Section A: Multiple choice
Please answer all five questions. Each question is worth five marks. No explanation is required and no extra marks will be given.
A1:
A manager knows the average total cost and the average variable cost for a given level of output. Which of the following costs can she not determine given this information?
a. Total cost
b. Average fixed cost
c. Total fixed cost
d. Total variable cost
e. The manager can determine all of the above costs given the information provided
A2:
Suppose a monopolist sells an identical product in several market segments, and practices price discrimination. Which of the following magnitudes must be equal in all market segments if the monopolist allocates quantities sold among the market segments in such a way as to maximize total profit?
a. ratio of price to marginal cost
b. ratio of marginal cost to marginal benefits
c. ratio of price to elasticity
d. marginal revenue
e. none of the above.
A3:
When the price faced by a perfectly competitive firm was $5, the firm produced nothing in the short run. When the price rose to $10, the firm produced 100 tons of output. From this we can infer that
a. The firm's marginal cost curve must be flat (horizontal)
b. The firm's marginal cost of production never falls below $5
c. The firm's average total cost of production was less than $10
d. The firm's total cost of producing 100 tons is less than $1,000
e. The minimum value of the firm's average variable cost lies between $5 and $10
A 4:
If the current quantity of output is less than the profit-maximizing quantity, then the next unit produced
a. Will decrease profit
b. Will increase cost more than it increases revenue
c. Will increase revenue more than it increases cost
d. Will increase revenue without increasing cost
e. May or may not increase profit
MULTIPLE CHOICE QUESTIONS CONTINUE ON NEXT PAGE
A5:
Suppose that flu shots create a positive externality equal to $12 per shot. Further suppose that the government offers a $5 per-shot subsidy to producers. What is the relationship between the market equilibrium quantity and the socially optimal quantity of flu shots produced?
a. They are equal
b. The market equilibrium quantity is greater than the socially optimal quantity
c. The market equilibrium quantity is smaller than the socially optimal quantity
d. There is not enough information to answer the question.
Section B: Essay questions (35 marks)
Please answer one of the following two questions (either B1 or B2). Each question is worth 35 marks.
B1:
According to press reports, some years ago the Ontario government directed the Ontario Power Authority (OPA) to get Ontario consumers to reduce their peak demand for electricity via conservation. Please consider the following three questions separately and independently of each other.
a) Given the fact that electricity generation has a large component of fixed costs, why would OPA have an interest in pushing consumers to reduce peak demand? Explain with reference to diagram(s) in the Course Notes.
b) The electricity distributors in the Ontario system claim to have lost revenues as a result of the conservation programs. What does this outcome suggest about the price elasticity of household demand for electricity? Explain, with the help of diagram(s).
c) In addition to the revenue reduction, each corporation in the Ontario electricity chain incurred costs for running the advertising (promotion) programs. The amount of these costs is independent of the volume of output.
Show the impact of advertising on the demand facing a typical producer with reference to a diagram in the Course Notes. Assume, for this purpose, that the market is characterized as monopolistic competition.
Discuss the impact of these costs on the price, output and profit of a typical producer with reference to diagram(s) in the Course Notes.
B2:
A monopoly firm faces the demand curve P = 11 - Q, where P is measured in dollars per unit and Q in thousands of units. The firm has a constant average total cost of $6 per unit.
a) Refer to a diagram in the Course Notes which comes closest to representing this situation. How might the diagram have to be modified?
b) Calculate the following: (i) the profit-maximizing price; (ii) the profit-maximizing quantity; (iii) the resulting maximum profit.
c) A government regulatory agency sets a price ceiling of $7. Calculate (i) the quantity the firm produces at this price; (ii) the resulting profit.
QUESTION B2 CONTINUES ON NEXT PAGE
d) What price ceiling yields the largest level of output consistent with the firm's long- run survival? What is that level of output?
e) Compare the allocative efficiency of the results in (b), (c) and (d).
Section B: Analysis of a Business Press Article
Please read the attached three-page article "Cotton farmers hit hard as prices drop to lowest since 2009" Financial Times December 9, 2014 and discuss the following questions. Employ the tools of microeconomic analysis you consider appropriate, including references to relevant diagrams in the Course Notes (with an explanation what happens to the curves in the diagram and why). No numerical answers are required.
a) The article says that a reduction in the price of cotton caused a fall in the revenues of cotton producers (farmers). What can you infer from this about the price elasticity of demand for cotton? Explain.
b) Assume that the Chinese government supports its cotton growers in the form of "minimum price support", i.e. imposition of a price floor on the price of cotton in China. With reference to a Course Notes diagram representing the Chinese domestic market for cotton, explain the consequences of imposition of the price floor.
c) Suppose that the Chinese government buys the difference between the quantity supplied by Chinese cotton farmers and the quantity demanded by Chinese consumers at the price floor and sells it on the world market. With reference to a suitable diagram in the Course Notes, explain the consequences of this action for the world market for cotton.
d) Consider a two-part diagram (make reference to relevant diagram(s) in Course Notes) where one part represents the world market for cotton and the other part represents a typical cotton grower (farmer) in Zambia. Keep in mind that the world market price fluctuates due to changes in the weather as well as changes in government spending on agricultural support programs (see graph in the article).
