Price Theory Study Questions set#4 MONOPOLY AND RELATED DISCUSSIONS 1.

Consider the following inverse demand curve faced by a monopolist: P= 100 -Q. a. Find the marginal revenue curve for the monopolist. b. At what quantity is total revenue maximized? c. If MC and AC are constant at $20, then what is the profit-maximizing output for a monopoly? What is the monopoly price?monopoly profit? d. How would your answer to part (c) change if a $10 per unit tax was imposed on the monopolist? Is the monopolist able to pass on all of the tax to consumers? Explain. e. What would be the P and Q in a competitive industry? f. Find consumer and producer surplus for a competitive industry and a monopoly. How do they compare? 2. True or false, explain. a. A monopolist can sell all that it wants at whatever price it wants. b. A monopolist necessarily makes a positive economic profit. c. The quantity at which TR is maximized is greater than the quantity at which total profit is maximized. d. a change in fixed costs does not change the quantity at which monopoly profit is maximized in the short run. e. A operates on the inelastic segment of its demand curve. (Use graph to explain.) 3. A movie studio pays its star actors 10% of total revenue. Who has the incentive to charge the highest price for a movie ticket---the studio or the stars? Explain. 4. A price-discriminating monopolist faces the following inverse demand functions: In Market One it is P1 = 20-Q1 where P1 is the price charged in Market 1 and Q1 is the quantity demanded in Market one. In Market Two it is P2 = 15-1.5Q2 where P2 is the price charged in Market 2 and Q2 is the quantity demanded in Market Two. Marginal cost is constant at $5. Find the profit-maximizing quantity and price charged in each market. Calculate profit in each market and joint profit. What would this firms price, quantity and profit be if it were constrained to charge the same price to all consumers? Show this outcome on a graph. 5. question deleted 6. Consider the following inverse demand function: P = 10 Q. Marginal cost is constant at $2. a. Find the TR and MR functions under perfect-price discrimination. What is profit-maximizing quantity? What is profit? b. The perfect-price discrimination outcome can be attained by an all-or-nothing packaging scheme. Explain how. 7. question deleted 8. a. What conditions make price discrimination possible? b. A monopoly can sell its good in the US, where the elasticity of demand is -2, and in South Korea, where the elasticity of demand is -4. Its marginal cost is $10. At what price does the monopoly sell its good in each country if resales are not possible?

ANSWERS 1. a. First, multiply each side of the inverse demand function by Q. This gives us the TR function: TR= PQ = 100Q - Q2. Next, take the derivative with respect to Q to get the MR function: dTR/dQ = MR = 100-2Q. (or you can use the rule that for any linear demand curve P = a bQ the marginal revenue curve is MR = a 2bQ. ) b. TR is maximized when MR equals zero. Therefore, set the MR function equal to zero and solve for Q: MR = 100-2Q = 0. This gives us Q = 50.

