Introduction to economics

EXAM SET #1
Microeconomics

1) Under what conditions will a decrease in the price of a product lead to a reduction in total spending
for that product?
ANSWER] Spending on a product (S) is given by the amount purchased Q times the unit price P; S=Q*P. We
know that a reduction in prices leads to an increase in the quantity being demanded, so that total expenditure
may increase or decrease according to the sensibility of demand to prices. This is captured by the elasticity of
demand
∆𝑄⁄𝑄
𝜂=
∆𝑃⁄𝑃
If the elasticity is low (𝜂 < 1) a reduction in prices will imply a reduction in total expenditure.

2) Consider Diagram #1. If a perfectly competitive market is in equilibrium in point B, what changes
would make the equilibrium move to point A?
ANSWER] We know that demand curves are downward sloping, while supply curves upward sloping. A
movement of the equilibrium from point B to point A will happen with an increase in demand, while the
supply is unaffected. Such an increase may be the result of changes in preferences for this product, increase
in the disposable income of consumers (for normal goods), increase in the relative price of alternative goods,
etc.
You were not asked to comment on whether this would be a short or a long-run equilibrium. In any case, this
exercise is related to a change in the short-run equilibrium of the market. The higher price in point A will
make this market more profitable, with consequences for the long-run equilibrium.

3) The total cost (TC) function for a firm in a perfectly competitive market is given by

𝑇𝐶 = 1,500 + 0.1 ∗ 𝑄 2
and its marginal cost (MC) curve is therefore given by
𝑀𝐶 = 0.2 ∗ 𝑄

1
 If the market price is 𝑃 = 20$ compute the profit-maximizing level of output, the firm total revenue
and total profit. Comment on your results.
ANSWER] Firms maximize profits when marginal costs are equal to marginal revenues. In a perfectly
competitive market marginal revenue is equal to the market price, so that
20
𝑀𝐶 = 0.2 ∗ 𝑄 = 20; 𝑄 = ; 𝑄 = 100
0.2
𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 = 𝑃 ∗ 𝑄 = 20 ∗ 100 = 2000

𝐶𝑜𝑠𝑡𝑠 = 1500 + 0.1 ∗ 𝑄 2 = 1500 + 0.1 ∗ 1002 = 1500 + 1000 = 2500

𝑃𝑟𝑜𝑓𝑖𝑡𝑠 = 𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 − 𝐶𝑜𝑠𝑡𝑠 = 2000 − 2500 = −500

The firm will suffer a loss of $500. Since variable costs (0.1 ∗ 𝑄 2 = 1000$) are less than revenues, the
firm will stay on the market and reduce its fixed costs to return to profitability.

4) A monopolist (Diagram #2) has the following demand curve (D), marginal revenue (MR), marginal
cost (MC) and total cost curves (TC)
𝐷) 𝑄 = 50 − 0.5 ∗ 𝑃
𝑀𝑅 = 100 − 4 ∗ 𝑄
𝑀𝐶 = 6 ∗ 𝑄

𝑇𝐶 = 100 + 3 ∗ 𝑄 2
Compute the consumer surplus corresponding to the profit-maximizing level of output.
Compute the consumer surplus in a perfectly competitive market with the same demand schedule
and a supply curve given by
𝑄 = 𝑃/6
Discuss.
ANSWER] Firms maximize profits when marginal costs are equal to marginal revenues. This implies that
the desired supply is given by
𝑀𝑅 = 𝑀𝐶 → 100 − 4 ∗ 𝑄 = 6 ∗ 𝑄 → 10 ∗ 𝑄 = 100 → 𝑄 = 10
This corresponds to the segment 0L in the diagram above to the right. The price at which the monopolist will
sell the product is the highest compatible with the demand curve, in point C. We compute it from the demand
curve
40
𝑄 = 50 − 0.5 ∗ 𝑃 → 0.5 ∗ 𝑃 = 50 − 10 → 𝑃 = = 80
0.5
This corresponds to the segment 0B in the diagram above to the right. The consumer surplus is given by the
difference between what consumers are willing to pay – as represented by the demand curve – and what they
actually pay – as given by the equilibrium price. This is therefore equal to the area of the triangle ABC.
The price in point A is given by the demand curve for an hypothetical value of Q=0
50
𝑄 = 50 − 0.5 ∗ 𝑃 → 0.5 ∗ 𝑃 = 50 − 0 → 𝑃 = = 100
0.5

