Final Exam Review Exercises

Final Exam Reminder:
- In class, Tuesday December 13, 11AM-12:15PM, Silver 405
- Closed book/Closed notes

- Non-graphing calculator allowed
Question 1. Firm A is the sole producer of a sport drink. A’s marginal cost
equals average cost M C = 30, and it faces market demand given by inverse
demand function P = 120 − 0.5Q.
(1) Suppose A produces quantity q = 140 units at price p = 50. Is there any
dead weight loss at current price and quantity? If yes, how much is the DWL?
(2) What is the monopoly price? What is the monopoly DWL?
Solution
(1) Yes there is DWL at current price and quantity. Perfect competitive quan-
tity is one that demand equals M C: that is 120 − 0.5Q = 30 =⇒ Qc = 180.
Current quantity is lower than the competitive quantity, so there is DWL. Cur-
rent producer surplus is (50 − 30) ∗ 140 = 2800, current consumer surplus is
140∗(120−50)
2 = 4900, so current total surplus is 2800 + 4900 = 7700. Compare to
the competitive scenario, competitive producer surplus is 0, consumer surplus
180∗(120−30)
2 = 8100. Therefore, current DWL is 8100 − 7700 = 400.
(180−140)(50−30)
Can also calculate DWL directly: 2 = 400.
(2) The monopoly quantity is Qm = 90 and the monopoly price is pm =

120 − 0.5 ∗ 90 = 75. Monopoly producer surplus is (75 − 30) ∗ 90 = 4050 and
90∗45
monopoly consumer surplus is 2 = 2025. Total surplus under monopoly is
4050 + 2025 = 6075. Therefore monopoly DWL is 8100 − 6075 = 2025.
Question 2. Assume that firm M is the manufacturer of lawn mowers, who

sells lawn mowers to retailer firm R. R then sells the lawn mowers to the public.
Suppose the marginal cost of production for the manufacturer is M CM = 15,
while for the retailer, the marginal cost of selling one lawn mower is the price
1
M charges plus an additional cost of $5 per lawn mower for its services, that
is, M CR = PM + 5. The inverse demand for lawn mowers by the public is
PR = 100 − Q, where PR is the lawn mower price charged to the public by
the retailer. Assume that, different from the class example, both M and R
are monopolists, in the upstream (manufacturing) and in the downstream (dis-
tributing), respectively.
(1) If both firms operate independently, calculate the lawn mowers produced,
price set by the two firms, and the profits of the two firms.
(2) Assume now that M and R merge into one firm. Calculate the lawn mowers
produced, price set by the new firm, and its profits.
(3) Compare the total surplus in the pre-merger case (i) vs. the post-merger
case (ii). How does this comparison differ from the example in class? Explain
the difference.
Solution
(1) First, we solve R’s profit maximization problem: since R is a monopolist in
the downstream, R equates its marginal revenue with marginal cost. That is,
MRR = 100 − 2Q = MCR = PM + 5
Rearranging terms, this gives PM = 95 − 2Q. This is the demand faced by the
upstream firm M . Hence M ’s marginal revenue is M RM = 95 − 4Q.
Now M as a monopolist in the upstream, also equates its marginal revenue with
marginal cost. That is,
MRM = 95 − 4Q = MCM = 15
This gives us Q = 20, therefore PR = 100 − Q = 80 and PM = 95 − 2 ∗ 20 = 55.

Firm M ’s profit: (PM − M CM ) ∗ Q = (55 − 15) ∗ 20 = 800.
Firm R’s profit: (PR − M CR ) ∗ Q = (80 − (55 + 5)) ∗ 20 = 400.
(2) After the vertical merger, the new firm’s marginal cost is M C = 15+5 = 20.
This new firm is a monopolist in the lawn mower market, which maximizes profit
by setting marginal revenue equal to marginal cost:
MR = 100 − 2Q = MC = 20
2
This gives us Q = 40. Therefore P = 100 − 40 = 60, and the new firm’s profit
is (P − M C) ∗ Q = (60 − 20) ∗ 40 = 1600.
(3) Pre-merger:
1
Total producer surplus: 800 + 400 = 1200. Consumer surplus: 2 ∗ 20 ∗ 20 = 200.
Total surplus: 1200 + 200 = 1400.
1
Post-merger: Producer surplus: 1600. Consumer surplus: 2 ∗ 40 ∗ 40 = 800.
Total surplus: 1600 + 800 = 2400.
So the total surplus is higher after the vertical merger. (As a matter of fact, both
producer surplus and consumer surplus are higher in the post-merger case.) This
is different from the conclusion from the class example, where there are competi-
tion in both upstream and downstream before the merger. In the class example,
vertical merger causes foreclosure, reduces the ability of the non-merged firm to
compete in downstream, and therefore reduces the degree of competition overall
and leads to bigger inefficiencies. In contrast, in this example since there were
no competition in either upstream or downstream, without the merger both the
upstream monopolist and the downstream monopolist have a price mark-up.
Hence the consumers are hurt by monopoly twice. With the vertical merger, we
reduce the double monopoly into one, and therefore helps reduce the inefficien-
cies caused by multiple monopolies. In short, the vice of vertical mergers lies in
foreclosure, but the problem of foreclosure does not exist in this special example.
Question 3.
Q
The (inverse) demand for turnips is P = 20 − 100 and the (inverse) supply of
1 Q
turnips is P = 2 + 200 . The market for turnips is assumed to be perfectly
competitive. The government imposes a $2 per unit tax on producers.
(1) What is the producer’s actual tax burden? What is the consumer’s actual
tax burden?
(2) Suppose now the $2 per unit tax is in the form of sales tax levied on con-
sumers instead. What is the producer’s actual tax burden? What is the con-
sumer’s actual tax burden?
Solution
Q 1 Q
(1) Before tax: the market equilibrium is given by 20 − 100 = 2 + 200 which
3
gives Q = 1300. Thus P = 7.
5 Q
After tax: the supply shifts up and the new supply is P = 2 + 200 . The market
Q Q 0 0
5
equilibrium is given by 20− 100 = 2 + 200 which gives Q = 3500 25
3 . Thus P = 3 .
Producer’s actual tax burden = Tax levied directly on producer + pre-tax price
25
- post-tax price = 2 + 7 − 3 = 23 .
Consumer’s actual tax burden = Tax levied directly on consumer - pre-tax price
25
+ post-tax price = 0 − 7 + 3 = 43 .
(2) Since the side of market is irrelevant in the distribution of actual tax bur-
dens, the actual tax burdens are the same as in (1).
Question 4. (Adapted from Gruber Ch.19 Q13) Massive Products, Inc., is a

