8/10/2019 EFM Solution

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Q-1 MCQ1. Ans C2. Ans A3. Ans C4. Ans C5. Ans B6. Ans A

Q-2 (b)

a. With a price elasticity of demand of 0.4, reducing the quantity demanded of cigarettes by 20% requires a50% increase in price, because 20/50 = 0.4. With the price of cigarettes currently $2, this would requirean increase in the price to $3.33 a pack using the midpoint method (note that ($3.33 $2)/$2.67 = .50).

b. The policy will have a larger effect five years from now than it does one year from now. The elasticity islarger in the long run, because it may take some time for people to reduce their cigarette usage. Thehabit of smoking is hard to break in the short run.

c. Because teenagers do not have as much income as adults, they are likely to have a higher price elasticity

of demand. Also, adults are more likely to be addicted to cigarettes, making it more difficult to reducetheir quantity demanded in response to a higher price.

Q-2(b)a. The fixed cost is $300, because fixed cost equals total cost minus variable cost. At an output of zero, the

only costs are fixed cost.

b.

Quantity TotalCost

VariableCost

Marginal Cost(using total cost)

Marginal Cost(using variable cost)

0 $300 $0 --- ---

1 350 50 $50 $50

2 390 90 40 40

3 420 120 30 30

4 450 150 30 30

5 490 190 40 40

6 540 240 50 50

Marginal cost equals the change in total cost for each additional unit of output. It is also equal to the change in variablecost for each additional unit of output. This occurs because total cost equals the sum of variable cost and fixed cost andfixed cost does not change as the quantity changes. Thus, as quantity increases, the increase in total cost equals the

increase in variable cost.

Q-5 (a)

10. a. The marginal revenue from selling to each type of consumer is shown in the following tables:

Price Quantity of AdultTickets

Total Revenue from Saleof Adult Tickets

Marginal Revenue fromSale of Adult Tickets

10 0 0 ----

9 100 900 9

8 200 1,600 7

7 300 2,100 5

6 300 1,800 -3

5 300 1,500 -3

4 300 1,200 -3

3 300 900 -3

2 300 600 -3

1 300 300 -3

0 300 0 -3

8/10/2019 EFM Solution

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Price Quantity of ChildTickets

Total Revenue from Saleof Child Tickets

Marginal Revenue fromSale of Child Tickets

10 0 0 ----

9 0 0 0

8 0 0 0

7 0 0 0

6 0 0 0

5 100 500 5

4 200 800 33 200 600 -2

2 200 400 -2

1 200 200 -2

0 200 0 -2

To maximize profit, you should charge adults $7 and sell 300 tickets. You should charge children $4 andsell 200 tickets. Total revenue will be $2,100 + $800 = $2,900. Because total cost is $2,000, profit will be$900.

b. If price discrimination were not allowed, you would want to set a price of $7 for the tickets. You wouldsell 300 tickets and profit would be $100.

c. The children who were willing to pay $4 but will not see the show now that the price is $7 will be worseoff. The producer is worse off because profit is lower. Total surplus is lower. There is no one that isbetter off.

d. In (a) total profit would be $400. In (b), there would be a $400 loss. There would be no change in (c).