Question #1 RussCo manufactures pesticides that can be sold directly to retail outlets or to a wholesale firm for further processing

and eventual sale as a completely different product. The demand function for each of these markets is: Retail Outlets: Wholesale Company: P1 = 55-2Q1 P2=40-Q2

What are the prices charged and what are the quantities sold in the respective markets. Phillipss total cost function for the manufacture of this product is TC=10+8(Q 1+Q2) A. Determine RussCo's total profit function? (4 points) B. What are the profit-maximizing price and output levels for the product in the two markets? (4 Points) C. At these levels of output, calculate the marginal revenue in each market? (4 points) D. What are RussCos total profits if the firm is effectively able to charge different prices in the two markets? (4 points) E. Calculate the profit-maximizing level of price and output if RussCo is required to charge the same price per unit in each market. What are RussCos profits under this condition? (4 points)

Sol a) Retail Outlets: Wholesale Company: P1 = 55-2Q1 P2=40-Q2

Profit = Total Revenue( TR) Total Cost (TC)

TR= P*Q Hence , TR = P1Q1+P2Q2 = (55-2Q1)*Q1 + (40-Q2)*Q2 = -2Q12 Q22 + 55 Q1 +40Q2 TOTAL REVENUE (TR) = -2Q12 Q22 + 55 Q1 +40Q2 TOTAL COST (TC) = 10 + 8(Q1+Q2)

PROFIT = TR- TC = -2Q12 Q22 + 55 Q1 +40Q2 [ 10 + 8(Q1+Q2) ] PROFIT FUNCTION= -2Q12 Q22+ 47Q1+32Q2-10

b) Retail Outlets: Profit maximum when: d (profit) = 0 dQ1 (i.e. differentiation of profit wrt to quantity is 0, then we get maxima)

d (-2Q12 Q22+ 47Q1+32Q2-10)= 0 dQ1 -4Q1+47=0 => Q1=11.75 unit

Profit-maximizing price , put Q1=11.75 in P1 = 55-2Q1 P1=31.5

Profit maximizing Price = $ 31.5 Output is 11.75 units

Wholesale market Profit maximum when: d (profit) = 0 dQ2 (i.e. differentiation of profit wrt to quantity is 0, then we get maxima)

d (-2Q12 Q22+ 47Q1+32Q2-10)= 0 dQ1 -2Q2+32=0 => Q2=16 unit

Profit-maximizing price , put Q2=16 in P2=40-Q2 P2=24

Profit maximizing Price = $ 24 Output is 16 units

c) Marginal Revenue(MR) MR = d (TR) dQ TR= P1Q1+P2Q2 MR = d (P1Q1+P2Q2) = P1 dQ1 (Retail Outlets)

Hence , Marginal revenue at 11.75 units is P 1=$31.5 = MR

MR = d (TR) = P2 dQ2

(Wholesale market)

MR = d (P1Q1+P2Q2) = P2 dQ2 Hence , Marginal revenue at 16 units is P 2=$24 = MR

d) PROFIT FUNCTION= -2Q12 Q22+ 47Q1+32Q2-10 When we charged differently in both the markets Total Profit = -2Q12 Q22+ 47Q1+32Q2-10 ( put values of Q 1,Q2)

= - 2 (11.75)2 162 + 47*11.75 + 32*16 10 = $522.125

Total Profit of the firm = $522.125

e) Profit-maximizing level of price and output when Price are same i.e. P 1=P2=P TR= P1Q1+P2Q2= P(Q1+Q2) TC= 10 + 8(Q1+Q2) PROFIT = P(Q1+Q2) - 10 - 8(Q1+Q2) PROFIT = (P-8)(Q1+Q2) 10

For maximizing profit, differentiation of Profit wrt Q1 = 0 For maximizing profit = d [(P-8) (Q1+Q2) 10] = P-8 =0 (Retail Outlets) dQ1 P=$ 8

For maximizing profit, differentiation of Profit wrt Q 2 = 0 For maximizing profit = d [(P-8) (Q1+Q2) 10] = P-8 =0 (Wholesale Market) dQ2 P=$ 8 Retail Outlets: 8 = 55-2Q1=> Q1=23.5 8 =40-Q2=> Q2=32

Wholesale Company:

PROFIT

= (P-8)(Q1+Q2) 10 = (8-8) (23.5+32)- 10 = -10

(-) minus sign indicates that there is loss RussCos Profit = -10; the firm is better off shutting down. Its a LOSS

Question #2 Kashian Airlines has determined that the price elasticity of demand for two customer segments (Coach and Business Class) is -1.35 and -2.50. Based on their expectations of profitability, Kashian realizes the price of a Coach seat should be $175 (one way). How much should Kashian charge for a Business Class ticket.? (20 Points) Sol Price Elasticity of Demand means percentage change in quantity demanded due to percentage change in price of the product (holding constant all the other determinants of demand, such as income).

