Economic Applications 2018-2019

Week 4, Tutorial Sheet 3

This tutorial sheet is based around chapter 14 and 15 of Mankiw and Taylor “Economics” and the
corresponding lecture notes. Students are required to have read these chapters before the tutorial.
Your tutor may not have time to go over all questions in tutorial; however, students are responsible
for revising the answer sheets on their own time.

Chapter 14 of the textbook relates to monopoly, and chapter 15 relates to monopolistic competition.

Make sure you submit your homework to your tutor before the start of your tutorial.

1. A publisher faces the following demand schedule for the next novel of one of its popular authors:

Price (€) Quantity demanded

100               0

90 100,000

80 200,000

70 300,000

60 400,000

50 500,000

40 600,000

30 700,000

20 800,000

10 900,000

  0 1,000,000    

The author is paid €2 million to write the book, and the marginal cost of publishing the book is a
constant €10 per book.

a. Compute total revenue, total cost and profit at each quantity. What quantity would a profit-
maximising publisher choose? What price would it charge?
b. Compute marginal revenue. (Recall that MR = ΔTR/ ΔQ.) How does marginal revenue
compare to the price? Explain.
c. Graph the marginal revenue, marginal cost and demand curves. At what quantity do the
marginal revenue and marginal cost curves cross? What does this signify?
d. In your graph, shade in the deadweight loss. Explain in words what this means.
e. If the author were paid €3 million instead of €2 million to write the book, how would this
affect the publisher's decision regarding the price to charge? Explain.
f. Suppose the publisher was not profit-maximising but was concerned with maximizing
economic efficiency. What price would it charge for the book? How much profit would it
make at this price?

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2. Explain what is meant by price discrimination and give an example. Discuss how the concept of
perfect price discrimination can help a monopolist firm to extract maximum profit from its
consumers. How realistic is this concept?

3. Consider the delivery of mail. In general, what is the shape of the average total cost curve? How
might the shape differ between isolated rural areas and densely populated urban areas? How might the
shape have changed over time? Explain.

4. Sparkle is one firm of many in the market for toothpaste, which is in long-run equilibrium.

a. Draw a diagram showing Sparkle's demand curve, marginal revenue curve, average total cost
curve and marginal cost curve. Label Sparkle's profit-maximizing output and price.
b. What is Sparkle's profit? Explain.
c. On your diagram, show the consumer surplus derived from the purchase of Sparkle
toothpaste. Also show the deadweight loss relative to the efficient level of output.
d. If the government forced Sparkle to produce the efficient level of output, what would happen
to the firm? What would happen to Sparkle's customers?

5. Discuss what is meant by contestable markets and explain how firms may deviate from profit-
maximising behaviour?

6. Discuss the costs and benefits to society of advertising.