MUHAMMAD FAWAD

51320

QUESTION 01

ANSWER
Based on our demand curve, when DeBeers decreases its prices two things happen – DeBeers
loses money on the 80 million Carats of diamonds they were originally selling, but they also gain
from 40 million new Carats they are able to sell. Calculating the areas of the increase and the
decreases, we find that they are both equal to $64,000.

QUESTION 02
ANSWER

A monopolist charges the highest price possible where MR = MC. Here, that occurs at a quantity
of 65 million Carats and a price of $2,700.

QUESTION 03

ANSWER

We can do both number 3 and 4 together on the graph below. Calculating the areas:

Monopoly (graph on right)

Producer Surplus (yellow area):

(2,700 – 1,300)(65) + (1300−0)(65)2(1300−0)(65)2
=$133.25 billion

Consumer Surplus (blue area):

(4000−2700)(65)2(4000−2700)(65)2

=$42.25 billion

Market Surplus (blue + yellow):

$133.25 billion +$42.25 billion

=$175.5 billion

QUESTION 04

ANSWER

Remember that social surplus is maximized where MC = MB, or where our MC intersects the
demand curve. This occurs at a quantity of 100 million carats and a price of $2,000

Social Surplus Maximizing (graph on left)

Producer Surplus (yellow area):

(2000−0)(100)2(2000−0)(100)2

=$100 billion

Consumer Surplus (blue area):

$latex \frac{\left(4000-2000\right)\left(100\right)}{2}$

=$100 billion

Market Surplus (blue + yellow):

$100 billion + $100 billion

=$200 billion

The difference between the market surplus under monopoly, and the market surplus when the
market is maximizing social surplus is equal to the deadweight loss. Note that social surplus
could also be maximized under perfect price discrimination.

DWL = $200 billion- $175.5 billion = $24.5 billion

 QUESTION 05

ANSWER

To calculate DeBeers profits we must find the ATC @ our given quantity. Since we know that P-
ATC = profit per unit, we can calculate the rectangular area between these two points to find
profit. At quantity of 65 million Carats of diamonds, our ATC = $1,700.

($2,700 – $1,700)(65)

=$65 billion
 QUESTION 06

ANSWER

As shown in the figure below as more firms enter the market, our demand curve no longer
represents the demand curve for the entire market. Some of DeBeer’s consumers will go
elsewhere, and the demand curve that DeBeer’s faces will shift inwards. As long as there are
positive profits (P > ATC) then this process will continue to occur. As we can see at point (45,
$1900) our demand curve (D2) is tangent to the ATC curve and MR = MC. These are the
conditions for a monopolistic competitor.

QUESTION 07

ANSWER

Similar to a monopoly, a monopolistic competitor charges the highest price possible where MR =
MC. Here, that occurs at a quantity of 45 million Carats and a price of $1,900.
 QUESTION 08

ANSWER

Remember that under monopolistic competition, profits are 0 in the long-run. Since the diamond
market has reached a state of long-run equilibrium, De Beers profits will be 0. In the diagram
above we can see that P=ATC, meaning that there are no profits.

QUESTION 09

ANSWER

Remember that social surplus is maximized where MC = MB, or where our MC intersects the
demand curve. This occurs at a quantity of 75 million carats and a price of $1,400.
We could once again calculate the consumer, and producer surplus, or we could also note on the
diagram that the decrease in surplus is equal to the red shaded area.

Calculating the red area:

($2,000 – $1,000) ( 70 – 45 ) /2

=$17,500

QUESTION 10

ANSWER

We actually can’t find directly the changes in consumer surplus by the information we are given,
since we cannot compare the deadweight loss from questions 4 and question 9. This is because
both of these look at the individual firm, and for monopolistic competition, we know there are
other firms in the market. We can notice that our price has decreased, and that our drop quantity
demanded will be offset by supply from other firms. We also know that consumers generally
prefer variety, and by opening up market more options are available.