1. Explain and drive the Averch-Johnson effect. A politician claims that under this effect the ratio of a firm's marginal product of capital to its marginal product of non-capital inputs is higher than the relative prices of capital and non-capital inputs. Is he right? Explain.

2. Suppose an airline company (that acts to maximize its profit) sells seats to passengers (X) as well as cargo space for shipping large goods (Y). The cost functions for producing these two goods are = 1,000 + 30 and = 850 + 30. And if the firm produces both goods together, the cost function is = 1,600 + 30 + 30. If 75% of the common costs are used to produce X and 25% are used to produce Y, and demand for X and Y are = 100 and = 100 . What is the FDC price and quantity for good X?

3. Assume that a water distribution monopoly serves two consumers types, industrial and residential. The demands by the two classes are as follows. Industrial: Q=30-P, and residential: q=24-p. The company has no costs other than the fixed cost of the pipeline, which is $328. Find the Ramsey prices. Explain the characteristics of Ramsey prices.

4. Explain the industry structure of the oil industry? How is it different than the electricity industry structure?

5. Assume that a cogeneration heating distribution system can be constructed for $14600 per unit of capacity and can be operated at variable costs of $0 (heat is supplied by an industrial facility that operates 24 hours every day). Assume that during 8 hours of the day the on peak demand for heat is P=a-bQ. Assume that during the other 16 hours of the day (off-peak) the demand for heat is one-half of the demand during the peak period. Assume that the cost of capital, r, is 10% and that heating distribution system does not depreciate.

a. Assume on-peak demand is P=16-0.08Q, and off-peak demand is P=16-0.16Q. If the existing capacity (Q) were 120 units, what would be the socially optimal prices during the on-peak hours and during the off-peak hours?

b. What would be the optimal capacity? What would be the prices at this optimal capacity?