Answers To Exercises Ch. 11

 Answers to Exercises in the Text
1.1 When the inverse demand curve is linear, marginal revenue has the same intercept and twice the
slope. Thus, if inverse demand is P = 300 – 3Q,then marginal revenue is MR = 300 – 6Q. The
demand curve intersects the horizontal, quantity axis when price equals zero:
p = 300 – 3Q
0 = 300 – 3Q
300 = 3Q
Q = 100 units.
The marginal revenue curve intersects the horizontal, quantity axis when marginal revenue equals
zero:
MR = 300 – 6Q
0 = 300 – 6Q
Q = 50 units.
1.2 Marginal revenue (MR) is the change in revenue (R) with respect to quantity:
Revenue is price multiplied by quantity:
211
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212 Perloff • Microeconomics: Theory and Applications with Calculus, Fourth Edition, Global Edition
R = p*Q.
Substituting the demand equation for p,

R = 10Q – 0.5(Q)
R = 10Q0.5.
Taking the derivative of R with respect to Q, marginal revenue is

MR = 5Q – 0.5.’
1.3 Marginal revenue is the change in revenue (R) with respect to output:
Revenue is price multiplied by quantity:

R = pQ.
Substituting in the demand function for p,

R = (a – bQ + 0.5CQ2)Q
R = aQ – bQ2 + 0.5CQ3.
Thus, marginal revenue is

MR = a – bQ + 1.5Q2.
When the inverse demand curve is linear, marginal revenue has the same intercept and twice the
slope. Thus, if inverse demand is
p = a – bQ,
then marginal revenue is

MR = a – 2bQ.
The first derivative of the marginal revenue function with respect to Q shows that marginal revenue
decreases with output:
The second derivative of the marginal revenue function with respect to Q shows whether marginal
revenue decreases with output at an increasing or decreasing rate:

Chapter 11 Monopoly and Monopsony 213
If c is positive, then marginal revenue decreases with output at a decreasing rate, and if c is negative,
then marginal revenue decreases at an increasing rate.
1.4 For a general linear inverse demand function, p(Q) = a – bQ, dQ/dp = – 1/b, so the elasticity is:  = –
p/(bQ). The demand curve hits the horizontal (quantity) axis at a/b. At half that quantity (the
midpoint of the demand curve), the quantity is a/(2b), and the price is a/2. Thus, the elasticity of
demand is  = – p/(bQ) = – (a/2)/[ab/(2b)] = – 1 at the midpoint of any linear demand curve. As the
chapter shows, a monopoly will not operate in the inelastic section of its demand curve, so a
monopoly will not operate in the right half of its linear demand curve.
1.5 Set MC  MR and solve:
If the answer does not change because marginal cost is still and therefore
the profit – maximizing condition is still the same.
1.6 Set MC  MR and solve:
1.7 Total revenue is: therefore marginal revenue is:
Marginal cost function is:

Marginal revenue curve (MR) and marginal cost curve (m(Q)) are shown in the figure on the next
page.

Profit function is: the F.O.C. is:
The S.O.C. is:
Therefore the S.O.C. is satisfied at i.e., the profit-maximizing output is
1.8 The revenue function for the monopolist is Its marginal

revenue function is therefore
The marginal cost function for the monopolist is
To maximize profit, the monopolist produces at the quantity where its marginal revenue equals its
marginal cost:

At and profit is
Since profit is positive, the monopolist should operate as it is more than covering its average cost of
production.
1.9 A monopoly maximizes profit by producing the quantity where marginal cost (MC) equals marginal
revenue (MR). Price is then set according to the demand curve (D), indicated by eprofit at pp and Qp in
the figure below. Revenue is maximized when the change in revenue (marginal revenue) from
producing one more unit of output is no longer positive. This occurs at a quantity where marginal
revenue equals zero (where MR intersects the horizontal quantity axis). Price is then set according to
the demand curve (D), indicated by erevenue at pr and Qr in the figure.
Mathematically, assume the firm's profit function (π(Q)) is

π(Q) = R(Q) – C(Q),
where R is total revenue and C is total cost. The firm maximizes profit by picking Q such that
The firm's revenue function (R(Q)) is maximized where

The profit-maximizing quantity is less than the revenue-maximizing quantity because
That is, the profit-maximizing quantity is less than the revenue-maximizing quantity because MR –
MC = 0 at a lower quantity than MR = 0.
1.10 The revenue function is: then the F.O.C. is:
The revenue-maximizing price is $5.

