Course - Managerial Economics

IIM BANGALORE

PROBLEM SET 6
TOPIC: Monopoly, Monopolistic Competition and Price
Discrimination

Multiple-Choice Questions\Conceptual Questions

1. A grocery store that offers one can of soup for $0.35 and three cans for $1.00 is engaging
in
a) first-degree price discrimination.
b) second-degree price discrimination.
c) third-degree price discrimination.
d) The answer cannot be determined without additional information

2. A firm will realize the highest level of profit if it is able to engage in

a) first-degree price discrimination.
b) second-degree price discrimination.
c) third-degree price discrimination.
d) The answer cannot be determined without additional information
1. For a profit maximizing monopoly, equilibrium condition is
a. P = MR = MC
b. P > MR = MC
c. P > MR > MC

2. Which of the following is LEAST likely to be a monopoly?

a. the sole owner of an occupational license
b. a pharmaceutical company with a patent on a drug
c. a store in a large shopping mall
d. the holder of a public franchise

3. For a monopoly, the industry demand curve is the firm's

a. profit function.
b. marginal revenue curve.
c. supply curve.
d. demand curves

4. Apollo, a highly profitable shoe company, has market power. It’s selling 15 million shoes
per year. The marginal cost of making extra shoes is quite low and doesn’t change much

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 if they produce more shoes. Apollo’s marketing experts conclude that if they increased
prices by 20%, profits would rise. For Apollo, is MC=MR, is MC>MR, or is MC
a. MC=MR
b. MC>MR
c. MC < MR

5. When firms in an industry produce differentiated products

a) short-run economic profit will always be positive
b) the demand curves facing firms will always be perfectly elastic
c) the demand curves facing firms will always be downward-sloping

6. The demand curve facing a monopolistically competitive firm is typically

a) perfectly elastic
b) more elastic than the demand curves facing either monopolists or perfect
competitors
c) more elastic than the demand curves facing monopolists, but less elastic than the
demand curves facing perfect

7. For the below mentioned market scenarios, identify whether the relevant strategy is First-
Degree (imperfect), or Second-Degree price discrimination. Also, briefly explain your
conclusion.

S.no. Scenario Type of Price Explanation

Discrimination

1 A car dealer negotiate and offer discounts to the

buyers. For instance, based on how a buyer in
dressed.

2 Uber pricing is based on your data: credit card you

use, where you live, the phone you’re using, and
your ride history.

3 A consumer who buys a 24-pack of soft drink cans

at the supermarket generally receives a discount
(per can) over the shopper who buys a single can.

Solution

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 S.no. Scenario Type of Price Explanation
Discrimination

1 A car dealer negotiate and offer discounts to the First degree Every buyer
buyers. For instance, based on how a buyer in gets a custom
dressed. price as per
his/her
willingness to
pay

2 Uber pricing is based on your data: credit card you First degree Every buyer
use, where you live, the phone you’re using, and gets a custom
your ride history. price as per
his/her
willingness to
pay

3 A consumer who buys a 24-pack of soft drink cans Second degree Consumers are
at the supermarket generally receives a discount charged
(per can) over the shopper who buys a single can. different prices
per unit for
different
quantities of
the same good
or service.

Numerical Questions

8. Use the following information to answer the next four questions. The demand curve for a
monopolist is given by P = 100 − Q, while the monopolist’s marginal cost is P = 3Q. At the
profit-maximizing level of output for the monopolist, the average total cost of production
is equal to $70.
i. This monopolist’s MR curve can be written as
a. MR = 100 − Q.
b. MR = 200 − Q.
c. MR = 100 − (1/2)Q.
d. MR = 100 − 2Q.
ii. For this monopolist the profit-maximizing level of output is equal to and the market price
for this

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output is ____
a. 20 units; $80
b. 25 units; $75
c. 20 units; $60
d. 50 units; $50
iii. Profits for this monopolist equal
a. $400.
b. $10.
c. $200.
d. $20.

iv. The deadweight loss associated with this monopoly

a. cannot be calculated from the information given.
b. is unimportant, since the monopoly is protected from competition due to the
existence of effective barriers to entry.
c. equals $50.
d. equals $25.

i. Demand curve, P = 100 -Q

Thus Total revenue = PQ = (100-Q)*Q
Thus differentiating w.r.t. Q, Marginal Revenue = 100 – 2Q

ii. For Profit maximization, MR = MC

100 – 2Q = 3Q → Q = 20
From the demand curve, P = $80

iii. Profits = Total Revenue – Total Cost

Profits = (P – AC)*Q
Profits = (80-70)-20 = $200

iv. Can be found graphically as below:

The shaded region in the graph is the deadweight loss. Where the marginal cost associated with
that quantity is lesser than the market price, but yet the sale doesn’t happen.

