2012 Microeconomics Exam FRQ #1
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Watch me answer it here
1. Steverail, the only provider of train service operating between two cities, is currently incurring economic losses.
The only provider = Monopoly
incurring losses = draw a monopoly graph showing a loss
(i) Steverail's loss-minimizing price and quantity, labeled Pm and Qm, respectively.
(ii) The area of economic losses, shaded.
(iii) The allocatively efficient quantity, labeled Qe.
Ok, I have drawn a total revenue curve on the bottom of the monopoly curve for Steverail's business.
If you know that where MR = 0 is unit elasticity then you know that the Demand curve above unit elasticity is the elastic section. In the elastic section of the demand curve, if a monopolist raises his price his revenue will decrease.
Monopoly Cheat Sheet
Answer - One point is earned for stating that the total revenue would decrease because the demand
is price elastic in that range of the demand curve where MR > 0.
(c) Assume a per-unit subsidy is provided to Steverail.
Why is the Per-Unit Subsidy considered a variable costs,,, because you only get the subsidy based on the amount you produce. If you don't produce you get nothing,,, so the amount of the subsidy you receive is variable.
Answer - One point is earned for stating that the quantity will increase because the subsidy will cause the MC curve to shift downward and intersect the MR curve at a larger quantity.
(ii) Will consumer surplus, increase, decrease, or not change?
A lower price will increase consumer surplus.
Answer - One point is earned for stating that the consumer surplus will increase.
(d) Assume instead that a lump-sum subsidy is provided to Steverail. For the short-run answer the following.
(i) Will the dead weight loss increase, decrease, or remain unchanged? Explain.
Ok,, so let me paint a picture. You are operating a coffee shop outside of your high school. On day a man stops by and gives you a $1,000 dollars (subsidy)... Does this effect what you pay your employees? Does this cause you to sell more coffee/ less coffee? No it doesn't,, your employees keep selling the same amounts of coffee as before. You now just have an extra $1,000 dollars in your pocket.
Deadweight loss is an inefficiency in that profit maximizing monopolies produce where MR = MC, and we know that at P = MC is allocative efficiency (no DWL)... So a lump-sum subsidy causes no change in quantity produced and does not effect DWL, society is no better off, but it does make you $1,000 richer.
Answer - One point is earned for stating that the deadweight loss will not change because the lumpsum
subsidy does not change the profit-maximizing quantity.
(ii) Will Steverail's economic losses, increase, decrease or not change?
A lump-sum subsidy will decrease the loss,,, money in your pocket will decrease your overall losses.
Answer - One point is earned for stating that economic losses will decrease.
