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ECO101H1 Lecture Notes - Lecture 8: Marginal Cost, Opportunity Cost, Reservation Price

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erinlocust928
19 Aug 2016
School
UTSG
Department
Economics
Course
ECO101H1
Professor
Jessica Burley

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ECO101H1 Full Course Notes
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ECO101H1 Full Course Notes
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Document Summary

Lecture 08: price effect: if price increases, there will be an increase of revenue equal to (p1-p0) x q1, quantity effect: as fewer units are purchased, there will be a decline in revenue equal to p0 x (q1-q0) Linear demand function: qd = a bp: slope = -b, at midway point on demand curve, q = a/2, p = a/2b, before midpoint, elasticity is greater than 1; after midpoint, elasticity is less than 1. Elasticity depends on the same factors that affect the demand function more generally (preferences, other prices, budgets) Elasticity tends to be higher when it"s easier to make substitutions in response to a price increase: availability of substitutes, whether a good is a luxury or necessity. Elasticity is higher for luxuries: share of the good in the budget. Higher for goods that are a larger share of the budget: time horizon of the response. Higher elasticity in the long run than the short run.

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Related Questions

A. A competitive firm

  1. can consider only its location in setting the price.
  2. must base its competitive price on product differentiation.
  3. has the ability to set its own price.
  4. must accept the price determined by the intersection of the market supply and demand curves.
  5. has no supply curve.

B. If a firm is making an economic profit, then

  1. the factors of production are being paid their opportunity costs.
  2. there will be no change in the number of firms if the industry is perfectly competitive.
  3. the factors of production are being paid less than their opportunity costs.
  4. the factors of production are being paid more than their opportunity costs.
  5. the firm will exit the industry

C. Along a downward-sloping monopoly demand curve,

  1. marginal revenue is greater than price.
  2. the elasticity of demand is constant.
  3. marginal revenue decreases when the price decreases.
  4. marginal revenue is equal to zero when the price is equal to zero

D. If, in the short run, a perfectly competitive firm is producing at a point where the total cost is greater than total revenue, then the firm should

  1. shut down because economic profits are negative.
  2. continue to produce as long as P > AVC.
  3. continue to produce because accounting profits are positive.
  4. set a higher price for its output.
  5. set a lower price for its output

E. For a perfectly competitive firm, the demand curve is

  1. the marginal revenue curve.
  2. perfectly inelastic.
  3. always equal to marginal cost.
  4. the same as the market demand curve

F. A firm in a(n) industry will have the most elastic demand curve

  1. monopolistic
  2. oligopolistic
  3. monopolistically competitive
  4. perfectly competitive

G. If the demand curve of a monopolist is in the inelastic range, then

  1. total revenue will fall if the price increases.
  2. total revenue will be unchanged if the price increases.
  3. total revenue will rise if the price increases.
  4. the total supply will increase by an equal amount if demand increases.
  5. the price will be unchanged if total revenue increases

H. Monopolistic competition and oligopoly are examples of

  1. monopoly.
  2. perfect competition.
  3. theories of consumer behavior.
  4. imperfect competition.
  5. the extreme cases on the market structure continuum

I. Under which market structure do firms face the flattest (most elastic) demand curve?

  1. perfect competition
  2. monopolistic competition
  3. oligopoly
  4. monopoly

J. At the point of long-run equilibrium for a perfectly competitive firm,

  1. economic profits are zero.
  2. TR > TC.
  3. TR < TC.
  4. P = AVC.
  5. normal profits are zero.

1. Using supply-and-demand diagrams, show the effect of the following events on the market for sweatshirts.

(a) A hurricane in South Carolina damages the cotton crop.

(b) The price of leather jackets falls.

(c) All colleges require morning exercise inappropriate attire

(d) New knitting machines are invented.

 

2. (a) What is the definition of quantity demanded?

(b) What is the definition of quantity supplied?

(c) List the 5 factors that cause the demand curve to shift to the left or the right.

(d) Choose one of the factors from part (b) and consider the market for bananas. On a well-labeled diagram, demonstrate what will occur in this market if there is a change in this factor.

(e) List the 4 factors that cause the supply curve to shift to the left or the right.

(f) Choose one of the factors from part (e) and consider the market for scooters. On a well-labeled diagram, demonstrate what will occur in this market if there is a change in this factor.

