Mid-Term Exam—Answer Sheet
Below you will find the answers to the mid-terms as well as a listing of some common
mistakes that students made in trying to answer the questions.
Problem #1. True, False, Uncertain
1a) FALSE. CD-RW disks are clearly not demand substitutes for CD-RW drives: people
will not switch from disks to drives when the price of disks goes up. (On the contrary,
these products are complements). They are also not supply substitutes neither: producers
of drives would not typically switch to the production of disks just because the price of
disks went up. (These are very different technologies, so drive producers are not the most
natural entrants in the disk market.)
(Note : given how little we focused on it in class, it is not necessary to talk about supply
substitutes to get full credit.)
Common Mistakes:
• CD-RW drives and disks are complements and therefore in the same market –
Not true, markets are not defined by complements but by substitutes. Although
when two products are complements (e.g. gas and cars) the markets are linked
the products are not in the same market because there is no supply or demand
substitutability.
• Two products are in the same market if they are demand substitutes –Partially
true, however it is better to state that two products are in the same market if
they are demand or supply substitutes.
1b) UNCERTAIN or FALSE, depending upon explanation. Optimal production will be
at the point where marginal cost equals marginal revenue. This will in general not be the
point of minimal average cost. It might be the point of minimal average cost by pure
coincidence: if the marginal cost, average cost, and marginal revenue curve all intersect
each other at the same point.
Common Mistakes:
• Marginal cost equals marginal revenue imply minimal average cost – Not true,
MC crosses the average cost curve at the minimum average cost point but this
does not mean that profits are optimized at that point. For example if at the
minimum average cost level, producing one extra unit generates more revenue
than cost (hence MR > MC) than the monopolist should produce this unit as it
will increase their profits even if this means higher average cost.
• In the long run a monopolist will produce at minimum average costs – Not
true, in the short as well as in the long run the monopolist optimizes its profit
by producing at the point where MR = MC and this does not imply lowest
marginal cost.
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