The sum of the cable car revenues and the economic impact is:
The F.O.C. is:
The optimal price is $3.
1.11 When demand is D1, the price the monopoly sets (vertically above the point of intersection of MR1
and MC on D1) is above the AC and thus the monopoly makes a positive profit. However, when the
demand curve shifts to the left, to D2, the demand is below the AC curve, and there is no price where
the monopoly can make a positive profit.

1.12 A competitive firm maximizes long-run profits by setting LMC  p, as long as price exceeds average
cost (it should shut down if p  LAC). Because marginal cost is above average cost only where AC
slopes up, the firm will never operate in an area where average cost is falling. A monopolist
maximizes profit by setting MR  MC, which can occur on either the upward- or downward-sloping
portion of the LAC curve. In the graph, DM represents the demand curve faced by the monopolist, and
dC represents the demand curve faced by a competitive firm.
1.13 One test of whether a firm is a profit-maximizing monopoly is to check whether it is operating in the
elastic portion of its demand curve. If it is, it will always operate in the elastic part of its demand
curve. Although this is a necessary condition for monopoly pricing, it is not a sufficient condition, so
this alone cannot lead to the conclusion that it is a monopoly. If the football club was maximizing
revenue instead, it would be operating where MR 0 and the elasticity of demand is 1.

1.14 For this to be the case, MR must be equal to MC at a price that is the same as the original price. The
rightward shift in the demand curve will shift MR rightward as well; if the MC curve is downward
sloping, output may rise with no change in the price.
1.15 Another explanation is that the A’s were exercising monopoly power. By restricting output (the
number of seats available), they may have been able to raise price.
2.1 There are several reasons why a monopolist may charge a price less than the profit-maximizing price.
In the application, the city-run monopoly charged a low price to attract tourists to the city. If the
monopoly exists because a government established a barrier to entry to potential competitors, that
government can reduce the monopoly’s market power by allowing other firms to enter, and, as new
firms enter the market, the former monopoly must lower its price to compete. If the monopoly exists
because the firm has a cost advantage over potential rivals due to a superior technology or
organization, it may reduce its price to deter the entry of potential competitors because, even though
the firm has no current competitors, any price above marginal cost will attract other firms. If the
monopolist chooses to maximize revenue instead of profit, it may charge a price less than the profit-
maximizing price. Moreover, if the monopolist can price discriminate (charge different customers
different prices; see Chapter 12), it may want to sell its last unit of output where price equals
marginal cost.
2.2 Amazon’s Lerner Index was (p  MC)/p = (359 – 159)/359  0.557. Using Equation 11.11, we know
that (p  MC)/p  0.557 = 1/, so   –1.795.
2.3 The Lerner Index is (84.95  37)/84.95 0.56. Hence Stamps.com believes that it faces a demand
elasticity of 1.79.

2.4 Given that Apple’s marginal cost was constant, its average variable cost equaled its marginal cost,
$200. Its average fixed cost was its fixed cost divided by the quantity produced, 736/Q. Thus, its
average cost was AC  200  736/Q. Because the inverse demand function was p  600  25Q,
Apple’s revenue function was R  600Q  25Q2, so MR  dR/dQ  600  50Q. Apple maximized its
profit where MR  600 – 50Q  200  MC. Solving this equation for the profit-maximizing output,
we find that Q  8 million units. By substituting this quantity into the inverse demand equation, we
determine that the profit-maximizing price was p  $400 per unit, as the figure shows. The firm’s
profit was   (p  AC)Q  [400  (200  736/8)]8  $864 million. Apple’s Lerner Index was (p –
MC)/p = [400 – 200]/400 = . According to Equation 11.11, a profit-maximizing monopoly operates