2
The area ABC is therefore equal to
𝐵𝐶 ∗ 𝐴𝐵 (100 − 80) ∗ 10
= = 100
2 2
If the diagram above is representing a perfectly competitive market with a supply curve given by 𝑄 =
𝑃/6, then the equilibrium price is given in point F where the amount demanded is equal to the amount
supplied:
𝑃
𝑆𝑢𝑝𝑝𝑙𝑦: 𝑄 = ; 𝐷𝑒𝑚𝑎𝑛𝑑: 𝑄 = 50 − 0.5 ∗ 𝑃
6
𝑃 300
= 50 − 0.5 ∗ 𝑃 → 𝑃 + 3 ∗ 𝑃 = 300; 𝑃 = = 75
6 4
75
𝑄= = 12.5
6
In this case the consumer surplus is given by the triangle ADF
𝐴𝐷 ∗ 𝐷𝐹 (100 − 75) ∗ 12.5
= = 156.25
2 2
The monopolist appropriates part of what would be the consumer surplus in a competitive market. This
extra-profit is given by the area DBCE
𝐷𝐵𝐶𝐸 = 𝐷𝐵 ∗ 𝐶𝐸 = (80 − 75) ∗ 10 = 50
And there will be a dead-weight loss given by the triangle CEF
𝐶𝐸 ∗ 𝐸𝐹 (80 − 75) ∗ (12.5 − 10)
𝐶𝐸𝐹 = = = 6.25
2 2

5. With reference to the matrix shown in the enclosed table, answer the following questions according to the
postulates of Game Theory:

a. American’s payoff at the Nash Equilibrium: ……$500million ………………………….

b. United’s payoff at the Nash Equilibrium: ………$500million …………………………...
c. The strategy that American will play…………… Raise AD spending ……………...
d. The strategy that United will play……………… Raise AD spending …………………….
e. The strategy that American would play and the associated payoff if United had decided to
leave AD spending the same
e1 American strategy ……… Raise AD spending ……………………………….
e2 American payoff…………$800million …………………………………………………….

United
Leave AD spending the
Raise AD spending
same
American Raise AD spending
American $500million American $800million
United $500million United $200million
American $200million American $800million
Leave AD spending the same
United $800million United $800million

3
ANSWER] To find the strategy of American we should evaluate the best option for each possible choice of
United.
If United→R(aise) American gets $500 with strategy R and $200 with strategy L. Strategy R is better
If United→L(eave) American gets $800 with strategy R and $800 with strategy L. Strategies are equivalent
If American→R(aise) United gets $500 with strategy R and $200 with strategy L. Strategy R is better
If American→L(eave) United gets $800 with strategy R and $800 with strategy L. Strategies are equivalent
Specific answers are given above

4
Introduction to economics
EXAM SET #2
Microeconomics

1) Under what conditions will an increase in the price of a product lead to a reduction in total spending
for that product?
ANSWER] Spending on a product (S) is given by the amount purchased Q times the unit price P; S=Q*P. We
know that a reduction in prices leads to an increase in the quantity being demanded, so that total expenditure
may increase or decrease according to the sensibility of demand to prices. This is captured by the elasticity of
demand
∆𝑄⁄𝑄
𝜂=
∆𝑃⁄𝑃
If the elasticity is high (𝜂 > 1) an increase in prices will imply a reduction in total expenditure.

2) Consider Diagram #1. If a perfectly competitive market is in equilibrium in point B, what changes
would make the equilibrium move to point D?
ANSWER] We know that demand curves are downward sloping, while supply curves upward sloping. A
movement of the equilibrium from point B to point D will happen with an increase in the supply, while the
demand is unaffected. Such an increase may be the result of lower unit costs of resources, increase in labor
productivity, increase in the number of firms in the market, etc.
You were not asked to comment on whether this would be a short or a long-run equilibrium. In any case, this
exercise is related to a change in the short-run equilibrium of the market. The lower price in point D will
make this market less profitable, with consequences for the long-run equilibrium.

