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PGP 2016: Problem Set 2

Firms in Monopoly & Oligopoly

1. A monopolist's demand curve is given by P = 500 2Q. The rm's current price is $300
and the rm sells 100 units of output per week.
(a) Calculate the rm's marginal revenue at the current price and quantity using the
expression for marginal revenue that utilizes the price elasticity of demand.
(b) Assuming that the rm's marginal cost is zero, is the rm maximizing prot?
2. Tinkerbell has a monopoly on formal gowns in the local market. She is currently charging
$250 per gown and sells 20 in a month. The elasticity of demand is -1.5 at this price and
output level. What must be Tinkerbell's marginal cost of the last gown produced if she
is maximizing prots?
3. Puggy's telecommunications rm has a monopoly in the local market. The elasticity of
demand is 4 at every price (Note: Demand is not linear.). Puggy's marginal costs are
constant at $0.90. If Puggy is maximizing prots, calculate the price she is charging. If
the local community institutes a $0.10 tax on each unit Puggy sells, calculate the new
price Puggy will charge consumers. What portion of the tax does Puggy absorb?
4. Huckleberry's Bait Shop has a monopoly on the bait market at Mississippi River. The
demand curve for bait is QD = 56 8P . This implies the marginal revenue function
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is M R(Q) = 7 14 Q. Huckleberry has two employees he can use to search for bait Miss Watson and Tom. The marginal cost of using Miss Watson to search for bait is
M CW (QW ) = 14 QW . The marginal cost of using Tom to search for bait is M CT (QT ) =
3
8 QT .

Determine how many units of bait each employee should gather. What is the price

Huckleberry receives for selling the bait?


5. The CFA Corporation provides accounting services to a wide variety of customers and
faces the following demand and marginal revenue curves: P = 10, 000 10Q and M R =
10, 000 20Q. CFA's marginal cost of service is M C = 5Q.

(a) If CFA charges a uniform price for a unit of accounting service, Q, what price must
it charge per unit, and how many units must it produce per time period in order to
maximize prot? Calculate the consumer surplus.
(b) If CFA could enforce rst-degree price discrimination, what would be the lowest
price that it would charge and how many units would it produce per time period?
(c) With perfect price discrimination and ignoring any xed cost, what is total prot?
How much additional consumer surplus is captured by switching from a uniform
price to rst-degree price discrimination?
6. The Catawba River City Park has a low demand D1 during work days, but on Saturday
and Sunday demand increases to D2 on Saturday and Sunday. The demand and marginal
revenue functions are:
D1 = P1 = 2 0.001Q1
M R1 = 2 0.002Q1
D2 = P2 = 20 0.01Q2
M R2 = 20 0.01Q2

where Q = number of cars entering the park each day. The marginal cost of operating
the park is the same on weekdays and weekends and is given by M C = 1 + 0.004Q.
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(a) In order to control crowds, the park's management uses peak-load pricing. This
scheme controls crowds and makes sure the park is self-supporting. Calculate the
appropriate prices to charge, and determine the number of cars entering the park,
Q1 and Q2 .

(b) Explain how switching from a uniform pricing scheme to a peak load pricing scheme
aects the market.
7. Shooting Star Books is a small publishing company that specializes in science ction
books. Like most publishers, Shooting Star releases new books in hard-cover form and
later releases paper-back versions of the books. The marginal cost of printing both types
of books is $2 per book, and Shooting Star maximizes prots by practicing intertemporal
price discrimination. The annual demand for recently released (hard-cover) books is
Q1 = 400 10P1 where quantity demanded is measured in thousands of books and

price is measured in dollars per book. The annual demand for the paper-back version of
previously released books is Q2 = 800 40P2 .
(a) What are the marginal revenue curves associated with the two demand curves for
books?
(b) What are the prot maximizing prices for hard-cover and paper-back books? What
are the quantities of books demanded at these prices for hard-cover and paper-back
books?
(c) Suppose the market demand for paper-back books shifts to Q2 = 150 100P2 .
How does this change aect the prot maximizing price and quantity in the paperback book market? Does this change aect the prot maximizing outcome in the
hard-cover book market?
8. Merriwell Corporation has a virtual monopoly in the ultra high speed computer market.
Merriwell has recently introduced a new computer that will be used by satellite instal3

lations around the world. The installations have identical demands for the computers.
Merriwell's managers have decided to lease rather than sell the computer, but they have
been unable to decide whether to use a single hourly rental charge or a two-part tari.
Under the two-part tari, users would be levied an "access charge" plus an hourly rental
rate. Merriwell's marketing sta estimates the demand and marginal revenue curves below for each potential user:
P = 45 0.025Q
M R = 45 0.05Q,