where (p  MC)/p  1/. Combining that equation with the Lerner Index from the previous step, we
learn that 1/, or   2.
2.5 The price/marginal cost ratio is 349/84 4.15. The Lerner Index is (349 – 84)/349 = 0.76. Thus
elasticity = –(1/.76) = –1.31.
2.6 a. Assume demand is . Then, the consumer surplus is the producer surplus is b  i,
and social deadweight loss is c  e. If the monopoly behaves like a price taker, the quantity will
be Qc, as shown in the figure on the next page.
b. When the new demand curve, is tangent to the original one at (Q*, P*), as shown in
the figure on the next page, the price and quantity will not change. However, the quantity if the
monopoly behaves like a price taker will change to Q2. Consumer surplus will decrease and will
be the area a  h under the concave demand curve; producer surplus will remain as  i;
deadweight loss will decrease to
c. Under the convex demand curve, the price and quantity will be the same as in the linear
case. But under the price-taker assumption, the quantity supplied will be Q3. Consumer surplus
will increase and will be the area a  d  h  f; producer surplus will remain as b  i; deadweight
loss will increase to  e  g.

2.7 To be on the contract curve (Pareto efficiency) requires that all goods be traded at competitive prices.
Because Jane is a monopolist, she sets the price of wood above the competitive price. At this higher
price, she receives more candy bars per unit of wood than with competitive prices, and consumers end
up with less wood than with competitive prices. The monopoly price line in the graph depicts this
higher price ratio. Instead of reaching the Pareto-optimal solution at a, Jane is able to use her market
power to force the solution at b, which is off the contract curve and Pareto inferior.
3.1 The total profit is total revenue minus total cost and tax.
The first-order condition is
Imposing a tax is equivalent to increasing the marginal cost, i.e., Hence after the tax is
imposed, output will drop, price will increase, and profit will be smaller.
3.2 A monopoly will maximize profits by picking a price, p, such that
If marginal cost equals m, then

The per-unit tax raises marginal cost by $1, so
In turn,
If ε equals –2, then the change in price is
=$2.00.
3.3 In the competitive case (see panel (a) of the figure below), equilibrium is determined where demand
equals supply. Marginal cost is
and the supply curve is p = 4Q (when p > 4). Setting demand equal to supply, the competitive pre-tax
equilibrium quantity and price are:
The specific tax shifts the supply curve up to p = 4Q + 6 so that, setting demand equal to supply, the
competitive after-tax equilibrium quantity and price are:
Thus, the incidence of the specific tax on consumers in the competitive case is 33%:

In the monopoly case (see figure b. below), profit-maximizing output and price are found by equating
marginal cost and marginal revenue. Revenue is and

marginal revenue is
Setting marginal revenue equal to marginal cost, the monopoly pre-tax equilibrium quantity and price
are
The specific tax shifts the marginal cost curve up to MC(Q) = 4Q + 6 so that, setting marginal
revenue equal to marginal cost, the monopoly after-tax equilibrium quantity and price are:
Thus, the incidence of the specific tax on consumers in the monopoly case is 25%:

3.4 A profit tax (of less than 100 percent) has no effect on a firm’s profit-maximizing behavior. Suppose
the government’s share of the profit is . Then the firm wants to maximize its after-tax profit, which
is (1  ). However, whatever choice of Q (or p) maximizes  will also maximize
(1  ). Consequently, the tribe’s behavior is unaffected by a change in the share that the
government receives. We can also answer this problem using calculus. The before-tax profit is B 
R(Q)  C(Q), and the aftertax profit is A  (1  )[R(Q)  C(Q)]. For both, the first-order condition is
marginal revenue equals marginal cost: dR(Q)/dQ  dC(Q)/dQ.
3.5 MR = 120 – 2Q

