Econ 100a Question Paper

Econ 100A–Midterm 2 solutions. Thursday, March 22, 2012.

True/False

(2 questions, 10 points total)

Answer true or false and explain your answer. Your answer must fit in the space provided. T/F 1. (5 points) Suppose the government wants to place a tax on one of two goods, and suppose that supply is perfectly elastic for both goods. If the government wants to minimize the deadweight loss from a tax of a given size, it should put the tax on whichever good has worse substitutes.

False: If the supply curves are identical, the only factor that determines the amount of deadweight loss is the elasticity of demand. Placing the tax on the good that has the lower elasticity of demand will minimize the deadweight loss of the tax. It is true
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you might have plugged the new prices into the firm’s supply function to get y ∗ (10, 10, 20) = 50·10 10+20 = 75. If you then plugged this into the 10·20 firm’s conditional factor demand at the new prices you would get L∗ (75; 10, 20) =
75 20 10 10+20 2

= 25.

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Problem 2. (24 points total) Consider a perfectly competitive industry with 10 identical firms, each of which has variable costs of 10y 2 and fixed costs of 1000. We will define the short run as the time scale in which firms cannot enter or exit the industry, and cannot avoid their fixed costs. (In other words, in the short run firms must continue to pay their fixed costs even if they produce zero output.) In the long run, firms can enter or exit the industry, and can avoid their fixed costs by shutting down. (a) (8 points) Compute the short-run inverse supply curve of the firm, and the short-run inverse supply curve of the industry, and graph them on the same graph. [Hint: it matters a lot that firms can’t avoid their fixed costs in the short
Thus, the after-tax price received by firms will be ps = 200. Otherwise firms would be losing money and would have an incentive to leave the industry, and the industry would not be in long-run equilibrium. Thus, we know that the tax will be passed on entirely to consumers, which means that the price paid by consumers will be pd = ps + t = 200 + 50 = 250. Setting the inverse demand curve equal to that price, we can compute the long-run after-tax equilibrium quantity, 250 = 700 − 5Y ⇒ YtLR = 90. To determine the number of firms in the industry we have to know how much output each firm will produce when they are operating at their minimum average cost. We computed the direct supply curve of p the firm in part (a), y(p) = 20 , which means that at the minimum of their average cost, minAC = 200, each firm will produce 200 = 10 units of output. Since the 20 industry as a whole is producing 90 units, there must be 9 firms in the industry. One has exited the industry. Your graph should look like