Industrial Organization For Business Decisions

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The Problem Set is due in 6 hours. Total of 3 Questions

1. Decide whether each of the following statements is True, False, or Uncertain, and give a brief but clear explanation why.

a. Due to particularly warm summer in Massachusetts, demand for air conditioners has increased for any given price. The upward-sloping supply curve has stayed unchanged.

Producer surplus will increase.

b. The long-run supply of rental apartments is upward sloping. A rent control policy that lowers rents below the free-market level will result in deadweight loss in the long run.

2. An econometric analysis of gasoline price data provided the following demand estimates, where log represents the natural logarithm:

Short run: log Qgasoline = 5 – 0.08 log Pgasoline

Long run: log Qgasoline = 5 – 0.6 log Pgasoline

a. -0.08 is the short-run price elasticity of demand for gasoline. What does this mean in words?

b. Does it make sense that the long-run elasticity is different from the short-run elasticity?

c. What does this imply for the volatility of gasoline prices in the short-run vs. the long run in response to oil price shocks?

3. In the competitive market for gasoline in Newton, supply and demand are given by:

Qd = 4 – (1/3)*P

Qs = -1 + P

where Q is the number of thousands of gallons per day, and P is the price per gallon in dollars

a) Calculate the consumer surplus and producer surplus at the equilibrium.

b) Now, suppose that the government subsidizes gasoline by paying retailers $1.00 for each gallon sold.

What will be the new equilibrium price paid by consumers and quantity bought?

Calculate the deadweight loss, if any.

4. “Alusaf has an 11% cost of capital and is considering a $1.6b investment today. If it goes ahead, aluminum production will begin in three years. Suppose that the price of Aluminum and the projected costs would be stable indefinitely from that point onward. What aluminum price would you need for the Hillside project to have a positive net present value (NPV)?1 Explain.” (interest rate is the cost of capital of r=11%)

State all assumptions made, and show the formula or method you use to calculate your answer.

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