Practice Free Response Questions Microeconomics Practice Free Response Questions

1) Assume that a profit-maximizing firm in a monopolistically competitive industry is in long-run equilibrium. Draw a correctly labeled graph that shows the profit-maximizing firm’s price and output. Difference between a competitive output, price & profit MC ATC D MR Qty P Q1 P1 A B ------------ B

i. Output ii. Profit iii. Modify Graph 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 ii. Profit iii. Modify Graph 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 (c) continued i. Output ii. Profit iii. Modify Graph 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 P MC ATC P A Economic Profits ATC1 D Q Q MR

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

Practice Free Response Question #2 Watsonia

There is one art museum on the island of Watsonia. The PRICE/COST Marginal Cost P6 P5 Average Total Cost P4 P3 P2 P1 Demand Q1 Q2 Q3 Q4 Q5 Q6 Q7 ATTENDANCE Marginal Revenue 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.

P5 Q2 a) Identify the price and quantity associated: PRICE/COST Marginal Cost P6 P5 Average Total Cost P4 P3 P2 P1 Demand Q1 Q2 Q3 Q4 Q5 Q6 Q7 ATTENDANCE Marginal Revenue a) Identify the price and quantity associated: i) The museum maximizes its profit. P5 Q2

P3 Q4 ii) The museum maximizes its total revenue Marginal Cost PRICE/COST Marginal Cost P6 P5 Average Total Cost P4 P3 P2 P1 Demand Q1 Q2 Q3 Q4 Q5 Q6 Q7 ATTENDANCE Marginal Revenue ii) The museum maximizes its total revenue P3 Q4

P4 Q3 The museum maximizes the sum of consumer and PRICE/COST Marginal Cost P6 P5 Average Total Cost P4 P3 P2 P1 Demand Q1 Q2 Q3 Q4 Q5 Q6 Q7 ATTENDANCE Marginal Revenue The museum maximizes the sum of consumer and producer surplus (total welfare) P4 Q3

P2 Q5 iv) The museum maximizes its attendance, as long as PRICE/COST Marginal Cost P6 P5 Average Total Cost P4 P3 P2 P1 Demand Q1 Q2 Q3 Q4 Q5 Q6 Q7 ATTENDANCE Marginal Revenue iv) The museum maximizes its attendance, as long as it breaks even. P2 Q5

MR is greater than zero; Q1 is left of the mid-point PRICE/COST Elastic Marginal Cost P6 P5 Average Total Cost P4 P3 P2 Inelastic P1 Demand Q1 Q2 Q3 Q4 Q5 Q6 Q7 ATTENDANCE Marginal Revenue 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.

Accounting profits are positive. PRICE/COST Marginal Cost P6 P5 Average Total Cost P4 P3 P2 P1 Demand Q1 Q2 Q3 Q4 Q5 Q6 Q7 ATTENDANCE Marginal Revenue 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.

Economic profit is zero and opportunity costs exist. PRICE/COST Marginal Cost P6 P5 Average Total Cost P4 P3 P2 P1 Demand Q1 Q2 Q3 Q4 Q5 Q6 Q7 ATTENDANCE Marginal Revenue 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.

Economic profit is zero and ATC includes opportunity costs. PRICE/COST Marginal Cost P6 P5 Average Total Cost P4 P3 P2 P1 Demand Q1 Q2 Q3 Q4 Q5 Q6 Q7 ATTENDANCE Marginal Revenue 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. Or-- Economic profit is zero and ATC includes opportunity costs.

Q7 Assume that the government decides the museum should PRICE/COST Marginal Cost P6 P5 Average Total Cost P4 P3 P2 P1 Demand Q1 Q2 Q3 Q4 Q5 Q6 Q7 ATTENDANCE Marginal Revenue Assume that the government decides the museum should charge no admission and agrees to subsidize the museum for any losses. Using the labeling in the graph, identify the museum’s attendance under that circumstance. Q7

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Outcome is NOT allocatively efficient. PRICE/COST Marginal Cost P6 P5 Average Total Cost P4 P3 P2 P1 Demand Q1 Q2 Q3 Q4 Q5 Q6 Q7 ATTENDANCE Marginal Revenue 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.

MC > P or MSC > MSB is greater than PRICE/COST Marginal Cost P6 P5 Average Total Cost P4 P3 P2 is greater than P1 Demand Q1 Q2 Q3 Q4 Q5 Q6 Q7 ATTENDANCE Marginal Revenue 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