3) The total cost (TC) function for a firm in a perfectly competitive market is given by

𝑇𝐶 = 1,000 + 0.2 ∗ 𝑄 2
and its marginal cost (MC) curve is therefore given by
𝑀𝐶 = 0.4 ∗ 𝑄
If the market price is 𝑃 = 20$ compute the profit-maximizing level of output, the firm total revenue
and total profit. Comment on your results.

5
 ANSWER] Firms maximize profits when marginal costs are equal to marginal revenues. In a perfectly
competitive market marginal revenue is equal to the market price, so that
20
𝑀𝐶 = 0.4 ∗ 𝑄 = 20; 𝑄 = ; 𝑄 = 50
0.4
𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 = 𝑃 ∗ 𝑄 = 20 ∗ 50 = 1000

𝐶𝑜𝑠𝑡𝑠 = 1000 + 0.2 ∗ 𝑄 2 = 1000 + 0.2 ∗ 502 = 1000 + 500 = 1500

𝑃𝑟𝑜𝑓𝑖𝑡𝑠 = 𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 − 𝐶𝑜𝑠𝑡𝑠 = 1000 − 1500 = −500
The firm will suffer a loss of $500. Since variable costs (0.2 ∗ 𝑄 2 = 500$) are less than revenues, the
firm will stay on the market and reduce its fixed costs to return to profitability.

4) A monopolist (Diagram #2) has the following demand curve (D), marginal revenue (MR), marginal
cost (MC) and total cost curves (TC)
𝐷) 𝑄 = 50 − 0.5 ∗ 𝑃
𝑀𝑅 = 100 − 4 ∗ 𝑄
𝑀𝐶 = 4 ∗ 𝑄
𝑇𝐶 = 100 + 2 ∗ 𝑄 2
Compute the consumer surplus corresponding to the profit-maximizing level of output.
Compute the consumer surplus in a perfectly competitive market with the same demand schedule
and a supply curve given by
𝑄 = 𝑃/4
Discuss.
ANSWER] Firms maximize profits when marginal costs are equal to marginal revenues. This implies that
the desired supply is given by
𝑀𝑅 = 𝑀𝐶 → 100 − 4 ∗ 𝑄 = 4 ∗ 𝑄 → 8 ∗ 𝑄 = 100 → 𝑄 = 12.5
This corresponds to the segment 0L in the diagram above to the right. The price at which the monopolist will
sell the product is the highest compatible with the demand curve, in point C. We compute it from the demand
curve
37.5
𝑄 = 50 − 0.5 ∗ 𝑃 → 0.5 ∗ 𝑃 = 50 − 12.5 → 𝑃 = = 75
0.5
This corresponds to the segment 0B in the diagram above to the right. The consumer surplus is given by the
difference between what consumers are willing to pay – as represented by the demand curve – and what they
actually pay – as given by the equilibrium price. This is therefore equal to the area of the triangle ABC.
The price in point A is given by the demand curve for an hypothetical value of Q=0
50
𝑄 = 50 − 0.5 ∗ 𝑃 → 0.5 ∗ 𝑃 = 50 − 0 → 𝑃 = = 100
0.5
The area ABC is therefore equal to
𝐵𝐶 ∗ 𝐴𝐵 (100 − 75) ∗ 12.5
= = 156.25
2 2
6
 If the diagram above is representing a perfectly competitive market with a supply curve given by 𝑄 =
𝑃/4, then the equilibrium price is given in point F where the amount demanded is equal to the amount
supplied:
𝑃
𝑆𝑢𝑝𝑝𝑙𝑦: 𝑄 = ; 𝐷𝑒𝑚𝑎𝑛𝑑: 𝑄 = 50 − 0.5 ∗ 𝑃
4
𝑃 200
= 50 − 0.5 ∗ 𝑃 → 𝑃 + 2 ∗ 𝑃 = 200; 𝑃 = = 66.67
4 3
200/3
𝑄= = 16.67
4
In this case the consumer surplus is given by the triangle ADF
𝐴𝐷 ∗ 𝐷𝐹 (100 − 66.67) ∗ 16.67
= = 277.78
2 2
The monopolist appropriates part of what would be the consumer surplus in a competitive market. This
extra-profit is given by the area DBCE
𝐷𝐵𝐶𝐸 = 𝐷𝐵 ∗ 𝐶𝐸 = (75 − 66.67) ∗ 12.5 = 104.167
And there will be a dead-weight loss given by the triangle CEF
𝐶𝐸 ∗ 𝐸𝐹 (75 − 66.67) ∗ (16.67 − 12.5)
𝐶𝐸𝐹 = = = 17.361
2 2