Without the tax, set 10 = 120 – 2Q, which yields Q = 55 and P = $65. The efficient price-quantity
combination is P = $10 and Q = 110. Thus CS = ½ (120– 65)*(55) = $1,512.50, PS = (65 – 10)*55 =
$3,025, and DWL = ½ (65 – 10)*(110 – 55) = $1,512.50.
With the tax, set 20 = 120 – 2Q, which yields Q = 50 and P =$70. The efficient price-quantity
combination is still P = $10, and Q = 110. Thus CS = ½ (120 – 70)*(50) = $1,250, PS = (70 – 20)*50
= $2,500, the government collects (10*50) = $500, and DWL = ½ (70 – 10)*(110 – 50) = $1,800.
Thus consumers lose, producers lose, the government gains, and society as a whole loses due to the
increased deadweight loss. The incidence of the tax on consumers is 50 percent, or (70 – 65)/10 = 0.5.
3.6 The effect of a franchise tax or lump sum tax on a monopoly is to reduce profits by the amount of the
tax. Because there is no change in marginal cost, the profit-maximizing/loss-minimizing output and
price remain unchanged, with one exception. If the tax is large enough, losses may exceed variable
costs. If that is the case, the firm will shut down (produce no output) in order to minimize losses.
4.1 Yes. As the “Electric Power Utilities” application illustrates, the demand curve could cut the average
cost curve only in its downward-sloping section. Consequently, the average cost is strictly downward
sloping in the relevant region.
4.2 No. In order for a firm to be a natural monopoly, its production must exhibit economies of scale; that
is, firm’s average cost curve must be downward sloping. If the firm operates in the upward-sloping
region of its average cost curve, it is possible that two or more firms could produce in the same
industry more efficiently than one firm.
4.3 The inverse demand function is p 775  375Q. Imposing a specific tax of $75 will be equivalent to
shifting the demand curve to p 700  375Q. With MC 25, profit-maximizing quantity and price
are Q 0.9 and p 437.5. The new deadweight loss will be (437.5  25)(2  0.9)$226.875 million.
4.4 When the demand curve is linear, the marginal revenue curve will always be linear with twice the
slope of the demand curve. This is true because when multiplying the demand curve by Q to obtain
total revenue, we always obtain a squared term in the revenue function, which then doubles the slope
when we take the derivative to obtain marginal revenue. For example, if the demand curve is
P  a  bQ
TR  aQ  bQ2
Because the slope of MR is double of the slope of the linear demand curve, MR curve always crosses
the MC segment in the middle between the y-axis and point (see figure in the Botox application).
Hence triangles A and C have one equal side and three equal angles, which implies that these
triangles are equal.

4.5 Once a book is online, it is available to consumers for free. As a result, the publisher may lose some
consumers after the copyright expires. Limiting the length of a copyright (in the United States or
elsewhere) would encourage the publisher to charge a higher price for the novel, as the publisher
attempts to recoup the cost of publishing the novel and earn profit in a shorter period before the
copyright expires. After the copyright runs out, the publisher may lower the price of the novel to stay
competitive with the online version.
5.1 In the figure below, the price is set at pC with optimal regulation, where the market demand curve, D,
intersects the monopoly’s marginal cost curve, MC, at eC. The optimally regulated monopoly sells QC
units. The profit-maximizing equilibrium is at eM, where marginal revenue equals marginal cost at
quantity, QM. The monopoly price is pM.
When a government sets a price ceiling, like pR, that is above the socially optimal level, but below the
monopoly’s profit-maximizing price, the regulated demand curve for the monopoly is horizontal at pR
up to QR. Since price is higher than socially optimal, output falls from QC to QR under the new
regulated monopoly optimum at eR, and welfare falls. The deadweight loss equals area A.

5.2 If the government sets a price cap between the monopoly price and the socially optimal price, output
increases from QM to QR, and deadweight loss is reduced from area abc to cdf.
5.3 With a price ceiling of $200, the monopoly will produce Q (775  200)/375 1.53 million vials
and the deadweight loss will be (200  25)  (2  1.53)/2 $41.1 million.
5.4 In this case, MR curve coincides with the demand curve. Equilibrium quantity is 100 and equilibrium
price is $100. Consumer surplus is zero and producer surplus is ($100  $10)  100  $9,000. If a
price ceiling of $30 is imposed, consumer surplus increases and producer surplus decreases by area
abcd. There is no deadweight loss.

5.5 See the figure below. Without import competition, Bleyer charges PM and sells QM. With competition
from China (which has lower marginal costs), the residual demand curve is the line segment below
the Chinese marginal cost curve. Given this residual demand curve, there is no price that Bleyer could
charge that would cover marginal costs, and the firm will exit the industry, given enough time. (Note
that the Chinese MC curve does not have to lie below Bleyer’s curve; if MC is at least equal to
Bleyer’s, the firm will have residual demand of zero at the MC price. It is also not necessary that the
Chinese industry be perfectly competitive, as long as the Chinese price is below Bleyer’s marginal
costs.)