(g) Choose one factor from part (b) and another from part (e) and consider the market for minivans. On a well-labeled diagram, demonstrate what will occur in this market given the change in both factors. (Hint: Draw separate diagrams for parts (d), (f), & (g))

3. Suppose that the price of basketball tickets at your college is determined by market forces. Currently, the demand and supply schedules are as follows:

page1image3877024

(a) Draw the demand and the supply curves. What is unusual about this supply curve? Why might this be true?

(b) What are the equilibrium price and quantity of tickets?

(c) Your college plans to increase total enrollment next year by 5,000 students. The additional students will have the following demand schedule:

page1image3870304

Now add the old demand schedule and the demand schedule for the new students to calculate the new demand schedule for the entire college. What will be the new equilibrium price and quantity?

 

 

4. Market research has revealed the following information about the market for chocolate bars: The demand schedule can be represented by the equation QD = 1600 − 300P, where QD is the quantity demanded and P is the price. The supply schedule can be represented by the equation QS = 1400 + 700P, where QS is the quantity supplied.

(a) Sketch a graph representing the market for chocolate bars. Identify the equilibrium point on your graph.

(b) Calculate the equilibrium price and quantity in the market for chocolate bars.

 

5. For each of the following pairs of goods, which good would you expect to have more elastic demand and why?

(a) Required textbooks or mystery novels

(b) Beethoven recordings or classical music recordings in general

(c) Subway rides during the next six months or subway rides during the next five years

(d) Root beer or water

(e) Insulin or Tylenol

(f) Food or bananas

 

6.Consider the following information from the market for lemonade:

Price Quantity Demanded Quantity Supplied
$1 500 cups 150 cups
$2 200 cups 310 cups

(a)  As the price changes from $1 to $2, what is the value of price elasticity of demand?

(b)  As the price changes from $1 to $2, what is the value of price elasticity of supply?

(c)  Sketch a diagram demonstrating the market for lemonade. Are the supply and demand curves relatively inelastic or elastic? Explain.

(d)  Suppose that when the price of lemonade increases from $1 to $2, the quantity demanded of orange juice increases from 150 cups to 190 cups. Calculate cross-price elasticity of demand for orange juice.

(e)  Are orange juice and lemonade substitute or complementary goods? Explain.

 

7. Suppose that business travelers and vacationers have the following demand for airline tickets from New York to Boston:

page2image1834528

(a)  As the price of tickets rises from $200 to $250, what is the price elasticity of demand for (i) business travelers and (ii) vacationers? (Use the midpoint method in your calculations)

(b)  Why might vacationers have a different elasticity from business travelers?

 

8. Suppose the price elasticity of demand for heating oil is 0.2 in the short run and 0.7 in the long run.

(a)  If the price of heating oil rises from $1.80 to $2.20 per gallon, what happens to the quantity of heating oil demand in the short run? In the long run? (Use the midpoint method in your calculations)

(b)  Why might this elasticity depend on the time horizon?


9. The Government has decided that the free-market price of cheese is too low.

(a) Suppose the government imposes a binding price floor in the cheese market. Draw a supply-and-demand diagram to show the effect of this policy on the price of cheese and the quantity of cheese sold. Is there a shortage or surplus of cheese?

(b) Farmers complain that the price foor has reduced their total revenue. Is this possible? Explain

(c) In response to farmer's complaints, the government agrees to purchase all the surplus cheese at the price floor. Compared to the basic price floor, who benefits from this new policy? Who loses?

Suppose that there are two firms competing in the market for taxi services. Big Ben Taxis has the marginal cost MCB = $9 per trip, and the fixed cost FCB = $3,000,000. While Whitehall Taxis has the marginal cost MCW = $15 per trip, and the fixed cost FCW = $1,000,000. Inverse demand for taxi trips in the market is given by the function, P = 75 − Q/10,000 . In this equation, P is the price of a taxi trip, and Q is the total quantity of taxi trips supplied by the two taxi companies.