c. Set MR equal to MC and solve for Q: 100-2Q = 20 which gives us Q = 40. To find price, plug Q=40 into the inverse demand function and solve for P. P = 100-40= $60. Profit= (P-AC)(Q)=(60-20)(40)= $1,600. d. MC = $20 + excise tax = $30. Follow the same steps as in part (c ) to get: Q=35,P=$65, and profit of $1,225. No, the monopolist is not able to pass on ALL of the tax. Price increases by $5 which is less than the $10/unit tax. e. In a competitive economy, P = MC (that is, competitive output occurs where the MC curve crosses the demand curve). To find, competitive quantity, set the inverse demand function equal to MC and solve for Q. So 100-Q = 20 which gives us Q = 80. P =MC = 20. f. Competitive Industry Monopoly Change Consumer Surplus 0.5(100-20)(80)=$3,200 0.5(100-60)(40)=$800 -$2,400 Producer Surplus 0 (60-20)(40)=$1,600 +$1,600 Social Total $3,200 $2,400 -$800 Monopoly leads to a deadweight loss of $800. 2a. False. A monopolist faces a downward-slopping demand curve. Hence, an increase in price means a drop in quantity sold. 2b. False. If the short-run AC curve lies everywhere above the demand curve, then the monopolist will incur losses. (NOTE: If the AC curve lies everywhere above the demand curve, the monopolist may still be able to make a positive profit by engaging in perfect-price discrimination). 2c. This is true as long as MC is positive. Profits are maximized at the quantity where MR=MC, and if MC is greater than zero, then so must MR>0. On the other hand, TR is maximized at the quantity where MR=0. This quantity is necessarily greater than the profit-maximizing quantity (as long as MC>0). 2d. True. a change in fixed costs does not change MC and therefore does not change the Q at which MR equals MC. 2e. False. A monopolist operates on the elastic segment ( e >1) of its demand curve. The elastic segment of its demand curve corresponds to MR > 0, and since profits are maximized at MR = MC and MC > 0 it follows that MR > 0 at the quantity the monopolist produces. If the monopolist was operating in the region of MR < 0 (that is, where e < 1), then it could increase TR by raising price. As it raises price, quantity demanded falls and therefore TC falls (firm is producing fewer units). With TR rising and TC falling then profit must be rising. 3. The movie stars would want to maximize TR since their payments equal 0.1TR, whereas the studio desires to maximize profit. The quantity at which TR is maximized is greater than the quantity at which profit is maximized (see 2c), and therefore the price would be lower at this TR-maximizing Q. 4. The firm maximizes profit by producing where MR =MC in EACH market. First, find the MR function for each market: TR1=20Q1-Q12 which gives us MR1 = 20-2Q1. For market two: TR2=15Q2-1.5Q22 which gives us MR2 = 15-3Q2. Second, set MR equal to MC and solve for quantities. Market One: 20-2Q1 = 5 which gives us Q1 = 7.5, and Market Two: 15-3Q2 = 5, which gives us Q2= 3.33. Third, plugging these quantities into the demand function gives us prices. P1 = 20-7.5 = $12.5 and P2 = 15-1.5(3.33)= $10. 1= (12.5-5)(7.5) = $56.25. 2=(10-5)(3.33) = $16.67. joint = $56.25+$16.67=$72.92. First, we need to find the market demand curve by horizontally adding the individual demand curves. To do this we must solve for quantity for each buyer: Q1=20-P and Q2 = 10-2/3P. Next, Q = Q1+ Q2 =(20-P)+(10-2/3P)=30-(5/3)P. After doing this, we re-solve for P so that P = 18-(3/5)Q. This allows us to write the market MR equation as MR = 18-(6/5)Q. (NOTE: Given the constraint that the price must be the same for both groups of buyers, you CANNOT get the market MR curve be horizontally summing the individual MR curvesdoing this implicitly assumes that the MR in each market will be the same at the profit-maximizing solution. But this would not be true if the price is the same in each market. That is why you must first derive the market demand curve and then get the MR curve from that.) Second, set MR = MC and solve for Q. 18-(6/5)Q=5, and so Q 10.833. Third, Plug Q = 10.833 into market demand curve to get price. P =18-(3/5)(10.833) $11.50. Fourth, find profit. Profit = (11.50-5)(10.833) = $70.42. 5. answer deleted

6.a. Under perfect price discrimination, total revenue equals the entire under the demand curve up to the quantity sold, so TR = 10-Q dQ = 10Q 0.5Q2 . MR = dTR/dQ = 10 Q. Setting MR = MC 10 Q = 2, or Q =8. Profit is TR TC = 10(8) 0.5(8)2 (2)(8) = $32. b. Require the consumer to purchase the good in a package of 8 units or not at all. The all-or-nothing price equals average revenue at a quantity of 8 units AR = 10 0.5Q = 10- 0.5(8) = $6. So the price of a package of 8 units is $6*8= $48. Profit = $48 - $16 = $32. 7. answer deleted 8. a. First, the firm must have some degree of market power, b. Resale of the good must be difficult, and c. The firm must be able to identify (or the consumers have to implicitly identify themselves) the different groups of buyers that it wants to price discriminate against. b. PUS = MC/[1+ (1/eUS)] = $10/[0.5] = $20 and PSK = $10/[0.80] = $13.33 $/unit 2e. With MC > 0, then MR>0 by profit maximization (MR =MC). absolute value of e > 1 e = 1 e < 1 D MR Quantity

Question 4 :Same price to all consumers. $20 P=20-Q (for P>$15) $15 P=18-(3/5)Q (for P<$15) $12 P=$11.50 Dmkt. $10 $5 MRmkt MR=18-(6/5)Q MC

10.833

Note: Because there is a kink in the market demand curve, there will be a discontinuity in the market MR curve.

$ per unit 10

Question 6. Perfect Price Discrimination

Pall-or-nothing = $6

$2 D = MR 8

MC AR Q