Question 1

(a) The following table shows the willingness to pay of three consumers for two different products 1 and 2.

Willingness to Pay

Product 1

Product 2

Consumer A

$40

$200

Consumer B

$120

$120

Consumer C

$200

$40

The marginal cost of producing each product is a constant $60.

Compare and contrast the prices and maximum profits earned from:

(i) selling the goods separately,

(ii) pure bundling, and

(iii) mixed bundling.

All workings must be shown.

(15 marks)

(b)Firms in a competitive market face a market demand curve given by the equation P = 100 - Q and an industry marginal cost curve given by the equation MC = 10 + Q.

In the process of production these firms generate noxious fumes into the atmosphere harming the living standards of nearby residents. The marginal external cost curve (MEC) is given by the equation MEC = Q.

What is the socially efficient level of output for this market? Calculate the per-unit tax that the government should impose on these firms to provide for this socially efficient level of output.

Calculate the deadweight loss of efficiency in resource allocation from a social viewpoint that would be generated if this market were not regulated.