolist with total cost function TC = 425 + 20Q and marginal cost MC = 20 is faced with consumers described by the demand function P = 235 - 2Q. What is the profit this monopolist will earn if it chooses its quantity and price optimally?

5353.13

When the price of widgets is 11, the quantity demanded of widgets is 283, and the quantity supplied of widgets is 101, what is the shortage on this market?

182

The market demand is given by the following function: P=554-4Q. The market supply is given by the following function: P=79+2Q. Calculate the equilibrium quantity. Round your answer to two decimals, if needed.

79.17

A monopolist with constant marginal cost of $21 produces 100 units of product that sells for a price of $49. If this monopolist was behaving competitively, it would produce 150 units of product. What is the revenue of this firm if it was to behave competitive?

3,150.00

A monopolist with total cost function TC = 445 + 20Q and a marginal cost MC = 20 is faced with consumers described by the demand function: P=228 - 2Q. What is the profit this monopolist will earn if it chooses its quantity and price optimally? Round your answer to two decimals, if needed.

4,963.00

Economists view competition as a generally good thing that usually leads to efficiency. In a few short sentences, can you provide and example of a situation when competition usually leads to bad outcomes for society?

Competition can sometimes lead to bad outcomes, especially when goods have positive externalities. For example, education may be underprovided because private schools focus only on their own benefits, such as tuition revenue whereas students focus more on personal learning, and do not consider the broader benefits to society; like a more skilled workforce and higher productivity.

In a few short sentences, provide an example of a good or service that is non-rival but excludable. Explain why do economist think that such goods are provided inefficiently by the market.

An example of this would be a gym membership. One person using this gym membership wouldn’t prevent anyone else from using. Only those who pay for the membership would be able to use it. Economists would argue that its being provided inefficiently because it limits the benefit it could have onto society as a whole. It is only limited to those willing to pay for it.

HIS ANSWER:
A movie (see the example above). The same movie can be enjoyed by many people (non-rival), but people who don't pay the ticket get excluded. This is basically a monopoly power problem (formally we call these club goods or artificially scarce goods). The movie theater finds it optimal to charge high prices and as a result you have half-empty theaters. From a socially optimal perspective, the marginal cost of letting in one more customer in the theater is close to zero. Especially when you have empty seats. Yet some people are not participating in these transactions because the price charged is too high. it is good for the theater but not good for consumers and for the market overall. Price discrimination, as explained in the earlier question, actually improves efficiency by doing just that: allowing new transactions to take place - new customers coming to see the movie. Of course this does not solve the problem completely, but it does improve it.

Imagine the following situation:

There are 30 of you in the class and each of you if given a seed-money endowment to start with. Suppose each of you is given $100. Then, you are each asked to decide how much would you like to contribute to a common investment fund. You can contribute any amount you wish: you can contribute nothing. The full $100, or anything in between. Whatever we collect in the investment fund is invested. At the end of the semester, after earning a great return (say it doubles), the money gets distributed equally to all of you.

Questions:
1. If you were faced with such a situation, how much would you contribute to the fund?
2. What economic problem does this scenario exemplify? Explain carefully the economic dynamics at play.

This feels similar to a common situation where tip money earned from waiters are collected into a pool to then get distributed at the end of the working week. Personally, I would prefer to keep my tip myself, especially if I could earn more money with my skills alone. Economically, this scenario exemplifies the free rider problem. The pooled tips, like the class investment fund, are shared equally regardless of contribution, so some individuals could contribute less or nothing while still benefiting from the higher contributions of others.

HIS ANSWER:
You shouldn't contribute anything. From each dollar you personally contribute, you get back 2/30 dollars so your individual ROI is negative. That being said, you do earn a positive ROI from whatever OTHER people contribute. So optimally, you should not contribute anything and simply free-ride. This is the public goods problem. People have incentives to free-ride, but when they do that, there will be no or very little public good. Socially speaking, everyone should contribute their full amount and earn 2x on the entire sum, but due to the individual free-riding incentives I just mentioned, if everyone is rational, we won't have any investment to double. By the way, if this question was on the actual exam, the only thing I would really grade is the second question. I wouldn't want to penalize anyone for choosing to contribute more than zero. That in itself is not proof of not understanding economics, as some people may understand very well the economics at play but still choose to contribute because they are not driven solely by their own benefits but they may also care about the social good. So an answer that says "I want to contribute all 100 dollars, but I clearly see this is the free-riding/public goods problem" would still earn full credit.

