Problem 2. Monopoly and Duopoly. (40 points). Initially there is one firm in a market for cars. The firm has a linear cost function: C(4) = 24. The market inverse demand function is given by P(Q) = 9 - Q. 1. What price will the firm charge? What quantity of cars will the firm sell? (8 points) 2. How much profit will the firm make? (4 points) 3. Now, a second firm enters the market. The second firm has an identical cost function. What will the Cournot equilibrium output for each firm be? (8 points) 4. What is the Stackelberg equilibrium output for each firm if firm 2 enters second? (7 points) 5. How much profit will each firm make in the Cournot game? How much in Stackelberg? (5 points) 6. Which type of market do consumers prefer: monopoly, Cournot duopoly or Stackelberg duopoly? Why? (8 points)EXERCISE Question 1 (Chapter 9 - Policy and Scenario Analysis with IS-LM-FE/AD-AS Framework) Suppose the economy is initially in its general equilibrium at full-employment output. Use the "Baseline" IS-LM-FE/AD-AS framework to graphically and qualitatively explain the following policies and scenarios. 1) "Short-run gain at a long-run pain" - An increase in government spending can only lead to a short-run increase in output, but ineffective in boosting the economy in the long run at the price of inflation. 2) "Money neutrality" - An increase in nominal money supply is effective only in the short run, but ineffective in boosting the economy in the long run. 3) A permanent negative long-run supply shock 4) A temporary negative supply shock 5) An increase in total factor productivity Suppose the economy is initially in its short-run equilibrium below the full-employment output. Draw the IS-LM-FE/AD-AS diagrams to the following stimulus policy to bring about full-employment output: 6) An increase in money supply (you can think of the recent quantitative easing) 7) An increase in government expenditure Question 2 (Chapter 10 - Temporary vs. Permanent Increase in Government Expenditure in Classical Analysis) CAUTION: Notice the differences between "Baseline" IS-LM and "Classical/RBC-styled" IS-LM! 1) Under the RBC framework, what is the channel by which an increase in government expenditure leads to an increase in full-employment level of output? Explain graphically and algebraically. 2) In RBC fashion, graphically explain the effects of temporary increase in government spending under the demand-supply in labor market, IS-LM-FE curves, and AD-AS curves. 3) Outline the main differences if the government expenditure increases permanently. (Hint: Chapter 3) Question 3 (Chapter 10 - Unanticipated vs. Anticipated Change in Money Supply in Classical Analysis) Assume the misperception theory in SRAS curve. 1) Graphically analyze the effect of an unanticipated increase in nominal money supply in IS-LM-FE and AD-AS diagrams. 2) Graphically analyze the effect of an anticipated increase in nominal money supply in IS-LM-FE and AD- AS diagrams. Question 4 (Chapter 10 - Deriving an AD Curve) Suppose the IS and LM curves are respectively given by: Y = 800 - 2000r 50000 Y = 100 + - P + 1000r Derive the equation for AD curve.EXERCISE Question 1 (Efficiency Wage) Suppose a firm observes the following relationship between the real wage and the effort exerted by its workers: Real Wage | Effort 14 10 12 14 16 46 18 51 The marginal product of labor is given by MPN = 260-2N 30 where E is the effort level and N is the number of employment. 1. If the firm can choose only one of the six wages above, what it should choose? 2. How many workers will it employ? 3. Suppose that there are 200 workers willing to work at a real wage of $8. What will happen to the number of workers employed by the firm? Question 2 (Numerical Example of IS-LM/AD-AS analysis with sticky price ) An economy is described by the following equations. Desired Consumption: C = 140 + 0.5(Y - T) - 250r Desired Investment: I'd = 120 - 250r Government Purchases: G = 0 Government Taxes: T = 0 Real Money Demand: L = 0.5Y - 1000r Nominal Money Supply: M = 1150 Full-Employment Output: Y = 500 Assume that the expected inflation is zero. 1. What are the values of r, P, Y, C, I, and L in long-run (full-employment) equilibrium? 2. Beggining in the full employent equilibrium in 1., suppose that the central bank increases the money supply by 75 so that now the money supply equals 1225. In the short run, the price level is fixed at the value we found in 1. What are the values of r, P, Y, C, I, and L in short run equilibrium? 3. Under M = 1225, what are the values r, P. Y, C, I, and L in long-run (full-employment) equilibrium? Question 3 (Keynesian IS-LM model) According to the Keynesian IS-LM model, what is the short run and long run effect of a wave of investor pessimism about the future profitability of capital on the following variables? The answer should be relative to the initial long-run equilibrium levels of each variable. . Output . Real Interest Rate . Employment . Price Level Question 3 (Keynesian IS-LM model) Consider an economy in which all workers are covered by contracts that specify the nominal wage and give the employer the right to choose the amount of employment. The production function is Y = 200VN and the corresponding marginal product of labor is MPN = 100 VN' 1. For a nominal wage of $10, what is the relationship between the price level and the amount of labor demanded by firms? 2. Using the same nominal wage, what is the relationship between the price level and the amount of output supplied by firms