Question

Analyze if the statements that are presented below are True or False. You MUST justify your answer to get credit. Answers without justification (even if they are correct) will be given zero marks.

1. (a) In any Pareto-optimal allocation of a two-good economy, each consumer has to consume a positive amount of both goods.

2. (b) A monopolist never produces on the elastic segment of its average revenue curve.

3. (c) If a firm’s production exhibits increasing returns to scale, then the firm’s marginal costs are decreasing and below its average costs.

4. (d) Maroon Theater practices third-degree price discrimination and sells tickets to three groups of customers: students, regular customers and senior citizens. The inverse demand of the three groups is linear. Furthermore, the students’ and senior citizens’ elasticities of demand for tickets are −4 and −3, respectively. Because the price charged to regular customers is greater than the price charged to senior citizens, we know with certainty that the ticket price for students will be lower than the ticket price for regular customers.

Answer 1

a) True

In a pareto optimal allocation, we can see an optimal allocation between both the goods such that neither of their individual allocations can be better off without affecting the other good. If allocation is negative (practically not possible), both the goods have a chance to move on to positive allocations which means that this isn't a pareto allocation in the first place. Therefore the goods consumed need to be positive in order to satisfy the pareto optimal condition.

b) False

A monopolist would not want to produce in inelastic segment of the demand curve. In an elastic segment, a small decrease in the price could result in a significant surge in demand, meaning the total revenue will rise. Therefore, monopolist will only be interested to produce in the elastic segment.

c) True

If a firm's experiencing increasing returns to scale, it essentially means that there is a more than proportional increase in output than the increase in inputs. In the long run, this means that the marginal cost decreases and is below the average cost. This is because in increasing economies of scale, producing an additional unit costs less, but that doesn't essentially mean the labor, capital, etc decreases as well. So, the fixed costs remain the same. Therefore, the average total cost decreases by very less amount as compared to marginal cost. Therefore MC is less than ATC.

d) False

From the elasticities of student and senior citizens, we see that students demand is more elastic which means that they are intially charged higher prices than Senior citizens and a small increase in price affects the demand. But since the elasticity of regular customers are not given, we can't certainly say student charges are higher or not.

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