A specialty coffee roaster has a production capacity of 50 lbs. of coffee per day, but at the current price of $17 per lb., it only sells 45 lbs. per day. The two owners of the shop are having a conversation about pricing. One of them argues they should lower the price in order to increase sales and take advantage of their full capacity, while the other one disagrees and proposes experimenting with a price increase. Who is right? Explain your reasoning. Or more generally, explain what should be the correct approach for a business like this? You might not be able to say 100% that one guy is wrong and the other is right, because there is a lot of relevant information that is not given to you. But think generally - what should be the goal and how to get there.

Be careful with this one. I'm not asking what would be the best for the market here. I'm asking what is the best for the business. So think like a business owner who understands economics, not like an public economist.

The goal of any business should be to maximize profits, not sales. Sometimes it is better to sell LESS at a HIGHER PRICE than selling MORE at a LOWER PRICE. So experimenting with a price increase is not a bad idea, even though that might mean you are not fully producing at capacity. But that is OK as long as your profits get higher.

Agricultural cooperatives are groups of individual farms that work together to meet certain common goals such as procuring seeds, fertilizers, and services such as distribution and marketing. While many of the activities that agricultural cooperatives engage in can increase market efficiency, sometimes agricultural cooperatives can engage in anti-competitive behavior. A couple of examples of agricultural cooperatives accused of behaving in an anti-competitive way are the United Potato Growers of America (in the US) and the Federation of Quebec Maple Syrup Producers (in Canada).

Explain in a few short sentences one or two ways in which an agricultural cooperative can behave anti-competitively and how that results in market inefficiencies.

A cooperative might decide it is in their best collective interests to destroy a portion of their production to create scarcity and artificially inflate the price. They might also flex their market share against producers that choose not to join the coop. For instance, they might threaten distributors not to do business with individual producers, but only with the coop. Essentially, the cooperative can act like a monopolist and restrict free-trading opportunities, which creates economic inefficiencies. You can also link this to the idea of cartels, which are firms that come together to essentially behave like a monopolist instead of competing aggressively with each other.

The profit maximizing price for a movie theater is $13 per ticket. The manager of the movie theater decides one day to offer discounted tickets for students at a price of $8 per ticket and notices that profits increased when offering these discounted tickets. How does this strategy of offering discounted tickets affect market efficiency? Explain your reasoning.

This is a common practice that is called price discrimination (we'll talk about it in detail later in the semester). Price discrimination actually increases market efficiency because it allows trades that would otherwise not occur to occur. The key issue here is think how this affects both the consumer surplus and the producer surplus. The fact that profits increase when the discounted tickets are offered means the movie theater had excess capacity (empty seats that cost nothing to be filled) while some students were finding the full price of 13 too high. So the movie theater brings in new paying customers to fill empty seats (thus earning more profits). At the same time, the students who were not willing to pay 13 initially but are now willing to pay 8 also gain some benefit from these trades so it's a win-win in a sense. Both the consumer and the producer surplus increase so the market overall gains.

Economists view competition as a generally good thing that usually leads to efficiency. In a few short sentences, can you provide an example of a situation when competition actually leads to bad outcomes for society?

The tragedy of the commons (common resources) is a typical example of a situation where competition is detrimental to society and cooperation does better. 

Define and explain in a few short sentences the concept of positive externalities and their effects on market functioning.

Positive externalities are benefits enjoyed by 3rd parties that do not take part in a market transaction or activity. For instance, when a contributor to the public good (as seen in Q1) creates benefits to everyone else. That is why everyone else has incentives to free ride on these benefits. The effect on markets is that free markets underprovide these goods or services associated with positive externalities. Individual decision makers only take into account their own private costs and benefits when they make their decisions, when the overall social benefit is actually much larger.