5. With reference to the matrix shown in the enclosed table, answer the following questions
assuming that the two companies act rationally following the postulates of Game Theory:

a. American’s payoff at the Nash Equilibrium: ……$200million ……………….

b. United’s payoff at the Nash Equilibrium: ………$200million …………………………...
c. The strategy that American will play………… Raise AD spending ………………………...
d. The strategy that United will play…………… Raise AD spending ……………………….
e. The strategy that United would play and the associated payoff if American had decided to
leave AD spending the same
e1 United strategy ………… Raise AD spending ……………………………………….
e2 United payoff……………$500million …………………………………………………….

American
Leave AD spending the
Raise AD spending
same
United Raise AD spending
United $200million United $100million
American $200million American $500million
Leave AD spending the United $500million United $300million
same American $100million American $300million

7
ANSWER] To find the strategy of American we should evaluate the best option for each possible choice of
United.
If United→R(aise) American gets $200 with strategy R and $500 with strategy L. Strategy L is better
If United→L(eave) American gets $100 with strategy R and $300 with strategy L. Strategy L is better
If American→R(aise) United gets $200 with strategy R and $500 with strategy L. Strategy L is better
If American→L(eave) United gets $100 with strategy R and $300 with strategy L. Strategy L is better
Leaving expenditure as they are is a DOMINANT strategy for both players.
Specific answers are given above

8
Introduction to economics
EXAM SET #3
Microeconomics

1) Under what conditions will a decrease in the price of a product lead to an increase in total spending
for that product?
ANSWER] Spending on a product (S) is given by the amount purchased Q times the unit price P; S=Q*P. We
know that a reduction in prices leads to an increase in the quantity being demanded, so that total expenditure
may increase or decrease according to the sensibility of demand to prices. This is captured by the elasticity of
demand
∆𝑄⁄𝑄
𝜂=
∆𝑃⁄𝑃
If the elasticity is high (𝜂 > 1) a reduction in prices will imply an increase in total expenditure.

2) Consider Diagram #1. If a perfectly competitive market is in equilibrium in point D, what changes
would make the equilibrium move to point B?
ANSWER] We know that demand curves are downward sloping, while supply curves upward sloping. A
movement of the equilibrium from point D to point B will happen with a decrease in the supply, while the
demand is unaffected. Such a decrease may be the result of higher unit costs of resources, a fall in labor
productivity, a decrease in the number of firms in the market, etc.
You were not asked to comment on whether this would be a short or a long-run equilibrium. In any case, this
exercise is related to a change in the short-run equilibrium of the market. The higher price in point B will
make this market more profitable, with consequences for the long-run equilibrium.

3) The total cost (TC) function for a firm in a perfectly competitive market is given by

𝑇𝐶 = 400 + 0.2 ∗ 𝑄 2
and its marginal cost (MC) curve is therefore given by
𝑀𝐶 = 0.4 ∗ 𝑄
If the market price is 𝑃 = 20$ compute the profit-maximizing level of output, the firm total revenue
and total profit. Comment on your results.

