The following is a free response question released by the College Board from a p
ID: 1144630 • Letter: T
Question
The following is a free response question released by the College Board from a previous AP exam to be used as practice for future exams. Answer each part of the question in the document below. When you are done, submit the assignment for grading by your instructor. This question will be graded out of 10 points.
1. The graph below shows the demand and cost curves of a firm that does not price discriminate.
(a) Suppose the firm produces at the profit-maximizing output. Using the labeling on the graph, identify each of the following.
(i) Level of output. Explain.
(ii) Price
(b) Suppose the firm produces at the revenue-maximizing output. Using the labeling on the graph, identify each of the following.
(i) Level of output. Explain.
(ii) Price
(c) Suppose the government regulates the firm’s price to produce the allocatively efficient level of output. Using the labeling on the graph, identify each of the following.
(i) The price the government would require the firm to set
Marginal Cost Average Total Cost P4 Demand Marginal Benefit 0 OUTPUT Marginal RevenueExplanation / Answer
1.(a).(i). Firm produces maximum profit when the following two conditions are satisfied :
where MC is marginal cost and MR is marginal revenue .
In the given graph point h satisfies the above conditions.
Therefore level of output is Q2 .
(ii). Price is obtained from demand curve .Therefore at Q2 output price is P5 (point b). Hence price is P5.
(b). (i).The condition for revenue maximisation is : MR=0 . MR=0 when output is Q3.
(ii).At Q3 price is P3. (P3,Q3) is the point d on demand curve.
(c). Government has two ways of setting Price .
First way is putting P=AC ( i.e set price at the level of AC ) . Point d(P3,Q3) is the corresponding point (where demand curve and TAC curve meets).
Second way is when price is set at the level of MC ( putting P=MC). Point g(P1,Q4) is the point where demand curve and marginal cost curve intersects.
Since Q4>Q3 therfore second way is considered . Hence price is P1.
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