Area of the shaded region is the area of the triangle.

Area = 0.5 * base * height = 0.5 * (80-60) * (25-20) = $50

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9. Monopoly sells its product to N = 10 identical consumers each of whom has individual
demand P = 30 - 2q, where q is quantity demanded by a single consumer at price P. The
firm has constant marginal cost MC = 5 and no fixed cost.

a) Suppose the firm cannot price discriminate. Derive aggregate market demand P(Q),
where Q is the quantity demanded by all consumers at price P. Set up firm's profit function
and profit-maximizing quantity 𝑄𝑀 and price 𝑃𝑀 . Calculate firm's profit, and deadweight
loss. Demonstrate on a diagram.

b) Give definition of first-degree price discrimination. Calculate quantity produced and

profits, if firm employs this pricing strategy.

a)Aggregate demand = Sum of all individual demands

q = 15 – 0.5p (Individual demand from given price-demand fn)

Aggregate Market Demand Q = 150 – 5P (Adding up all individual demand for 10 people
to get aggregate demand) ;
Can also re-arrange as P = 30 - 0.2Q

Finding Profit Maximizing Qty and Price

For Monopoly, ideal Quantity for max profits is at MR = MC

TR = Q*P = 30Q – 0.2Q2

MR = d(TR)/dQ = 30 – 0.4Q

MC = 5 (Given)
Equating MR = MC, get, QM = 62.5 units ;

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Subbing into Demand fn, we get PM = $17.5

Profit Calculation
Profits = Total Revenue – Total Costs
= 62.5*17.5 - 5*62.5 (Since there are no fixed costs, each unit costs only MC = 5$ to
produce)
Profit = $781.25

DW Loss Calculation

Finding the co-ordinates of the triangle and calc. area.

Height = 17.5 – 5 = 12.5
Base = 125-62.5 = 62.5 (Note: We found 125 by calculating where MC and Demand
line intersect by equating the functions)
Area = ½ * 12.5*62.5 = $390.625 = DW Loss

b) Give definition of first-degree price discrimination. Calculate quantity produced and

profits, if firm employs this pricing strategy.
FD price discrimination is when firm charges each consumer the max he or she is willing to
pay.
If the firm is able to do this, they charge along the demand line (At each price level, they will
sell the max Q they can sell to the individual consumers)
So now, MR curve is same as aggregate demand curve given by P = 30-0.2Q
Optimal output for peak profits is given by MR = MC.

30-0.2Q = 5 ; Q*= 125 units (The point found in the earlier graph for DW loss)

Since there are no fixed costs, as the MC is constant w.r.t Q, total costs = MC x Q*

Total Revenue = Whole area under the demand curve till Q*.
Total Profits = Total Revenue – Total Costs

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This is graphically, the region and given by area of the triangle.
Profit = ½* Base * Height = ½*125*(30-5) = $1562.5

10. Suppose the following table describes the market demand schedule for a monopoly.

a. Draw a graph of this market demand schedule for the monopoly.

b. Compute the firm’s total revenue and marginal revenue figures for the table below.

c. Draw the monopolist’s marginal revenue curve on the graph you drew in part (a) of this
problem.

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d. Write an equation for this monopolist’s market demand curve and for its MR curve.
Compare these two equations. What is true about the y-intercept of these two equations?
What is the relationship between the slope of the demand curve and the slope of the MR
curve?
e. If the firm’s marginal cost is constant and equal to $200, what is this monopolist’s profit-
maximizing level of output and what price will this monopolist charge for this good? Label this
quantity and this price on your graph.

4) A)

B)

PRICE QUANTITY TOTAL REVENUE MARGINAL REVENUE

1000 0 0
320000/400= 800
800 400 320000
160000/400= 400
600 800 480000
0/400=0
400 1200 480000
-160000/400= -400
200 1600 320000
-320000/400= -800
0 2000 0

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C)

D) To find the market demand equation, we can use two data points. Let’s consider (400,800) and
(800,600) are two data points of price and quantity respectively. Equation for line is y=mx +c, where
y is price and x is quantity.

Slope of demand curve line is:

(y2- y1)/(x2-x1) = (600-800) / (800-400) = -0.5

Plugging back the value of slope into linear equation along with the clear intercept of c = 1000, we
get: P= 1000 – 0.5Q

Similarly, equation for marginal revenue is

P = 1000 - Q

We observe that the y-intercept of both equations is same. Slope of marginal revenue is -1 and slope
of demand curve is -0.5.

Marginal revenue curve is steeper than slope of demand curve. In fact, Slope of MR curve= 2 x slope
of demand curve.

E) Profit maximizing output will the point at which MR=MC.

Since MC= 200,

Profit maximization occurs at, 1000 – Q = 200

Solving, we get Q=800

Substituting quantity back in demand equation will give P= 600.