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Microeconomics I

Assignment 3
Due on: October 20, 2014 (before 2:30 PM)
To be submitted to Mr. Manhar (TA)

1. Suppose there is only one farmer in a village who owns all the available land and
produces rice for the entire local market. His total costs are given by T C = 5Q. The
market demand curve for rice is p = 25 Q. The farmer is free to decide the selling
price and quantity of rice.
(a) Determine the profit maximizing levels of price and quantity. Also, calculate
profits at this output.
(b) Calculate social welfare.
Now government carries out a radical land reform as a result of which almost everybody in this village becomes a producer of rice. However, there is only one unlucky
villager who could not be provided with land (due to limited availability) and has no
choice but to remain a buyer, luckily the only one in the market. But our egalitarian
government compensates him with a good amount of money. The money is so good
that a strong income effect raises his individual demand curve to the level of previous
market demand curve.
So in effect, the village market faces the same market demand as before, but with
only one buyer and many identical producers whose cost conditions are given by
T C = 5Q.
The buyer being the only one, enjoys the power to decide the buying price and
quantity and his objective is to attain maximum consumer surplus.

IGIDR

2014

Microeconomics I, Assignment 3

(c) Determine the optimal price and quantity for the entire market.
(d) Calculate social welfare and comment on the efficiency of this market.
4+3+4+4=15
2. There are two consumers who have utility functions
u1 (q1 , m1 ) = 10x1 + m1
u2 (q2 , m2 ) = 5x2 + m2
The price of the m-good is one, and each consumer has a large initial wealth. Both
goods can only be consumed in non-negative amounts.
A monopolist supplies the q-good. The monopolist knows that the consumers are
of two different types, and type A has the utility function u1 (.) and type B has the
utility function u2 (.). However, the monopolist does not know who is of which type.
The monopolists cost function is as follows.

0 if q 10
C(q) =

if q > 10
Solve the monopolists profit maximization problem. Illustrate your answer graphically.
10
3. Consider the following. There is one firm, firm 1. There are two markets, market 1
and market 2. Firm 1 is the monopolist in both market 1 market 2. Let x and y
denote, respectively, output of firm 1 in market 1 and output of firm 1 in market 2.
The demand is infinitely elastic in market 1 at p1 = 50 and the inverse demand in
market 2 is p2 = 200 y. Cost function of firm 1 is given by C1 =
F is the fixed cost.
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(x+y)2
2

+ F , where

IGIDR

2014

Microeconomics I, Assignment 3

Suppose that the government intervenes in market 1, which raises the price in market
1 to 55.
(a) Will firm 1 like such intervention?
(b) Will your answer to (a) change, if firm 1s cost function was C1 = cx + (d
x)y + F , where > 0?
(c) Illustrate your answers graphically.
Now, suppose that firm 1 can supply any amount of output in market 2 at price
p2 = 50 or less. However, no firm can sell a positive amount of output in market 2
at a price higher than p2 = 50.
(d) Will your answer to (a) change? Why or why not?
(e) Will your answer to (b) change? Why or why not?
8+8+3+8+8=35
4. Suppose that there is a firm, called firm 1, which is the only producer of the (perishable, i.e. non-durable) good x. Firm 1 survives for two periods and aims to maximize
its profit. The prevailing rate of interest is r.
The production technology of firm 1 exhibits constant returns to scale and there is no
fixed cost of production. Further, firm 1s production technology remains the same
in both periods.
Market demand functions in period 1 and period 2 are given by p1 = a q1 and
p2 = a+bq1 q2 , respectively, where a > b > 0 and qi denotes the quantity demanded
in period i (i = 1, 2).
If firm 1 produces x1 amount in period 1, the government imposes tax/subsidy at
the rate tx1 on its period 2s production.

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IGIDR

2014

Microeconomics I, Assignment 3

(a) For any given t, calculate firm 1s output decisions and equilibrium prices in
period 1 and period 2. Please specify the necessary parametric restrictions to
have meaningful solutions. Can you tell us the relation between t and b, if any?
(b) Suppose that the governments objective is the maximize social welfare. What
will be the optimal t?
(c) How will your answer to (b) change, if firm 1 is a foreign firm and the market
for the good is the domestic market?
(d) Will your answer to (b) change, if firm 1 is a domestic firm and sells its output
in a foreign countrys market?
10+10+10+10=40

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