ECON 310-1: Microeconomic Theory Northwestern University, Winter 2017

Professors James A. Hornsten and Ronald R. Braeutigam

Problem Set #9. Monopoly and Monopsony

1) Do B&B Problem 11.11 (profit maximization, IEPR)

2) Do B&B Problem 11.13 (jumpy MC)

3) Do B&B Problem 11.18 (IEPR)

4) Do B&B Problem 11.28 (monopsony)

5) Do B&B Problem 11.29 (monopsony)

Solutions to Problem Set #9. Monopoly and Monopsony

11.11. Assume that a monopolist sells a product with a total cost function TC = 1,200 +
0.5Q2 and a corresponding marginal cost function MC = Q. The market demand curve is
given by the equation P = 300 - Q.
a) Find the profit-maximizing output and price for this monopolist. Is the monopolist
profitable?
b) Calculate the price elasticity of demand at the monopolists profit-maximizing price. Also
calculate the marginal cost at the monopolists profit-maximizing output. Verify that the
IEPR holds.

a) If demand is given by P = 300 Q then MR = 300 2Q . To find the optimum set

MR = MC .
300 2Q = Q
Q = 100

At Q = 100 price will be P = 300 100 = 200 . At this price and quantity total revenue will be
TR = 200(100) = 20,000 and total cost will be TC = 1200 + .5(100)2 = 6, 200 . Therefore, the
firm will earn a profit of = TR TC = 13,800 .

b) The price elasticity at the profit-maximizing price is

 Q P
Q,P =
P Q

With the demand curve Q = 300 P , Q

P = 1. Therefore, at the profit-maximizing price

200
Q , P = 1
100
Q , P = 2

The marginal cost at the profit-maximizing output is MC = Q = 100. The inverse elasticity
pricing rule states that at the profit-maximizing price

P MC 1
=
P Q,P

In this case we have

200 100 1
=
200 2
1 1
=
2 2

Thus, the IEPR holds for this monopolist.

11.13. A monopolist serves a market in which the demand is P = 120 - 2Q. It has a fixed cost
of 300. Its marginal cost is 10 for the first 15 units (MC = 10 when 0 Q 15). If it wants
to produce more than 15 units, it must pay overtime wages to its workers, and its marginal
cost is then 20. What is the maximum amount of profit the firm can earn?

The marginal revenue curve is MR = 120 4Q. Initially we are not sure whether the optimal
quantity will be less than 15 units (in which case MC = 10), or more than 20 units (where MC =
20).
There are two regions of output:
Region I: where MC = 10 and 0 < Q < 15
Region II: where MC = 20 and 15 < Q
Lets assume that the MC = 10 and optimal quantity is less than or equal to 15 units. In that case,
setting MR = MC, we find that 120 4Q = 10, or that Q = 27.5. But when Q = 27.5, MC is not
10, so the assumption that the optimal quantity is in Region I is not correct.
Now lets assume that the MC = 20 and optimal quantity is greater than 15 units. In that case,
setting MR = MC, we find that 120 4Q = 20, or that Q = 25. When Q = 25, MC is 20, so that
marginal cost we have assumed is correct at the optimal output level we have calculated. The
market price is P = 120 2(25) = 70.
Revenue = PQ = 70(25) = 1750
Variable cost = 10(15) + 20 (25 15) = 350
Fixed Cost = 300
Profit = 1750 350 300 = 1100.
11.18. Suppose a monopolist has an inverse demand function given by P = 100Q-1/2. What is
the monopolists optimal markup of price above marginal cost?

Remember that the demand elasticity in a constant elasticity demand function is the exponent on
P when the demand function is written in the regular form, i.e. Q = f (P).We can manipulate the
2 . This implies that
inverse demand function to get the regular demand function, Q = 10,000P
P MC 1
the demand elasticity is 2. Therefore, using the IEPR, = . So the optimal percentage
P 2
mark-up of price over marginal cost is , or 50 percent.

11.28. A coal mine operates with a production function Q = L/2, where L is the quantity of
labor it employs and Q is total output. The firm is a price taker in the output market, where
the price is currently 32. The firm is a monopsonist in the labor market, where the supply
curve for labor is w = 4L.
a) What is the monopsonists marginal expenditure function, MEL?
b) Calculate the monopsonists optimal quantity of labor. What wage rate must the
monopsonist pay to attract this quantity of labor?
c) What is the deadweight loss due to monopsony in this market?

a) For this monopsonist

w
MEL = w + L
L
MEL = 4 L + L(4)
MEL = 8 L

b) The monopsonist will maximize profit at the point where MRPL = MEL , where
Q
MRPL = P
L
Q
In this example, L = 0.5 , so MRPL = 0.5P . Since P = 32 , MRPL = 16 . Now setting
MRPL = MEL implies

16 = 8 L
L=2

At this quantity of labor, w = 4 L = 8 .

c) In a competitive labor market, w = MRPL. So the competitive supply of labor satisfies 4L

= 16 or L = 4, with w = 4L = 16. The deadweight loss due to monopsony is equal to area A in the
graph below, or 0.5(16 8)(4 2) = 8.
 w MEL = 8L
w = 4L
16 MRPL = 16
A

2 4 L

11.29. A firm produces output, measured by Q, which is sold in a market in which the price
P = 20, regardless of the size of Q. The output is produced using only one input, labor
(measured by L); the production function is Q(L) = L. There are many suppliers of labor,
and the supply schedule is w = 2L, where w is the wage rate. The firm is a monopsonist in
the labor market.
a) What wage rate will the monopsonist pay?
b) How much extra profit does the firm earn when it pays labor as a monopsonist instead of
paying the wage rate that would be observed in a perfectly competitive market?

a) The monopsonist will choose L so that the marginal expenditure on labor equals the marginal
revenue product of labor. Since the supply of labor is linear, the marginal expenditure will have
the same vertical intercept (zero in this case) and twice the slope of the supply curve. Thus, MEL
= 4L. The marginal revenue product of labor is just the market price (20) times the marginal
product of labor (1); so MRPL = 20. The monopsonist would hire labor so that 20 = 4L; thus, L =
5. The monopsonist will pay a wage rate on the supply curve, so w = 2(5) = 10.
(b) The monopsonist produces 5 units of output with the 5 units of labor it hires. Revenue = 20(5)
= 100.
Costs are wL= 10(5) = 50. So profit = revenue minus cost = 100 50 = 50.
By contrast, if it operated as a perfectly competitive firm, it would produce where the marginal
revenue product of labor (20) equals the wage rate on the supply curve for labor (2L), with L =
10.
With its 10 units of labor the firm would produce 10 units of out, and receive revenue or 20(10) =
200.
It would pay the wage rate = 2L = 2(10) = 20, so its cost would be wL = 20(10) = 200. Its profits
would be zero.
This the firm increases its profit by 50 by acting as a monopsonist.