Ed=% Change in quantity demanded/% Change in price=(Q 2-Q1)/Q1/(P2-P1)/P1= P1 - Price before change P2 - Price after change Q1 - Quantity before change Q2 - Quantity after change Ed- Price elasticity of demand The above formula usually yields a negative value, due to the inverse nature of the relationship between price and quantity demanded, as described by the "law of demand". For example, if the price increases by 5% and quantity demanded decreases by 5%, then the elasticity at the initial price and quantity = 5%/5% = 1. In the above case as the price elasticity of Coach Segment is -1.35 that means that if the price of coach fair increase by 1% then the quantity will be reduced by 1.35%. In similar case of business segment the price elasticity is -2.5 , that shows that if the price of business fair increase by 1% then the quantity will be reduced by 2.5%. So we can say that Piece elasticity ep is directly proportional to original price [ other things remain constant) [ ep1/ ep2] = Pcoach/Pbusiness 1.35/2.5 = $175/ Pbusiness Pbusiness= $ 324.07 Price of business class will be $ 324.07 charged by Kashian Airlines

Question #3 In 2000, the town of Brothers Bay in Door County Wisconsin had a more-or-less free market in boat services. Any adult citizen could provide boat services as long as the drivers and the boats satisfy certain safety standards. Suppose that the marginal cost per trip of a boat ride is constant, where MC = $5, and that each boat has a capacity of 20 trips per day. If the demand function for boat rides was Q d = 1200 20P, where demand is measured in rides per day. Assume that the industry is perfectly competitive. A. What is the competitive equilibrium price per ride?(4 points) B. What is the equilibrium number of rides per day? (2 Points) How many boats will there be in equilibrium? (2 Points) C. In this competitive market, what is the aggregate profit?(4 points) D. In 2005, the town board of Brothers Bay created a boat licensing board and issued a license to each of the existing boats. The board stated that it would continue to adjust the boat fares so that the demand for rides equals the supply of rides, but no new licenses will be issued in the future. In effect, all profit would be turned over to the township for licenses. How many licenses would be sold? (3 Points) E. In 2010, costs had not changed, but the demand curve for boat rides had become Qd = 1220 20P. What was the equilibrium price of a ride in 2010? (3 Points) F. In 2010, how much money would each current boat license owner be willing to pay to prevent any new licenses from being issued? (2 Points) Sol#a Competitive equilibrium Price per ride Qd = 1200 20P P = (1200- Qd)/20 Total Revenue = P*Q TR=60Q Q2/20 At equilibrium: MR=MC=P= d (TR) = $ 5 dQ 60- Q/10 = 5 => Q= 550 rides per day Competitive equilibrium Price per ride => 1200 20P= 550 P= $32.5

Sol # b Equilibrium rides per day = 550

Number of boats in equilibrium = 550 / 20 = 27.5 = 27 (approx).

Sol# c Aggregate profit = TR TC = Total Revenue Total Cost As MC *Q = TC (60- Q/10)*Q = 60 Q Q2 /10 Aggregate profit = Total Revenue Total Cost = (60Q Q2/20) (60 Q Q2 /10) Profit = Q2/20

PROFIT ( Q=550) = 550 2/20= $ 15125

Sol#d As the question is talking about the licenses in the equilibrium (boat fares so that the demand for rides equals the supply of rides) Profit generated = $ 15125 But this profit is given to township for licenses Hence Number of licenses sold will become = Number of boat = 27 Sol # e Demand curve for boat rides had become Q d = 1220 20P. Cost has not changed = $ 5 = MC P = (1220- Q)/20 TR=P* Q TR=61Q Q2/20 MC=61-Q/10 5=61-Q/10 Q= 560 rides per day

equilibrium Price ,

P = (1220- Q)/20 = $ 33

Sol# f No of boats now = 560/20= 28 Profit per boat now = (Q2/20)*(1/28)= $560 License owner have to pay = $ 560 Question 4 Suppose that the demand curve for apples is given by Q d = 140- 5P, where Qdis the number of pounds demanded per year and p is the price per pound. The supply of apples can be described by Qs = 40 + 3P, where Qs is the number of pounds provided. A What is the equilibrium price? (Hint: At the equilibrium, quantity demanded and quantity supplied are equal, Qd = Qs.) (2 Points) B What is the equilibrium quantity supplied and demanded? (2 Points) C Calculate the consumer surplus at the equilibrium price. (3 Points) D Calculate the producer surplus at the equilibrium price. (3 Points) E Calculate the total surplus at the equilibrium price. (4 Points) F Now suppose that the government imposes a tax of $8 per each pound sold, paid by the consumers,. Inthis case, what are the price and the consumer surplus? (6 Points) Sol#4 Equilibrium price is when Qd = Qs ( i.e. quantity demanded and quantity supplied are equal) 140- 5P= 40 + 3P P= $12.5 Equilibrium Price = $ 12.5

