Practice Final

Business 33001

Question 1: True/False/Uncertain

1) (5 points) Wood and apples are produced jointly from apple trees. Researchers discover
that burning wood from apple trees is the cleanest form of fuel. The price of wood will
rise; the price of apples will fall.

2) (5 points) A per-unit tax on disk drives will increase the price of computers, but a per-
unit tax on computers will reduce the price of disk drives.

3) (5 points) Perfectly competitive firms should shut down if their economic profits are less
than zero, and they should choose to operate if their revenues are greater than their
explicit costs.

4) (5 points) Jill receives a $10,000 per year scholarship to go to college. Jack is offered no
financial aid of any kind. College tuition is $25,000 per year, and college lasts four
years. If both Jack and Jill decide to go to college, Jacks marginal willingness to pay
for college must be greater than Jills marginal willingness to pay for college.

5) (5 points) A firm uses two inputs in production, capital and labor. The price of capital
and labor are the same. At the firms present usage of capital and labor, each unit of
capital is more productive than each unit of labor. In the long run, the firm should
purchase more capital and less labor than it currently is using.
Question 2: (20 points)

Over the years, Disneyland has used two methods to price its product. Under method 1, they
charged each customer a fixed entrance fee plus a per-unit charge for each ride the customer
took. Under method 2 (used currently), consumers pay an entrance fee and rides are free.

a. (7 points) Assume that Disneyland incurs a cost of C1 each time a person takes a ride
on one of its attractions. If it charges for the ride, it must also incur a cost C2 per ride
of collecting a ticket from each patron. What is the optimal entrance fee and price per
ride if Disneyland uses method 1? (Hint: Draw a demand curve for rides by a
representative patron, and show your answer graphically.) Make sure to justify your
answer.

b. (7 points) Under the same cost structure, what is the optimal entrance fee if
Disneyland uses method 2? Explain.

c. (6 points) Under what conditions, if any, will method 2 be more profitable to

Disneyland than method 1?

Question 3 (25 Points):

There are three firms that produce cogs (Acme Cogs, Better Cogs, and Cogswell Cogs) and there
are barriers to entry into the cogs industry.

The market demand for cogs is:

Q D = 28 P

Cogs firms have the following cost functions:

C A ( q A ) = 4q A
C B ( q B ) = 4q B
C C ( q C ) = 4q C

where CA and qA are Acmes cost function and output; CB and qB are Betters cost function and
output; and CC and qC are Cogswells cost function and output.

a. (8 points) If the firms compete by simultaneously setting output, how many cogs will
each firm produce?
 b. (10 points) Now, Better Cogs and Cogswell Cogs are considering merging. How
many cogs will Acme produce and how many cogs will the merged firm
BetterCogswell Cogsproduce if the merger happens? You may assume that it will
cost BetterCogswell Cogs $4 to produce each cog. Should Better and Cogswell
merge?

c. (7 points) Now suppose that by merging BetterCogswell Cogs will gain the ability to
set quantity first. Should Better and Cogswell merge now?

Question 4 (16 Points):

Suppose that a firms' production functions is q=20LK1/2. The cost of a unit of labor is $10 and
the cost of a unit of capital is $40.

a. The firm would like to produce 200 units. What is the optimal L and K to
produce this?
b. What if the firm wants to produce 300 units?

Question 5 (15 Points):

1
A monopolist faces a demand curve approximated by Q=
D
125 P . The monoplist's total cost
2
function is C (=
Q) 10Q + 2Q .
2

a. What is the marginal revenue function?

b. What is the monopolist marginal cost function?

c. What should the monopolist produce? What price should they set?
Question 6 (30 Points):

NotoSoft sells flowchart software to three types of users: Cheapskates, Regular Users, and
Power Users. There are 100 users of each type. Within each group, the consumers have
identical preferences. The willingness-to-pay (WTP) for the software is a function of whether
the software is the Basic Version or the Premium Version. Each consumer will only buy
one version of the software program. The WTP values are given in the following table:

Software Cheapskates Regular Users Power Users

Basic Version $20 $60 $100
Premium Version $22 $80 $500

Given the prices set by NotoSoft, each consumer will purchase the version which maximizes
surplus (WTP minus price), as long as the surplus > 0. Assume that marginal costs are zero (MC
= 0), and that NotoSoft always sets prices to maximize profits.

a. Suppose NotoSoft is forced to charge the same price for both versions of the software and
that NotoSoft is forced to charge the same price for all types of users (i.e., NotoSoft can
only set one price). How much should NotoSoft charge? How many units of each
version does NotoSoft sell? How much profit will NotoSoft earn?
b. Now suppose NotoSoft can charge separate prices for each type of user and that NotoSoft
can also charge different prices for each version of the software. What prices will
NotoSoft charge? How many units of each version does NotoSoft sell? How much profit
will NotoSoft earn?
c. Now suppose NotoSoft cannot charge different prices to different types of users but
NotoSoft can charge different prices for each version of the software. What prices will
NotoSoft charge? How many units of each version does NotoSoft sell? How much profit
will NotoSoft earn?
d. Finally, suppose that NotoSoft can distinguish Cheapskates from everyone else (through,
say, a Student ID card). So now NotoSoft can charge four prices: (1) Basic Version
price for Cheapskates, (2) Premium Version price for Cheapskates, (3) Basic Version
price for everyone else, and (4) Premium Version price for everyone else. What prices
will NotoSoft charge? How many units of each version does NotoSoft sell? How much
profit will NotoSoft earn?
e. In 1-3 sentences, describe why the profits in parts (c) and parts (d) are less than the
profits in part (b).