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Practice Free Response Questions. 1) Assume that a profit-maximizing firm in a monopolistically competitive industry is in long-run equilibrium. (a) Draw.

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Presentation on theme: "Practice Free Response Questions. 1) Assume that a profit-maximizing firm in a monopolistically competitive industry is in long-run equilibrium. (a) Draw."— Presentation transcript:

1 Practice Free Response Questions

2 1) Assume that a profit-maximizing firm in a monopolistically competitive industry is in long-run equilibrium. (a) Draw a correctly labeled graph that shows the profit-maximizing firm’s price and output. i.Difference between a competitive output, price & profit MC ATC D MR Qty P Q1Q1 P1P1 A ------------ B B

3 (b) The city eliminates the business license fee (a fixed cost) for all firms in this industry. How does the elimination of the license fee affect: i) Output/Price does NOT change WHY: a ∆ in fixed costs does not ∆ marginal costs or marginal revenue. i. Output ii. Profit iii. Modify Graph

4 MC ATC D MR Q P Q P ii) As fixed costs ↓ ATC Shifts downward => profits ↑ (from zero to shaded Area) c) In long run this would attract more competition -Demand would shift left -Profit would = ZERO -Quantity would fall ATC 1 Economic Profits (c) continued i. Output ii. Profit iii. Modify Graph A

5 D MR ----------------- Unit ElasticElastic range Inelastic Range ● Demand Curve & Elasticity 1)Firms Operate in Elastic Portion of Demand 2)Elasticity = 1 when MR = 0

6 Practice Free Response Question #2 Watsonia

7 Marginal Cost Average Total Cost Demand Marginal Revenue ATTENDANCEQ1Q2Q3Q4Q5Q6Q7 0 P1 P2 P3 P4 P5 P6 PRICE/COST 1. There is one art museum on the island of Watsonia. The museum’s demand and cost curves are shown in the graph above. The museum currently relies on an admission charge for some of its funding. Its directors are debating about how to set the admission charge.

8 Marginal Cost Average Total Cost Demand Marginal Revenue ATTENDANCEQ1Q2Q3Q4Q5Q6Q7 0 P1 P2 P3 P4 P5 P6 PRICE/COST a) Identify the price and quantity associated: i) The museum maximizes its profit. P5 Q2

9 Marginal Cost Average Total Cost Demand Marginal Revenue ATTENDANCEQ1Q2Q3Q4Q5Q6Q7 0 P1 P2 P3 P4 P5 P6 PRICE/COST ii) The museum maximizes its total revenue P3Q4

10 Marginal Cost Average Total Cost Demand Marginal Revenue ATTENDANCEQ1Q2Q3Q4Q5Q6Q7 0 P1 P2 P3 P4 P5 P6 PRICE/COST iii) The museum maximizes the sum of consumer and producer surplus (total welfare) P4Q3

11 Marginal Cost Average Total Cost Demand Marginal Revenue ATTENDANCEQ1Q2Q3Q4Q5Q6Q7 0 P1 P2 P3 P4 P5 P6 PRICE/COST iv) The museum maximizes its attendance, as long as it breaks even. P2Q5

12 Marginal Cost Average Total Cost Demand Marginal Revenue ATTENDANCEQ1Q2Q3Q4Q5Q6Q7 0 P1 P2 P3 P4 P5 P6 PRICE/COST b) When the attendance is Q1, is the demand price elastic, inelastic, or unit elastic? Explain. Demand is elastic at Q1. MR is greater than zero; Q1 is left of the mid-point or in the upper half of the demand. Elastic Inelastic

13 Marginal Cost Average Total Cost Demand Marginal Revenue ATTENDANCEQ1Q2Q3Q4Q5Q6Q7 0 P1 P2 P3 P4 P5 P6 PRICE/COST c) Assume that the price is set at P2. Assuming the existence of an opportunity cost, indicate whether the museum’s accounting profits would be positive, negative, or zero. Explain why. Accounting profits are positive.

14 Marginal Cost Average Total Cost Demand Marginal Revenue ATTENDANCEQ1Q2Q3Q4Q5Q6Q7 0 P1 P2 P3 P4 P5 P6 PRICE/COST c) Assume that the price is set at P2. Assuming the existence of an opportunity cost, indicate whether the museum’s accounting profits would be positive, negative, or zero. Explain why. Economic profit is zero and opportunity costs exist.

15 Marginal Cost Average Total Cost Demand Marginal Revenue ATTENDANCEQ1Q2Q3Q4Q5Q6Q7 0 P1 P2 P3 P4 P5 P6 PRICE/COST c) Assume that the price is set at P2. Assuming the existence of an opportunity cost, indicate whether the museum’s accounting profits would be positive, negative, or zero. Explain why. Economic profit is zero and ATC includes opportunity costs. Or--

16 Marginal Cost Average Total Cost Demand Marginal Revenue ATTENDANCEQ1Q2Q3Q4Q5Q6Q7 0 P1 P2 P3 P4 P5 P6 PRICE/COST d) Assume that the government decides the museum should charge no admission and agrees to subsidize the museum for any losses. i)Using the labeling in the graph, identify the museum’s attendance under that circumstance. Q7

17 http://www.youtube.com/watch?v=azNo8ttSCiY Innovation in Schools

18 Marginal Cost Average Total Cost Demand Marginal Revenue ATTENDANCEQ1Q2Q3Q4Q5Q6Q7 0 P1 P2 P3 P4 P5 P6 PRICE/COST d) Assume that the government decides the museum should charge no admission and agrees to subsidize the museum for any losses. ii) Would the outcome be allocatively efficient? Explain. Outcome is NOT allocatively efficient.

19 Marginal Cost Average Total Cost Demand Marginal Revenue ATTENDANCEQ1Q2Q3Q4Q5Q6Q7 0 P1 P2 P3 P4 P5 P6 PRICE/COST d) Assume that the government decides the museum should charge no admission and agrees to subsidize the museum for any losses. ii) Would the outcome be allocatively efficient? Explain. MC > P or MSC > MSB is greater than


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