NCEA Level 3 Economics 91400 Structures free practice questions with answers

Question 1 (21 marks) [Monopoly]

(a) A monopoly sells a regional airport. Graph One shows its demand (AR), marginal revenue (MR), marginal cost (MC) and average cost (AC) curves. The profit-maximising price and quantity are marked Pm and Qm, and two areas are lettered. Using the labels and letters on Graph One, state: (i) the area of supernormal profit; (ii) the area of deadweight loss; (iii) whether Pm is above, below or equal to MC at Qm. Cost / Revenue / Price ($) Quantity AR MR MC AC A B Qm Pm Graph One: A monopoly (the monopolist’s revenue and cost curves)

(a) Answer: (i) A; (ii) B; (iii) Pm is above MC (P > MC)

• Evidence level: Achieved (reads the profit and deadweight-loss areas and compares price with marginal cost).

• Supernormal profit is the rectangle between price Pm and average cost AC at Qm, out to Qm: area A.

• Deadweight loss is the triangle between AR (demand) and MC for the units between Qm and the output where AR = MC: area B.

• At Qm the price Pm is above MC (MC is read from the MC curve directly below the point on AR), so P > MC.

(b) The monopoly’s demand is P = 52 − 1Q and its total cost is TC = 19 + 22Q + 2Q², where Q is in thousand units and TC is in $ thousand. Use marginal analysis to find the profit-maximising output and price, then calculate total revenue, total cost and profit. State whether the profit is supernormal, normal or a loss.

(b) Answer: Qm = 5 thousand; Pm = $47; TR = $235 thousand; TC = $179 thousand; profit = $56 thousand (supernormal profit)

• Evidence level: Merit (derives MR and MC, sets MR = MC and finds revenue, cost and profit).

• MR = 52 − 2Q (twice as steep as demand) and MC = 22 + 4Q.

• Set MR = MC: 52 − 2Q = 22 + 4Q, so 6Q = 30 and Qm = 5 thousand.

• Price from demand: Pm = 52 − 1 × 5 = $47.

• Total revenue = 47 × 5 = $235 thousand. Total cost = 19 + 22 × 5 + 2 × 5² = $179 thousand.

• Profit = 235 − 179 = $56 thousand: this is supernormal profit.

(c) Explain why the monopoly produces Qm and not a higher or lower quantity, using marginal analysis, and explain whether the monopoly is allocatively efficient. Use your answers to the calculation and Graph One.

(c) Answer: MR = MC at Qm; P > MC so allocatively inefficient; deadweight loss $2.5 thousand

• Evidence level: Excellence (uses marginal analysis both sides of Qm and quantifies the inefficiency).

• Achievement: The monopoly produces where MR = MC because that maximises profit. It is allocatively inefficient because the price is above marginal cost.

• Merit: At Qm = 5 thousand, MR = MC = $42. Below Qm each extra unit adds more to revenue than to cost (MR > MC), so profit rises if output rises; above Qm each extra unit adds more to cost than to revenue (MR < MC), so profit falls. The price Pm = $47 is read from the demand curve, and it is above MC ($42).