Define and explain in a few short sentences the concept of negative externalities and their effects on market functioning.

Negative externalities are costs imposed on 3rd parties that do not take part in the decision-making process. The effect on markets is that the private cost (that is taken into account by the decision-maker) is much smaller than the social cost, so the decision maker overproduces/overconsumes the product or service associated with these negative externalities. Say I'm a smoker and my private cost of smoking is $5 per day. As long as my benefit from smoking is say $10 per day, I keep smoking. But maybe my smoking also imposes a cost on my family and friends that is $20 per day. Socially speaking, I should stop smoking. But because I only take into account my own private costs and benefits I don't. Markets with negative externalities over-produce and/or overconsume compared to the socially desirable outcome.

MIDTERM QUESTION


For the toll road question, the key economic aspect to identify here was that markets are efficient when prices truly reflect demand and supply conditions. That was a central point of the market functioning and market misfunctioning units. So that is the economic idea that should have driven your thinking. Since supply is more or less fixed in this instance, the way to think is how to make prices better reflect the demand conditions? Obviously flat prices are not very efficient unless you think that demand is also more or less fixed, which is not. So generally, you had to think about changing the pricing structure in such a way as to better reflect demand factors. The most obvious ways (and also the most common answers received from you) was to implement a consumption-based pricing such as charging by mile or by exit so that those with a higher demand for the road pay more and/or to implement a time-of-day congestion-based pricing where again prices are raised during periods of high demand and lowered during periods of low demand. This is similar to what I tried explaining in the Uber case-study when I talked about surge pricing.

MIDTERM QUESTION


the trickiest one and the one that the least amount of you got right, was the one about price-gouging. Some of you correctly identified that the Daraprim case is a situation that does indeed require regulation, but very few of you correctly explained why that is so. Most explanations were based on the fact that the drug is a necessity, and it saved lives, but economic arguments don't care about that. It doesn't matter if we are talking about a life saving drug or the next WB blockbuster...economic inefficiencies exist because we are clearly dealing with a monopoly (which was one of the 4 main types of market failures presented in the notes). Although it wasn't specifically stated in the case that Turing was the only license holder, the fact they raised the price so fast and so high should have made all of you understand that the only way they could have done that (other than trying to bankrupt themselves on purpose) was because they had monopoly power as the only license holder. Without monopoly power, such a large increase in price would obviously lead to them losing all their buyers so they would have never done that without monopoly power. Some of you realized that this indeed a market structure issue,  but tried to argue this does not require price regulation, but some form of competition regulation instead. While that idea could be, in principle, applied to other monopolies, this is not really feasible in this area because pharmaceutical products are government created monopolies through the patents they are granted for the development of these drugs. So the government can't award patents and create these monopolies and at the same time increase competition. So the only available tool remaining in these situations is price regulation.

MIDTERM QUESTION


Moving over to the other case, where most of you failed was that you let your human nature also take lead in judging the Harvey situation. Most of you picked again on the idea of necessity or even on morality issues, when the question said nothing of morality. I'm with you on that. I know it's humanly unthinkable to see people trying to take advantage of the situation, but to properly judge economics you need to think with a clear mind. Selling cases of water in downtown Houston is as close to perfect competition as it gets. Anyone who has some water to spare can load it up in their truck and drive downtown to sell it. There are no entry barriers. Morally speaking, it might be preferable that people donated it rather than selling it, but from a market functioning perspective there's absolutely nothing wrong with prices going nuts as long as that is due to demand and supply factors and as long as there is free entry on those markets. So actually, according to basic market functioning, we should not have laws restricting price gouging during natural disasters because these laws are actually doing more harm than good.