9
 ANSWER] Firms maximize profits when marginal costs are equal to marginal revenues. In a perfectly
competitive market marginal revenue is equal to the market price, so that
20
𝑀𝐶 = 0.4 ∗ 𝑄 = 20; 𝑄 = ; 𝑄 = 50
0.4
𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 = 𝑃 ∗ 𝑄 = 20 ∗ 50 = 1000

𝐶𝑜𝑠𝑡𝑠 = 400 + 0.2 ∗ 𝑄 2 = 400 + 0.2 ∗ 502 = 400 + 500 = 900

𝑃𝑟𝑜𝑓𝑖𝑡𝑠 = 𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 − 𝐶𝑜𝑠𝑡𝑠 = 1000 − 900 = 100
The firm will make a profit of $100. This is an incentive to expand its business in the long run.

4) A monopolist (Diagram #2) has the following demand curve (D), marginal revenue (MR), marginal
cost (MC) and total cost curves (TC)
𝐷) 𝑄 = 100 − 0.5 ∗ 𝑃
𝑀𝑅 = 200 − 4 ∗ 𝑄
𝑀𝐶 = 6 ∗ 𝑄

𝑇𝐶 = 100 + 3 ∗ 𝑄 2
Compute the consumer surplus corresponding to the profit-maximizing level of output.
Compute the consumer surplus in a perfectly competitive market with the same demand schedule
and a supply curve given by
𝑄 = 𝑃/6
Discuss.
ANSWER] Firms maximize profits when marginal costs are equal to marginal revenues. This implies that
the desired supply is given by
𝑀𝑅 = 𝑀𝐶 → 200 − 4 ∗ 𝑄 = 6 ∗ 𝑄 → 10 ∗ 𝑄 = 200 → 𝑄 = 20
This corresponds to the segment 0L in the diagram above to the right. The price at which the monopolist will
sell the product is the highest compatible with the demand curve, in point C. We compute it from the demand
curve
80
𝑄 = 100 − 0.5 ∗ 𝑃 → 0.5 ∗ 𝑃 = 100 − 20 → 𝑃 = = 160
0.5
This corresponds to the segment 0B in the diagram above to the right. The consumer surplus is given by the
difference between what consumers are willing to pay – as represented by the demand curve – and what they
actually pay – as given by the equilibrium price. This is therefore equal to the area of the triangle ABC.
The price in point A is given by the demand curve for an hypothetical value of Q=0
100
𝑄 = 100 − 0.5 ∗ 𝑃 → 0.5 ∗ 𝑃 = 100 − 0 → 𝑃 = = 200
0.5
The area ABC is therefore equal to
𝐵𝐶 ∗ 𝐴𝐵 (200 − 160) ∗ 20
= = 400
2 2

10
 If the diagram above is representing a perfectly competitive market with a supply curve given by 𝑄 =
𝑃/6, then the equilibrium price is given in point F where the amount demanded is equal to the amount
supplied:
𝑃
𝑆𝑢𝑝𝑝𝑙𝑦: 𝑄 = ; 𝐷𝑒𝑚𝑎𝑛𝑑: 𝑄 = 100 − 0.5 ∗ 𝑃
6
𝑃 600
= 100 − 0.5 ∗ 𝑃 → 𝑃 + 3 ∗ 𝑃 = 600; 𝑃 = = 150
6 4
150
𝑄= = 25
6
In this case the consumer surplus is given by the triangle ADF
𝐴𝐷 ∗ 𝐷𝐹 (200 − 150) ∗ 25
= = 625
2 2
The monopolist appropriates part of what would be the consumer surplus in a competitive market. This
extra-profit is given by the area DBCE
𝐷𝐵𝐶𝐸 = 𝐷𝐵 ∗ 𝐶𝐸 = (160 − 150) ∗ 20 = 200
And there will be a dead-weight loss given by the triangle CEF
𝐶𝐸 ∗ 𝐸𝐹 (160 − 150) ∗ (25 − 20)
𝐶𝐸𝐹 = = = 25
2 2

5. With reference to the matrix shown in the enclosed table, answer the following questions
according to the postulates of Game Theory:

a. American’s payoff at the Nash Equilibrium: ……$100million …………………….

b. United’s payoff at the Nash Equilibrium: ………$100million …………………………...
c. The strategy that American will play…………… Raise AD spending ……………………………...
d. The strategy that United will play………………… Raise AD spending ……………………….
e. The strategy that American would play and the associated payoff if United had decided to
leave AD spending the same
e1 American strategy ………………… Raise AD spending ………………………………….
e2 American payoff……………………$400million ………………………………………….