where P = price per hour of computer time, and Q = the number of hours of computer
time leased per month. Merriwell oers their users extensive maintenance assistance and
technical support. The rm's engineers estimate that marginal cost is $30 per computer
hour.
(a) Assuming that Merriwell chooses to set a single price, what are the rm's prot
maximizing price and output?
(b) Assuming that Merriwell uses a two-part tari, what "access charge" and hourly
rental fee should the rm set? Compare the rm's revenues under the options in (a)
and (b).
(c) Briey describe how diering demand curves among the various buyers would alter
the two-part tari.
9. Luna Lovegood's fashion boutique sells earrings and pendants. Luna has two types of
customers. Their willingness-to-pay for earrings and pendants are given in the table
below. If Luna bundles the earrings and pendants together, could she increase revenue?
Earrings Pendants
Type I

100

65

Type II

90

75

10. Suppose that the market demand for good that can be produced at no cost is given as
follows P = 1200 Q.
(a) What will be the prot maximizing level of output and price for a monopolist?
(b) What level of output would be produced by each rm in a Cournot duopoly in the
long run? What will the price be?
(c) What will be the level of output and price in the long run if this industry were
perfectly competitive?
11. The market for an industrial chemical has a single dominant rm and a competitive fringe
comprised of many rms that behave as price takers. The dominant rm has recently
begun behaving as a price leader, setting price while the competitive fringe follows. The
market demand curve and competitive fringe supply curve are given below. Marginal
cost for the dominant rm is $0.75 per gallon.
QM = 140, 000 32, 000P
QF = 60, 000 + 8, 000P

where QM = market quantity demanded, and QF = the supply of the competitive fringe.
Quantities are measured in gallons per week, and price is measured as a price per gallon.
(a) Determine the price and output that would prevail in the market under the conditions described above. Identify output for the dominant rm as well as the competitive fringe.
(b) Assume that the market demand curve shifts rightward by 40, 000 units. Show that
the dominant rm is indeed a price leader. What output (leader and follower) and
market price will prevail after the change in demand?
12. Consider two identical rms (no. 1 and no. 2) that face a linear market demand curve.
Each rm has a marginal cost of zero and the two rms together face demand P =
50 0.5Q, where Q = Q1 + Q2 .

(a) Find the Cournot equilibrium Q and P for each rm.


(b) Find the equilibrium Q and P for each rm assuming that the rms collude and
share the prot equally.
(c) Contrast the eciencies of the markets in (a) and (b) above.
13. The demand for on-line brokerage services is QD = 6, 500 100P (P = 65 0.01QD ). If
the on-line brokerage rms collude, the collusive marginal revenue function is M R(Q) =
65 0.02Q. The brokerage rm specic marginal cost functions are:
M C1 (q1 ) = 1.5q1 ,
M C2 (q2 ) = 2.0q2 ,
M C3 (q3 ) = 2.5q3 ,
M C4 (q4 ) = 3.0q4 .

Calculate the collusive output level and market price. If the brokerage rms behaved
competitively and each rm set its own marginal cost equal to price, what would be the
output level and market price?
14. Lambert-Rogers Company is a manufacturer of petrochemical products. The rm's research eorts have resulted in the development of a new auto fuel injector cleaner that
is considerably more eective than other products on the market. Another rm, G.H.
Squires Company, independently developed a very similar product that is as eective
as the Lambert-Rogers formula. To avoid a lengthy court battle over conicting patent
claims, the two rms have decided to cross-license each other's patents and proceed with
production. It is unlikely that other petrochemical companies will be able to duplicate
the product, making the market a duopoly for the foreseeable future. Lambert-Rogers
estimates the demand curve given below for the new cleaner. Marginal cost is estimated
to be a constant $2 per bottle.
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Q = 300, 000 25, 000P

where P = dollars per bottle and Q = monthly sales in bottles.


(a) Lambert-Rogers and G.H. Squires have very similar operating strategies. Consequently, the management of Lambert-Rogers believes that the Cournot model is
appropriate for analyzing the market, provided that both rms enter at the same
time. Calculate Lambert-Rogers' prot-maximizing output and price according to
this model.
(b) Lambert-Rogers' productive capacity and technical expertise could allow them to
enter the market several months before Squires. Choose an appropriate model and
analyze the impact of Lambert Rogers being rst into the market. Should LambertRogers hurry to enter rst?
15. Two competing rms, A and B, produce a homogeneous good and both have a marginal
cost of MC = $100. Comment on what would happen in the following scenarios if both
rms are in Bertrand equilibrium.
(a) Marginal cost of rm A doubles.
(b) Marginal cost of both rms increases.
(c) Demand curve shifts to the right.