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Economics 200 Problem Set 3 (Due at the beginning of class on December 3rd, 2008)

Question 1 The Wall Street Journal reported that more and more people are eating something other than turkey at Thanksgiving. In fact, Turtle Island Foods in Hood River, Oregon has started to make Tofurky, a vegetarian turkey substitute. So far, Tofurky sales are 35,000 birds and rising. a. Assume the turkey market is perfectly competitive. Show a typical turkey farm with typical cost curves that is in long run equilibrium, and any profits or losses it may be making. Show the corresponding overall equilibrium price and quantity in the competitive turkey industry. b. Show the short run impact of increasing demand for Tofurky meals on the profit of a turkey farm, and on the turkey market in general. What happens in the long run to both the representative farm and the market? c. The turkey lobby is extremely powerful in Congress. Congress levies an Aint No Turkey Tax on the manufacturers of tofu turkeys who were making profits in the short run. These manufacturers now begin making a loss after the tax. Graph the tofu turkey: what has happened to equilibrium price and quantity for the industry? What has happened to the profit maximizing price, quantity, and profit of companies like Turtle Island Foods? What happens in the long run? (You need to discuss the long-run changes, there is no need to graph them)

Question 2 Suppose that a natural monopolist was required by law to charge average total cost. On a diagram, label the price charged and the deadweight loss to society relative to marginalcost pricing.

Question 3 A large share of the world supply of diamonds comes from Russia and South Africa. Suppose that the marginal cost of mining diamonds is constant at $1,000 per diamond, and the demand for diamonds is described by the following schedule: Price $8,000 $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 Quantity 5,000 diamonds 6,000 7,000 8,000 9,000 10,000 11,000 12,000

a. If there were many suppliers of diamonds, what would be the price and quantity? b. If there were only one supplier of diamonds, what would be the price and quantity? c. If Russia and South Africa formed a cartel, what would be the price and quantity? If the countries split the market evenly, what would be South Africas production and profit? What would happen to South Africas profit if it increased its production by 1,000 while Russia stuck to the cartel agreement? d. Use your answer in part (c) to explain why cartel agreements are often not successful.

Question 4 The makers of Tylenol pain reliever do a lot of advertising and have loyal customers. In contrast, the markers of acetaminophen do no advertising, and their customers hop only for the lowest price. Assume that the marginal costs of Tylenol and generic acetaminophen are the same and constant. a. Draw a diagram showing Tylenols demand, marginal-revenue, and marginal-cost curves. Label Tylenols price and markup over marginal cost. b. Repeat part (a) for a producer of generic acetaminophen. How do the diagrams differ? Which company has a bigger markup? Explain. c. Which company has the bigger incentive for careful quality control? Why?