United
Leave AD spending the
Raise AD spending
same
American Leave AD spending the American $300million American $50million
same United $300million United $400million
American $400million American $100million
Raise AD spending
United $50million United $100million

ANSWER] To find the strategy of American we should evaluate the best option for each possible choice of
United.

11
If United→R(aise) American gets $100 with strategy R and $50 with strategy L. Strategy R is better
If United→L(eave) American gets $400 with strategy R and $300 with strategy L. Strategy R is better
If American→R(aise) United gets $100 with strategy R and $50 with strategy L. Strategy R is better
If American→L(eave) United gets $400 with strategy R and $300 with strategy L. Strategy R is better
Raising expenditure is a DOMINANT strategy for both players.
Specific answers are given above

12
Introduction to economics
EXAM SET #4
Microeconomics

1) Under what conditions will an increase in the price of a product lead to an increase in total spending
for that product?
ANSWER] Spending on a product (S) is given by the amount purchased Q times the unit price P; S=Q*P. We
know that a reduction in prices leads to an increase in the quantity being demanded, so that total expenditure
may increase or decrease according to the sensibility of demand to prices. This is captured by the elasticity of
demand
∆𝑄⁄𝑄
𝜂=
∆𝑃⁄𝑃
If the elasticity is low (𝜂 < 1) an increase in prices will imply an increase in total expenditure.

2) Consider Diagram #1. If a perfectly competitive market is in equilibrium in point A, what changes
would make the equilibrium move to point B?
ANSWER] We know that demand curves are downward sloping, while supply curves upward sloping. A
movement of the equilibrium from point A to point B will happen with a decrease in demand, while the
supply is unaffected. Such a decrease may be the result of lower household income, lower price of alternative
goods, etc.
You were not asked to comment on whether this would be a short or a long-run equilibrium. In any case, this
exercise is related to a change in the short-run equilibrium of the market. The lower price in point B will
make this market less profitable, with consequences for the long-run equilibrium.

3) The total cost (TC) function for a firm in a perfectly competitive market is given by

𝑇𝐶 = 1,000 + 0.1 ∗ 𝑄 2
and its marginal cost (MC) curve is therefore given by
𝑀𝐶 = 0.2 ∗ 𝑄

13
 If the market price is 𝑃 = 20$ compute the profit-maximizing level of output, the firm total revenue
and total profit. Comment on your results.
ANSWER] Firms maximize profits when marginal costs are equal to marginal revenues. In a perfectly
competitive market marginal revenue is equal to the market price, so that
20
𝑀𝐶 = 0.2 ∗ 𝑄 = 20; 𝑄 = ; 𝑄 = 100
0.2
𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 = 𝑃 ∗ 𝑄 = 20 ∗ 100 = 2000

𝐶𝑜𝑠𝑡𝑠 = 1000 + 0.1 ∗ 𝑄 2 = 1000 + 0.1 ∗ 1002 = 1000 + 1000 = 2000

𝑃𝑟𝑜𝑓𝑖𝑡𝑠 = 𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 − 𝐶𝑜𝑠𝑡𝑠 = 2000 − 200 = 0
Firms make no profits but also no losses. This is coherent with long-run equilibrium.

4) A monopolist (Diagram #2) has the following demand curve (D), marginal revenue (MR), marginal
cost (MC) and total cost curves (TC)
𝐷) 𝑄 = 50 − 0.125 ∗ 𝑃
𝑀𝑅 = 400 − 16 ∗ 𝑄
𝑀𝐶 = 4 ∗ 𝑄

𝑇𝐶 = 100 + 2 ∗ 𝑄 2
Compute the consumer surplus corresponding to the profit-maximizing level of output.
Compute the consumer surplus in a perfectly competitive market with the same demand schedule
and a supply curve given by
𝑄 = 𝑃/4
Discuss.