monopolist whose cost of production is given by 10Q + Q2 (so its marginal cost
is given by M C = 10 + 2Q). Demand for Massive Products’ massive products
is Q = 200 − 2P .
(1) Calculate the monopolist price, profit, and consumer surplus.

(2) How will the monopolist’s price and profits change if a tax of $15 per unit
is imposed on the buyers of the product?
(3) What is the deadweight loss of the tax?
Solution
(1) First we calculate the profit-maximizing quantity by setting marginal cost
equal to marginal revenue. Marginal cost is 10 + 2Q. Marginal revenue can be
found by solving for the inverse demand curve, P = 100 − 12 Q and noting that
the marginal revenue curve has the same P-axis intercept and is twice as steeply
sloped. Hence, marginal revenue is 100 − Q. Setting M R = M C and solving
for Q,
10 + 2Q = 100 − Q ⇒ Q = 30
Therefore, the monopolist quantity is 30, and the monopolist price can be found
from the inverse demand curve: P = 100 − 12 (30) = 85. Monopolist profit
4
is computed as the difference between total revenue and total cost, namely
85 ∗ 30 − 10 ∗ 30 − (30)2 = 1350.
Consumer surplus can be computed as the area of the triangle with width Q = 30
and height 100 − 85 = 15. Consumer surplus = 12 (30)(15) = 225.
(2) Imposing a $15 per unit tax on consumers will change their inverse demand
to P = 100 − 12 Q − 15 = 85 − 12 Q. The new marginal revenue is 85 − Q. Setting
equal to marginal cost and solving gives 85 − Q = 10 + 2Q ⇒ Q = 25.
Post-tax price is thus P = 85 − 12 (25) = 72.5. Profit is (72.5)(25) − 10 ∗ 25 −
(25)2 = 937.5.
(3) We can calculate DWL as the area of the trapezoid bounded between the
demand curve and the MC curve, and between Qt and QM :
DWL = 12 [((100 − 30 25
2 ) − 10 − 2 ∗ 30) + ((100 − 2 ) − 10 − 2 ∗ 25)](30 − 25) = 106.25.
(Equivalently, after tax producer surplus is 937.5, consumer surplus is 21 (25)(85−

72.5) = 156.25. The tax revenue is 25 ∗ 15 = 375. Total surplus after tax is
156.25 + 937.5 + 375 = 1468.75.
Before tax total surplus is 225 + 1350 = 1575. Hence DWL of the tax is
1575 − 1468.75 = 106.25.)
Question 5. (Adapted from Gruber Ch.20 Q10)

The market demand for stuffed rabbit is Q = 2600 − 20P , and the supply of
stuffed rabbit is Q = 12P . The market for stuffed rabbit is perfectly competitive.
(1) The government intends to place a $4 per bunny tax on stuffed rabbit pro-
duction. Calculate the DWL of this tax.
(2) The government intends to place a $4 per bunny tax on stuffed rabbit con-
sumption. Calculate the DWL of this tax.
Solution
1 1
(1) Inverse demand is P = 130 − 20 Q and supply is P = 12 Q.
1 1
Before tax: 130 − 20 Q = 12 Q ⇒ Q = 975.
1 1
After tax: 130 − 20 Q = 12 Q + 4 ⇒ Q = 945.
1
DWL of tax is 2 ∗ 4 ∗ |945 − 975| = 60.
5
(2) Intuitively we would expect the DWL to exactly the same as in (i). To
confirm,
1 1
Before tax: 130 − 20 Q = 12 Q ⇒ Q = 975.
1 1
After tax: 130 − 20 Q − 4 = 12 Q ⇒ Q = 945.
1
DWL of tax is 2 ∗ 4 ∗ |945 − 975| = 60.

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Final Exam Reminder:

- In class, Tuesday December 13, 11AM-12:15PM, Silver 405

- Closed book/Closed notes

(2) The monopoly quantity is Qm = 90 and the monopoly price is pm =

Question 2. Assume that firm M is the manufacturer of lawn mowers, who

MRR = 100 − 2Q = MCR = PM + 5

This gives us Q = 20, therefore PR = 100 − Q = 80 and PM = 95 − 2 ∗ 20 = 55.

Question 4. (Adapted from Gruber Ch.19 Q13) Massive Products, Inc., is a

(1) Calculate the monopolist price, profit, and consumer surplus.

(Equivalently, after tax producer surplus is 937.5, consumer surplus is 21 (25)(85−

Question 5. (Adapted from Gruber Ch.20 Q10)

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