Question

part 2 questions

M Micro Theory - HW4 Due: Nov 21st Part 1: Suppose that the market demand curve is P=100-Q and the market supply curve is P=Q. 1. What is the competitive market equilibrium (CME) price and quantity? 2. What is the maximum amount of total surplus in this market? 3. What is consumer surplus, producer surplus, and total surplus at the CME? 4. If this market were dominated by a monopoly, what would be the resulting price and quantity? Hint: the monopoly's marginal cost curve is the supply curve. You need to derive the marginal revenue curve to find the monopoly solution. 5. What is consumer surplus, producer surplus, and total surplus under the monopoly? 6. What is the deadweight loss associated with a lack of competition? 7. If the government sets a price ceiling on the monopoly at $40, what will the monopoly choose for Q? 8. What is total surplus, consumer surplus, and producer surplus when the monopoly faces this price ceiling? How does it compare to what you found in 5? 9. If the government wants to eliminate deadweight loss associated with the monopoly using a price ceiling, where should the government set the price ceiling? Part 2: Suppose there are two firms: a chemical plant and a fishing company. They both maximize profit choosing the quantity of production (Qc for the chemical plant and Qf for the fishing company). The chemical plant's profit function is: 320c-402. The fishing company's profit function is 100,-Q-5Q. 1. Identify the externality in this problem. Is it positive or negative? What might be the reason for this externality? 2. Solve each firm's profit maximization problem (optimal Qc and QD), assuming they don't collude. 3. What is each firm's profit at the solution? 4. Show that it is possible for the fishing company to pay the chemical plant a fee so that it produces less Qc and that an arrangement can be made so that the fishing company's profit increases without reducing the profit of the chemical plant. 5. The result in 4 is known as the Coase Theorem. It is a theorem that suggests externalities might be resolved without the need for government intervention. This idea, however, has been criticized for being overly simplistic in that it ignores some real-world barriers that could prohibit negotiations like the one illustrated in 4. What kinds of barriers might exist in reality that might make negotiations like these difficult? The point of this problem is that government interventions might be necessary in the real-world. 6. Describe a government policy that would increase the profit of both companies (relative to their profits found in 3)?

Answer 1

1) The externality in this question is negative externality. This is evident as you can see the increased cost in fishing company's profit function as it is affected by the quantity produced by the chemical plant.

2)

elta Dt. Pg Chemical plont Fishing Compons 320ह - पढटे Dfesentiaite ts ह८ गद 32 20 a - ১ed s ০ 5 281

3)

28 O ae10(5)- 20 1 -25-2o - 64 12 8 64 E

4)

324 -25-2o 28 64 64 ミF Let Fee fyed to chemieal Plart he This Should be so chemicaelot hos some level rreit cven abter neduting production 320 -40 F 11

19 25 -2 6 16 elte 26 Pait at this rishing Compa Fee needed to get 64in9it frit at thsde and alta Fe 28 5-25-St-36=-16 36 49 2 16 60 50-25-53-406

5)

i) Difficulty in assigning property rights : In reality there is difficulty in assigning property rights. There is unsurety about to whom the property right should belong to.

ii)Transaction Cost : Coase theorem assumes no transaction costs in settling of contracts, but in reality transaction costs can be really high and can affect the outcome

iii)Complete information assumption: There is also the assumption of complete information, this is certainly not the case in the real world where asymmetric information persists.

6)

Government policy that can increase profits of both would be where it restricts the quantity produced by chemical plant and compensates it by giving it a subsidy by the same of higher amount by which the profits have declined.

This will increase the profits of both companies