Question 1: Find the equilibrium price and quantities for the case in which the two taxi companies engage in Cournot (quantity) competition. What profits will Big Ben Taxis and Whitehall Taxis earn. (11 Marks)

Question 2: Using your answers to question 1, determine which firm has the greater market power. (4 Marks)

Question 3: Now suppose that a firm can only supply taxi services if it purchases a licence from the government. What is the highest fee that the government can charge for a license, if the government wants both Big Ben Taxis and Whitehall Taxis to purchase a license? (Note: A licence does not place a limit on the number of taxi trips a company can supply. You should assume that both firms are charged the same fee.) (2 Marks)

Question 4: If, instead, the government wants to maximise the revenue it receives from taxi license fees, how many licenses should it sell, and what fee should it charge? (8 Marks)

Q1 and Q2 answered, can anyone help with Q3 and Q4?

Q1

)P = 75 - (Q / 10,000) = 75 - [(QB + QW) / 10,000] (

QB, QW: Quantity of Big Ben & Whitehall respectively)

Total revenue, Big Ben, TRB = P x QB = 75QB - [(QB2 + QW.QB) / 10,000]

Marginal revenue, Big Ben, MRB = dTRB / dQB = 75 - [(2QB + QW) / 10,000]

Equating MRB with MCB, 75 - [(2QB + QW) / 10,000] = 9 750,000 - 2QB - QW = 90,000 2QB + QW = 660,000 .......(1) [Reaction function of Big Ben]

Total revenue, Whitewall, TRW = P x QW = 75QW - [(QW.QB + QW2) / 10,000]

Marginal revenue, Whitehall, MRW = dTRW / dQW = 75 - [(QB + 2QW) / 10,000]

Equating with MCW, 75 - [(QB + 2QW) / 10,000] = 15 750,000 - QB - 2QW = 150,000 QB + 2QW = 600,000 .....(2) [Reaction function of Whitehall]

Cournot equilibrium is obtained by solving (1) and (2).

2QB + QW = 660,000 .......(1) (2) x 2 results: 2QB + 4QW = 1,200,000 ...(3)

(3) - (1) yields:

3QW = 540,000 QW = 180,000 QB = 600,000 - 2QW = 600,000 - (2 x 180,000) = 600,000 - 360,000 = 240,000

Q = QW + QB = 180,000 + 240,000 = 420,000 P = 75 - (420,000 / 10,000) = 75 - 42 = 33

Profit = Total revenue - Total cost = (P x Q) - [FC + (MC x Q)] = Q x (P - MC) - FC [FC: Fixed cost]

Profit, Big Ben = [240,000 x (33 - 9)] - 3,000,000 = (240,000 x 24) - 3,000,000 = 5,760,000 - 3,000,000 = 2,760,000

Profit, Whitehall = [180,000 x (33 - 15) - 1,000,000 = (180,000 x 18) - 1,000,000 = 3,240,000 - 1,000,000 = 2,240,000 (3)

The fixed fee charged by government is equal to consumer surplus (CS) for each company, where CS is the area between demand curve and market price.

From demand curve, When Q = 0, P = 75 [Reservation price] For Big Ben, CS = (1/2) x $(75 - 33) x 240,000 = (1/2) x $42 x 240,000 = $5,040,000

This is the maximum license fee for Big Ben. For Whitehall, CS= (1/2) x $(75 - 33) x 180,000 = (1/2) x $42 x 180,000 = $3,780,000

This is the maximum license fee for Whitehall. (4) Revenue is maximized when marginal revenue is zero.

Marginal revenue, Big Ben, MRB = dTRB / dQB = 75 - [(2QB + QW) / 10,000] So, 75 - [(2QB + QW) / 10,000] = 0 750,000 - 2QB - QW = 0 2QB + QW = 750,000 ......(4)

Marginal revenue, Whitehall, MRW = dTRW / dQW = 75 - [(QB + 2QW) / 10,000] So, 75 - [(QB + 2QW) / 10,000] = 0 750,000 - QB - 2QW = 0 QB + 2QW = 750,000 ....(5) Multiplying (5) by 2, 2QB + 4QW = 1,500,000 ......(6) 2QB + QW = 750,000 ...... (4) (6) - (4) gives: 3QW = 750,000 QW = 250,000 QB = 750,000 - (2 x 250,000) = 750,000 - 500,000 = 250,000 Q = QB + QW = 250,000 + 250,000 = 500,000 P = 75 - (500,000 / 10,000) = 75 - 50 = $25