ANSWER] Firms maximize profits when marginal costs are equal to marginal revenues. This implies that
the desired supply is given by
𝑀𝑅 = 𝑀𝐶 → 400 − 16 ∗ 𝑄 = 4 ∗ 𝑄 → 20 ∗ 𝑄 = 400 → 𝑄 = 20
This corresponds to the segment 0L in the diagram above to the right. The price at which the monopolist will
sell the product is the highest compatible with the demand curve, in point C. We compute it from the demand
curve
30
𝑄 = 50 − 0.125 ∗ 𝑃 → 0.125 ∗ 𝑃 = 50 − 20 → 𝑃 = = 240
0.125
This corresponds to the segment 0B in the diagram above to the right. The consumer surplus is given by the
difference between what consumers are willing to pay – as represented by the demand curve – and what they
actually pay – as given by the equilibrium price. This is therefore equal to the area of the triangle ABC.
The price in point A is given by the demand curve for an hypothetical value of Q=0
50
𝑄 = 50 − 0.125 ∗ 𝑃 → 0.125 ∗ 𝑃 = 50 − 0 → 𝑃 = = 400
0.125

14
The area ABC is therefore equal to
𝐵𝐶 ∗ 𝐴𝐵 (400 − 240) ∗ 20
= = 1600
2 2
If the diagram above is representing a perfectly competitive market with a supply curve given by 𝑄 =
𝑃/6, then the equilibrium price is given in point F where the amount demanded is equal to the amount
supplied:
𝑃
𝑆𝑢𝑝𝑝𝑙𝑦: 𝑄 = ; 𝐷𝑒𝑚𝑎𝑛𝑑: 𝑄 = 50 − 0.125 ∗ 𝑃
4
𝑃 400
= 50 − 0.125 ∗ 𝑃 → 2 ∗ 𝑃 + 𝑃 = 400; 𝑃 = = 133.3
4 3
133.3
𝑄= = 33.3
4
In this case the consumer surplus is given by the triangle ADF
𝐴𝐷 ∗ 𝐷𝐹 (400 − 133.3) ∗ 33.3
= = 4444.4
2 2
The monopolist appropriates part of what would be the consumer surplus in a competitive market. This
extra-profit is given by the area DBCE
𝐷𝐵𝐶𝐸 = 𝐷𝐵 ∗ 𝐶𝐸 = (240 − 133.3) ∗ 20 = 2133.3
And there will be a dead-weight loss given by the triangle CEF
𝐶𝐸 ∗ 𝐸𝐹 (240 − 133.3) ∗ (33.3 − 20)
𝐶𝐸𝐹 = = = 711.1
2 2

5. With reference to the matrix shown in the enclosed table, answer the following questions
assuming that the two companies act rationally following the postulates of Game Theory:

a. American’s payoff at the Nash Equilibrium: ……$50million ………………….

b. United’s payoff at the Nash Equilibrium: ………$50million ……………………………...
c. The strategy that American will play…………… Raise AD spending ……………………………...
d. The strategy that United will play……………… Raise AD spending ……………………….
e. The strategy that United would play and the associated payoff if American had decided to
leave AD spending the same
e1 United strategy ………………… Raise AD spending ………………………………………….
e2 United payoff…………………$500million …………………………………………….

American
Leave AD spending the
Raise AD spending
same
United Raise AD spending
United $50million United $500million
American $50million American $10million
Leave AD spending the United $10million United $200million
same American $500million American $200million

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ANSWER] To find the strategy of American we should evaluate the best option for each possible choice of
United.
If United→R(aise) American gets $50 with strategy R and $10 with strategy L. Strategy R is better
If United→L(eave) American gets $500 with strategy R and $200 with strategy L. Strategy R is better
If American→R(aise) United gets $50 with strategy R and $10 with strategy L. Strategy R is better
If American→L(eave) United gets $500 with strategy R and $200 with strategy L. Strategy R is better
Raising expenditure is a DOMINANT strategy for both players.
Specific answers are given above

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