Dr. Barry Haworth
University of Louisville
Department of Economics
Economics 301

Practice Problems: Midterm #3

1. A monopolist faces the following demand and marginal revenue curves:

Demand Q = 60 - P
Marginal Revenue MR = 60 - 2Q

The monopolist faces constant average and marginal costs, such that: AC = MC = 10.

a. What output level and price maximize this monopolistís profits?

b. What are the most profits that this monopolist can earn?

Assume that the market changes, so that the "new" demand and MR curves are steeper (i.e. more inelastic). Those new curves are given as:

New Demand Q = 55 - 0.5P
New Marginal Revenue MR = 110 - 4Q

c. What is the new profit maximizing level of output, the new price, and new level of profits?

d. Compare the Dead Weight Loss (DWL) of these two settings. Which has greater DWL?

2. Firms would be better off in the long run if they could slow down the entry of rival firms. As entry becomes more difficult, firms have greater opportunities to secure greater than zero long run profits.

a. Is it possible for firms to make entry more difficult?

b. What kinds of strategic actions might deter entry?

c. Do incumbant firms (i.e. existing firms) possess advantages over potential entrants when choosing these strategies?

3. Suppose advertising expenditures are able to increase a firmís sales.

a. Describe a model that helps a firm to decide on the profit-maximizing level of advertising.

b. Describe the marginal rule that a firm should use with advertising expenditures.

4. Bill and Ted will play a game of chicken, where both speed in their car toward one another on a single lane road. The first to veer off is the chicken, whereby the other is considered a hero and reaps the appropriate benefits from his "hero-dom". If neither veers, then both die a painful, fiery death.

In the matrix below, the payoffs (in terms of utility) for this game are given.

a. What type of game is this?

b. Does this game have a Nash equilibrium?

c. Is a threat by either Bill or Ted to not veer away (i.e. not be a chicken) a credible threat?

Suppose Bill removed his steering wheel, making it impossible to veer away. Once removed, Ted must determine a strategy as the game begins.

d. How has Bill changed the nature of this game?

e. Would Billís precommitment to the "donít veer" strategy make Bill better off?