ECO 1201 : INTRODUCTION TO MICROECONOMICS
ASSIGNMENT THREE
QUESTION ONE
a) Describe the indifference curves associated with two goods that are perfect substitutes. What if they are
perfect complements?
Indifference curves represent the combinations of two goods that provide the consumer with the same
level of satisfaction.
Perfect Substitutes: For perfect substitutes, the indifference curves are straight lines. This indicates that
the consumer is willing to substitute one good for the other at a constant rate (e.g., 1:1). For example,
if you have two identical products, like two types of pens, the consumer would be indifferent between
them.
Perfect Complements: For perfect complements, the indifference curves are L-shaped, where the
consumer needs the goods in fixed proportions (e.g., 1 pair of shoes and 1 sock). The consumer would
not want more of one good without the exact amount of the other.
b) A monopolist is producing at a point at which marginal cost exceeds marginal revenue. How
should it adjust its output to increase profit?
When Marginal Cost (MC) exceeds Marginal Revenue (MR): The monopolist is producing too much
output. To increase profit, the monopolist should reduce output until MR equals MC.
c) Which of the following two statements involves positive economic analysis and which normative?
Explain your answer(s).
i) Gasoline rationing (allocating to each individual a maximum amount of gasoline that can be
purchased each year) is poor social policy because it interferes with the workings of the
competitive market system.
This statement is normative because it is a value judgment about the desirability of gasoline
rationing. It reflects an opinion about whether it is a good or bad policy.
ii) Gasoline rationing is a policy under which more people are made worse off than are made better
off.
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This statement is positive because it describes the actual consequences of gasoline rationing
(i.e., that more people are made worse off than better off). It can be tested or verified with data.
QUESTION TWO
The late Nobel laureate economist George Stigler wrote that the “purely ‘economic’ case against monopoly
is that it reduces aggregate economic welfare… when the monopolist raises prices above the competitive
level in order to reap his monopoly profits, customers buy less of the product, less is produced, and society
as whole is worse off.”
Draw a graph to summarize what Stigler said. Specifically, indicate in the graph the price that is
what Stigler refers to as “the competitive level.” Compare this price to the price at which the firm
earns “monopoly profits.
Use your graph to explain why society is worse off when a monopolist charges a price that earns
monopoly profits rather than when price is set at the “competitive level”.
At Competitive Level (P_C):
The price is equal to the marginal cost (P_C = MC), which means that the quantity produced (Q_C)
maximizes total welfare. Consumers are willing to pay a price equal to the cost of producing the
last unit, and all mutually beneficial trades occur.
At Monopoly Level (P_M):
The monopolist sets a higher price (P_M) and produces a lower quantity (Q_M). The price exceeds
the marginal cost (P_M > MC), leading to a deadweight loss. This deadweight loss represents the
loss of economic welfare because there are consumers who value the product more than its cost of
production but are unable to purchase it at the higher monopoly price.
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Societal Impact:
The reduction in quantity from Q_C to Q_M means that fewer transactions occur, leading to a loss
of consumer surplus and producer surplus. The area representing the lost welfare (the triangle
between the demand curve and the marginal cost curve from Q_M to Q_C) illustrates the
inefficiency created by monopoly pricing.
SUBMIT BY 5TH MARCH, 2025- 5.00PM
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