BUSS1040 Final Exam practice 1
EXAMPLE FINAL EXAM QUESTIONS – short answer section
B1 - (14 MARKS)
Jeff has a vineyard in the Tamar Valley in Tasmania where he produces premium
quality wine. He sells the wine online, mainly to consumers in Tasmania and NSW
who have the following demand curves:
TqpTasmania 2160 −=
NqpNSW −= 80
Jeff’s marginal (and average) cost of producing premium quality wine is equal to 10.
Assume that there can be no resale of wine by purchasers and that Jeff can determine
the location of the buyer, Tasmania or NSW, based on where the wine is to be sent.
a) If Jeff engages in third degree price discrimination, at what price does he sell wine
to buyers in Tasmania and NSW? How much does he sell in each market and what
are his total profits? Indicate the market equilibrium in a clear and well-labeled
diagram. [4 marks]
b) If Jeff must act as a single price monopolist at what price does he sell his wine to
consumers? What are his profits? Who gains and who loses compared to the
outcome in (a)? Show the outcome in a well-labeled diagram [4 marks]
[if you need to work with decimal numbers, please work with 2 digits behind the
decimal point only]
c) Consider the whole market (consisting of Tasmania and NSW). If Jeff was able to
engage in perfect price discrimination, how much wine would he sell and what
would be his profit? Explain in a few words what this means and at what price he
would be selling his wine. Is this a desirable market outcome from an efficiency
point of view? Why or why not? [3 marks]
d) Jeff realizes that there is large demand across both states for a low-quality table
wine, with low alcohol content. For simplicity, assume he can produce table wine
at a marginal (and average) cost of $0. There seem to be two different types of
consumers in the market, but Jeff cannot distinguish between them.
qpaddictswinetable −= 50
qpsliwinetable 2140ker −=
Jeff is considering making the following offers. He offers both “packages” and
consumers can choose which one they prefer:
• 50 units of table wine at a price of $1250
• 60 units of table wine at a price of $1350
What profits will Jeff make from selling these offers of table wine? What type of
pricing behaviour is this called? Using this type of pricing, could Jeff do better
and increase his profits? If so, give an example. [3 marks]
BUSS1040 Final Exam practice 2
Answers:
a) Profit-max in both markets separately: MC=MR.
MRt=60-qt, MC=10 thus qt=50, Pt=35
MRn=80-2qn, MC=10 thus qn=35, Pn=45.
Total Profit = (50*35) + (35*45) – 10*(50 + 35) = 2475
b) Single price monopolist:
• Total market demand (horizontal sum, but with a kink in the demand curve):
Q = 200 – 3p for p≤60
Q = 80 – p for 60[Note: Q = qt + qn = 200 – 3p, or p = 200/3 – Q/3 is not the complete
demand curve.]
• Profit-max: MC=MR: MR = 200/3 – 2/3 * Q and MC=10, thus Qm = 85, pm
= 115/3 = 38.33.
• Well-labeled figure with D, MR and MC, Qm where MC=MR and resulting
Pm.
• Monopolist sells same total quantity, but sells less to consumers in Tasmania
(they lose bc they pay higher price and consume less), while NSW consumers
buy more (they benefit from a lower price). Monopolist has a lower profits
since he cannot price discriminate anymore: profit = 85 * 38.33 – 85*10 =
2408.05 (or if rounding: 85*38 – 85*10 = 2380).
c) Perfect price discrimination: Each unit sells for a different price: P = MB to
consumer = Marg WTP of consumer. Hence MR curve = D-curve and Jeff sells
up to p = MC.
• From part b) we know: whole market demand Q = 200 – 3p, or p = 200/3 –
Q/3
• Jeff sells until (MR=MC) 200/3 – Q/3 = 10, thus Q=170. Total profit = ½ *
(60-10)*170 + (60-10)*20 + ½ * (80-60)*20 = 5450. [Total profit = ½ *
(200/3 – 10) * 170 = 4816.66 if students did not get the kinked D-curve]
• Each unit is sold at a different price (between 80 and 10 with the kinked D-
curve).
• Efficient market outcome: market produces efficient quantity (all units for
which MB > MC). Consumer surplus = 0, all surplus goes to producer in
terms of profits.
d) 2nd degree price discrimination or menu pricing.
Addicts: (i) WTP(50 units) = ½ * 50*50 = 1250, (ii) WTP(60 units) = 1250
Likers: (i) WTP(50) = ½ * (40-15)*50 + 15*50 = 1375. (ii) WTP(60 units) = ½
*(40-10)*60 + (10*60) = 900 + 600 = 1500. Note: WTP(80 units)=1600.
Who buys what?
If 50 @ $1250, then Addicts purchase (surplus=0), Likers could purchase
(surplus=125).
If also 60 @ 1350 offered, then Likers buy this (surplus=150), Addicts not
interested.
ð Outcome: Addicts: 50 units, Likers: 60 units.
BUSS1040 Final Exam practice 3
ð Profits = 1250 + 1350 – 0 = 2600
A possible alternative yielding higher profits would be (for example) to offer 50
units at $1250 and 80 units at $1450 (likers have surplus=150).
B2 - (11 MARKS)
Whooping cough is on the rise: the number of recorded sufferers has increased noticeably
in the past few years. Whooping cough is a serious and highly contagious respiratory
infection. It causes some suffering for adults and teenagers, but it is particularly
dangerous for infants. The latter group is affected more seriously and it may be fatal in
extreme cases. Immunisation is the best way to prevent the disease and the spreading of
it. However, very few individuals actually get a vaccination.