Think about it this way: if I sit on my couch watching football and eating chips during Harvey and I hoarded water from HEB the week before, there's nothing to incentivize me to give that away. But if I see on TV that people are selling if for $100 a case, I might actually move my behind off my couch and bring some water to where it is needed, thus curing the shortage on the market. And if enough people do that, prices will quickly come back down. Also, if HEB was to raise their prices the week before, maybe I wouldn't have hoarded that much water and I would've only purchased what I truly needed. So actually, allowing prices to climb (sometimes to what seems like exorbitant levels) has a clear role in the well-functioning of markets. People only tend to think about that from a humanitarian side, but fail to realize that prices and profits have an additional role in the market place: to direct resources where they are needed and to make people economize when a resource is scarce. The problem during natural disasters is the shortages created, not the affordability issues.  You can afford water just fine, but you will still die of thirst if there's no water for you to buy. Supply chains get interrupted by disasters and this is the main reason for the shortages to occur and for prices to rise (supply shifts left)/ And to cure the shortages fast, you need to let prices rise. That will incentivize consumers to economize and will incentivize producers to send more resources there. Again, this is very similar to the issue discussed in the Uber case study with the surge pricing. I truly appreciate when you guys start realizing these similarities because that truly means you are learning...not just to mechanically solve for a market equilibrium or something like that, but truly learn how to see big patterns of reasoning which can be very powerful. I would encourage all of you to go through the material a bit more carefully, and not just to superficially study but get at the deeper thoughts that economics has to offer. Try to see how ideas link with each other and how the different cases presented in the notes link with some of the questions that come up on exams. There is purposeful thought behind everything that I incorporate into the course.

Now of course the irony of this whole case is the fact that we do have anti-price gouging laws during natural disasters for markets that are pretty competitive, while we do not have anti price-gouging laws for monopolies. So this might be another reason that led many of you astray: to confuse the laws we have with the laws we should have. According to economics, market interventions should not occur on competitive markets, but definitely in monopoly situations. I would truly congratulate the few of you who got this question right, because that truly shows you got the gist of the whole idea behind the "virtues and limitations of the free market system". Please keep in mind that the "need" or "necessity" itself does not mean anything in terms of market efficiency. Just because something is truly needed, does not automatically mean we should have governments get in and control that market. Do not fall into that trap. If these markets function well and are competitive, regulation can do more harm than good and then it is especially bad if these are truly necessities. And by the same token, even if something is a luxury, when monopolies control markets, those markets are still inefficient and could benefit from some regulation. Some of you, for instance, claimed that Daraprim is not a necessity or that simply because insurance companies pay for the drug and that the final consumer doesn't get to bear the entire burden of the price, then we do not need intervention. But that actually makes the problem even worse because it gives the monopolist extra market power by artificially lowering demand elasticity.

On a competitive market, consumers demand139 units and producers supply 13 units at a price of 5. When price increases to 10, consumers demand 76 units and producers supply 48 units. By how much did the market shortage decrease because of this price increase?

98

When the price of widgets is 65, the quantity demanded of widgets is 7, and the quantity supplied of widgets is 64. What is the surplus on this market?

57

At the current price, there is a shortage of 52 units on the market and consumers demand 81 units. What is the quantity supplied by producers?

29

The market demand is given by the following function: P=200 - Q. The market supply is given by the following function: P = 50 + 2Q. Calculate the shortage that occurs on the market If the market price is 76. Round your answer to two decimals, if needed.

111.00

The market demand is given by the following function: P - 559 - 2Q. The market supply is given by the following function: P = 70 + 2Q. Calculate the equilibrium quantity. Round your answer to two decimals, if needed.

122.25

A perfectly competitive firm with total cost function TC = 200 + Q² and marginal cost function MC = 20 + 2Q, is competing on a market where the market price is $62. What is the firm’s profit, if it chooses to produce optimally? Round your answer to two decimals, if needed.

241.00

A monopolist with total cost function TC = 367 + 20Q and marginal cost MC = 20 is faced with consumers described by the demand function P = 238 - 2Q. What is the profit this monopolist will earn if it chooses its quantity and price optimally? Round your answer to two decimals, if needed.

5573.50