- What is the likely response of a typical Zambian cotton grower to the developments in part (c) in the short run?
- In the long run?
e) Consider a similar two-part diagram as in (d), where one part represents the world market for cotton and the other part represents a typical cotton grower (farmer) in the United States.
- Suppose that the farmer receives government support in the form of "direct payments" per acre of land, independent of the amount of cotton produced. What is the impact of this type of support on (i) the quantity produced by a typical farmer? (ii) the farmer's profit? Explain.
- Suppose instead that the farmer receives government support in the form of subsidies for crop insurance per pound of cotton produced. What is the impact of this type of support on (i) the quantity produced by a typical farmer? (ii) the farmer's profit? Explain.
Cotton farmers hit hard as prices drop to lowest since 2009
Emiko Terazono and Gregory Meyer Financial Times December 9, 2014
Evelyn Nguleka fears for Zambia's cotton growers. The head of the farmers union in the southern African country says a dramatic fall in incomes as prices plummet to a five-year low is causing serious pain in a sector that employs 21 per cent of the population. Life is becoming "increasingly difficult", she says.
Almost 9,000 miles away in the US state of Texas, Steve Verett of Plains Cotton Growers, a local farmer association, echoes Ms Nguleka's fears. "We're strictly at the mercy of the market," he says. "It's going to be very difficult for cotton producers going forward at these price levels."
Plentiful global supplies, thanks to favourable weather and market distortions caused by a large-scale Chinese support programme for its growers, have driven prices below 60 cents a pound this year - the lowest levels since 2009 - hitting farmers around the world. And with China, the world's largest importer, dictating the market to farmers in rich and poor countries alike, "we are more or less price takers", says Ms Nguleka.
But the big difference between growers in wealthy regions such as Texas and the likes of Zambia's smallholder farmers is that those in richer countries have a safety net, in the shape of generous government subsidies.
Cotton growers are among the most heavily supported of the world's farmers, "along with the rice pudding commodities of rice, milk and sugar", says William Martin, research manager, agriculture and rural development at the World Bank. As a result the commodity has frequently been at the centre of trade disputes between producing countries.
Government subsidies, including direct production support, border protection, crop insurance and minimum price support, totalled $6.5bn in 2013-14 according to the International Cotton Advisory Committee, an intergovernmental organisation.
America's 18,000 cotton farms are covered by crop insurance programmes based on prices prevailing in futures markets. Next year, US farm legislation will end "direct payments" for cotton and other growers, which aroused resentment because farmers received them whether they planted a crop or not.
But in 2013-14 the country's farmers received $453m in subsidies for crop insurance premiums, according to the ICAC. The insurance programme will expand under the new farm law, although other subsidies will dry up.
China's farmers received direct support to the tune of $5.1bn in 2013-14, the ICAC says.
Jose Sette, ICAC's executive director, is to some degree sympathetic to governments that support their farmers. "We do understand the pressure governments feel. They want to protect what is many ways the weakest link in the supply chain, which is the grower," he says.
But, he warns, subsidies provide incentives that distort the market and end up harming farmers. "Subsidies reduce the pain in the short term at the cost of prolonging price weakness. There is no free lunch here."
The main cause of the low cotton price is the fallout from China's support programme for its growers. Under the scheme, which ran from 2011 until this year, the government purchased cotton from farmers at a set price, building up a massive stockpile - the country's reserves have risen almost sixfold since 2010 and it holds 60 per cent of the world's cotton inventories. Earlier this year it replaced the scheme with subsidies and has since both curbed imports and begun pushing its cotton reserves on to the market at reduced prices.
Analysts fear that falling prices, which have triggered price support programmes in other producing countries such as Pakistan and India, could further increase global inventories.
For prices to recover, global production needs to be cut and the massive stockpile run down, industry experts warn. "We have to expect a period of low prices until we work through this stock situation," says Mr Sette.
But a prolonged period of low prices will hit low-income nations hardest. Cotton is one of the most important crops in sub-Saharan Africa, with some 15m people
in the region directly dependent on it. Some of the poorest countries on the continent rely on it for export revenues.
Back in Zambia, Ms Nguleka says the country's cotton farmers, bereft of the support received by their counterparts in richer nations, may be forced to seek alternatives. "The farmers in Zambia have to fend for themselves," she says. "They may switch from cotton to something else."
But Kelli Merritt, who farms 1,600 acres of cotton in west Texas and is president of CropMark Direct, a cotton merchant and broker, says that most farmers in the dryland areas of Texas do not have this option.
"In general in west Texas the crop is cotton," she says. "And the second crop is cotton. And the third crop is cotton."