Suppose demand for vaccination against whooping cough is Q = 200-2p and supply can
be represented as p = 22+Q/4. Suppose the external benefit to society of immunisation is
B = 21.
a) What is the market equilibrium without any government intervention? Compute it and
draw it in a well-labelled diagram. Note: draw a large and clear figure since you will need
to add to it in parts (b) and (c) of this question. [2 marks]
b) What is the socially optimal outcome in this market and the resulting deadweight loss?
Compute and clearly indicate both of these in the diagram from part (a). Explain briefly
why there is a DWL. [3 marks]
c) Suppose the government decides to provide a subsidy per vaccination, and pays the
subsidy to sellers. What is the optimal subsidy per vaccination? Explain why and clearly
show your answer in the diagram from part (a). [If it gets too messy, please draw a new
diagram] [3 marks]
d) In case study 4.2. (How can we unjam traffic jams?) and 4.3 (Why would we want to
trade pollution?) there was a discussion about different ways to address externalities.
Discuss alternative mechanisms to address positive and negative externalities [3 marks].
Answer: See correct figure at end of the question
a) Marginal private benefit (MPB): p=100-Q/2. Marginal private cost (MPC):
p=22+Q/4, or Q=4p-88. Market equilibrium where MPB=MPC, thus at p=48,
Q=104
+ market equil in well-labeled figure: see below
b) Social optimum?
Marginal social benefit (MSB)=MPB+external benefit: p=100-Q/2 +21 = 121-
Q/2 (or Q = 242 – 2p). Thus social optimum at Q=132, p=55.
Add MSB and social optimum in figure: see below.
DWL at market equilibrium without intervention: MSB(at Q=104)=69, thus DWL
= ½ * (69 – 48) * (132-104) =294. Indicate DWL in figure: see below.
BUSS1040 Final Exam practice 4
DWL because consumers do not take into account the external benefit of them
getting a vaccination (it helps protect other people too), thus underconsumption.
c) Optimal subsidy? By definition, the optimal subsidy = MEB at social optimum
(constant in this case - easy) = 21.
Result: MPC’ = MPC – subsidy = 22 + Q/4 – 21 = 1 + Q/4. Resulting
equilibrium at MPC’=MPB: Q=132, p=55.
Add MPC-subs curve and social optimum in figure, see below (though MPC-subs
should have intercept=1 on vertical axis!)
This subsidy shifts down the supply curve, thus external benefit is internalized
(though on seller side and the market reaches the socially optimal outcome.
d) Negative externalities: (1) Pigovian or corrective taxes (e.g. congestion tax),
production quotas (or regulation of car travel, car traffic). These correct the
output market towards the socially optimal output; while (2) emissions taxes (e.g.
carbon tax) or cap and trade programs/tradeable pollution permits directly
address the negative externality itself. It is left to the market to determine the
price of pollution (permits) and reduce pollution in the most efficient way.
MPB
100
22
200 Quantity
MPC
DWL
External
benefit =
subs = 21
104 132
MSB
48
55
121
69
242
MPC
+subs
BUSS1040 Final Exam practice 5
Positive externalities: (Pigovian) subsidies, below-cost provision by government
(e.g. education), or patents/copyright
B.3 – (10 marks)
(a) Suppose the aggregate expenditures (AE) curve is given by the equation
AE = 56.25 + G + MPC (Y – tY – T), where G is government spending, MPC is the
marginal propensity to consume, t is the proportional tax rate, T is lump-sum taxes,
and Y is real income (GDP).
i. Suppose G = 475, T = 300, MPC = 0.75, and t = 0.25. Draw the AE curve on
a graph with AE on the y-axis and Y on the x-axis. Draw a 45 degree line and
indicate the intercept and slope of the AE curve. [1 mark]
ii. Solve for the equilibrium level of output. Show this on the graph. [1 mark]
iii. Calculate the budget deficit? (Hint: what is G – T – tY ?) [1 mark]
iv. Now suppose the government increases spending to G = 635 and lump-sum
taxes to T = 420. Show the new AE curve on the diagram and solve for the
new equilibrium level of output. [1 mark]
v. Calculate the new budget deficit and compare your answer to (iii). Explain
what happened as clearly as possible. [2 marks]
(b) The Reserve Bank lowered the cash rate by 4.25 percentage points between August
2008 and April 2009 to support the Australian economy during the Global Financial
Crisis. What effect would the reduction in interest rates have on consumption, business
investment, the exchange rate and net exports? Explain why. [4 marks]
Answer
(a)
i. Intercept is 306.25 and slope is 0.5625 = 9/16
ii. Output = 700
iii. Deficit = 0.
iv. AE curve shifts up: intercept 376.25, same slope ; Y = 860 .
v. Deficit = 0 ; A fraction (1-MPC) of disposable income is saved so a $1
increase in T and $1 increase is G raises autonomous expenditures.
BUSS1040 Final Exam practice 6
Equilibrium output rises as a result, raising proportional taxes
collected. Thus, G can increase by more than the increase in T and
keep the budget balanced.
(b)
a. Raises consumption ; decreases the return to saving .
b. Increases business investment ; reduces required rate of return .
c. Lowers exchange rate ; reduces return on Australian financial assets
relative to overseas financial assets .
d. Increases net exports ; makes Australian products relatively cheaper in
foreign currency terms, increasing demand .