b) Equilibrium quantity supplied and demanded will be equal Put P= $ 12.5 in Qd = 140- 5P or Qs = 40 + 3P Qd=Qs= 40+ 3*12.5 = 77.5 unit Quantity supplied= Quantity demanded = 77.5 unit

c)& d) & e) Consumer surplus is the difference between the total amount that consumers are willing and able to pay for a good or service (indicated by the demand curve) and the total amount that they actually pay (the market price).

Producer surplus is the difference between what producers are willing and able to supply a good for and the price they actually receive. The level of producer surplus is shown by the area above the supply curve and below the market price. Total surplus = Consumer surplus + Economic surplus.

CONSUMER SURPLUS F (0, 28) <<< -------------------- PRICE

Equilibrium point Supply curve D (77.5, 12.5) Q=40+3P

E(0, 12.5)

P=$ 12.5
C(140,0) 0 (0, 0) QUANTITY----------

Sol c)
B (0,-13.33)

A(140,0)

DEMAND CURVE Q=140-5P PRODUCER SURPLUS

CONSUMER SURPLUS = * ED*EF = (77.5)(28-12.5) = $600.625

d) PRODUCER SURPLUS = * ED*EB = (77.5)(12.5+13.33) = $161.43

e) TOTAL SURPLUS = CONSUMER SURPLUS + PRODUCER SURPLUS = $(600.625+ 161.43)

TOTAL SURPLUS = $ 762.062

f) When $8 tax is added equilibrium will change Hence Price becomes = Equilibrium Price=$ 12.5 + $8 = $ 20.5=P new

We know that Qd = 140- 5P Pnew= (140-Qd)/5 =>$20.5 = (140-Qd)/5 => Qd = 37.5 pounds Consumer surplus = * (28-20.5)*37.5 = $ 159.375 Price = $ 20.5 Consumer surplus = $ 159.375

Question #5

A. Does anyone have a dominant strategy? (6 points) B. What is the Nash Equilibrium? (6 points) C. What is the socially optimal solution (at what point is total profit maximized)? (6 points) D. How would a negotiated solution lead to this socially optimal solution (technically this is called a Coase Solutionhowever, the path to this solution is straightforward)? (1 point) E. If you had to call in a mediator to negotiate this socially optimal solution, how much would they charge and why? (1 point)s Solution

a) A dominant strategy will be one which will be successful or optimal for a firm regardless of what others do, that is , no matter what strategy the rival firms adopt . Lets us illustrate this dominant strategy in this case (duopoly) in the choice of whether to advertise or not . In this case deciding in favor of advertising by a firm to promote its sales and hence profits or deciding not to advertise are the two strategies. Thus ADVERTISING and NOT ADVERTISING are the two strategies between which each firm has to make a choice. We assume that there are two firms A and B which have o make a choice between two strategies. The above diagram which is the outcome is presented in form of a payoff matrix .It should be noted that outcomes or profits made by a firm by adopting a strategy is influenced by the choice of a particular strategy by the rival firm.

It will be seen from the payoff matrix If both firms adopts ADVERTISING A PROFIT =$ 4 B PROFIT =$ 4 A advertise , B not A=$20 B=$1 B advertise , A NOT A=$1 B=$20 If both dont adopt advertising A=$10 B=$10 Since, both firms are symmetric in their corresponding strategies of advertising or not advertising and hence both have a case of not having dominant strategy with respect to each other.

b) Nash Equilibrium We have seen that sometimes both firms dont have dominant strategies still they achieve equilibrium in the adoption of strategies. The application of Nash Equilibrium is quite relevant here. In the above matrix FIRM A has no dominant strategy we reached the conclusion that the equilibrium state is reached when FIRM A adopts strategy of advertising, given that the firm B will choose the strategy of advertising, that is Firm A is making the best choice , given the choice by its rival firm B and Firm B is choosing the best strategy given the strategy of Firm A. c.] Optimal Solution is when both did not advertise and each earn a profit of $ 10 in this case , which is the best optimal solution for both the firm. d.] In law and economics, the Coase solution describes the economic efficiency of an economic allocation or outcome in the presence of externalities. The theorem states that if trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of resources , hence in this case of firm A and B , an negotiated solution will lead to socially optimal solution. e.] Intermediate will be called in and suppose he may charge 1% of $ 10 i.e. $ 1 which is our assumption to reach a optimal solution.