5.6 See the following figure . Prior to the removal of the tariff, the monopoly chooses its profit-
maximizing price and quantity, PM and QM. With the removal of the tariff, the monopoly’s MR curve
is horizontal up to the point that the world supply curve reaches the demand curve (and is equal to its
original MR curve after that point). As shown, the domestic monopoly increases its production to
QNEW, the price falls to the world price, and the international firms sell virtually nothing. Consumers
gain areas a + b + c. The monopolist loses a + b, but gains f, so that now producer surplus is d + e + f.
Deadweight loss, which was originally c + f + g, falls to g.
This result depends on the relative positions of the world supply curve and monopoly MC. If the
world price is sufficiently low, the monopolist may be driven out of business. (Also, if the world
supply curve were upward sloping, the monopolist might retain some pricing power, and external
firms and the monopolist might split the market.)
6.1 Given that the demand curve is p  10  Q, its marginal revenue curve is MR  10  2Q. Thus the
output that maximizes the monopoly’s profit is determined by MR  10  2Q  2  MC, or Q*  4. At
that output level, its price is p*  6, and its profit is *  16. If the monopoly chooses to sell eight
units in the first period (it has no incentive to sell more), its price is 2 and it makes no profit. Given
that the firm sells eight units in the first period, its demand curve in the second period is p  10  Q/,
so its marginal revenue function is MR  10  2Q/. The output that leads to its maximum profit is
determined by MR  10  2Q/  2  MC, or its output is 4. Thus its price is 6, and its profit is 16.
It pays for the firm to set a low price in the first period if the lost profit, 16, is less than the extra
profit in the second period, which is 16(  1). Thus it pays to set a low price in the first period if
16  16(  1), or 2  .

6.2 When the hoi polloi buy the chocolate, the snobs won’t buy. So the monopoly is facing a relatively
flat demand curve, which suggests a low price, high quantity outcome. On the contrary, if the hoi
polloi do not buy the chocolate, the snobs will buy. In this situation, the monopoly will face a steep
demand curve, resulting in a high price, low quantity outcome. If the demand curve for the snobs is
substantially steeper than that for the hoi polloi such that the profit from the former is larger than that
from the latter, the monopoly will choose to cater to the snobs.
7.1 The monopsonist will advertise if the increase in pre-advertising expense profits exceed $1,000. This
occurs if the advertisement causes the wage bill to fall by more than $1,000. The ad causes the wage
and marginal expense for labor to fall. Marginal cost for the firm is reduced, and employment of that
input increases, as does output. The marginal revenue product of the additional output must exceed
the marginal expense of the input, plus the cost of the advertisement.
7.2 The portion of the minimum-wage line that lies to the left of the intersection with the supply curve
becomes the new marginal expense curve. If the minimum wage is not set at the competitive wage
level, deadweight loss is created. If it is above the competitive level, the firm hires up to where the
minimum-wage line crosses the demand curve. If the minimum is below the competitive level but
above the monopsony wage w1, the firm hires up to where the minimum wage line crosses the supply
curve, L*. Note that in both cases, L  L2, where L2 is the competitive equilibrium.
7.3 No. There can be no monopsony power if the input supply curve is horizontal. The marginal expense
will be the same as the average expense per unit.

A monopsony chooses a price-quantity combination from the industry supply curve that maximizes
its profit. The monopsony’s marginal expenditure (for example, the additional cost of hiring one
more worker) depends on the shape of the supply curve. If the supply curve is upward sloping, then
the marginal expenditure is greater than the average expenditure, and the monopsony will maximize
profit by buying a quantity that is less than that which would be purchased by competitive buyers at a
price below the price that competitive buyers would pay. However, if the supply curve is horizontal
at the market price, then a monopsony’s marginal expenditure to purchase one more unit of a good
would be the good’s price. In this case, the monopsony would pay the same price that a competitive
firm would pay.
7.4 A price support above the price set by a monopsony will increase price and the amount of input
employed. In particular, if the price support is set at the price where the supply curve intersects the
demand curve, the equilibrium will be identical competitive equilibrium.
7.5 The monopsony’s total expenditure on labor is Its marginal

expenditure is
The monopsony maximizes profit by hiring labor up to the point where marginal expenditure equals
demand (the marginal revenue product of labor):
The value the monopsony places on the last worker (the height of its demand curve) is 60, while the
wage it pays (the height of the supply curve) is 40. The gap indicates monopsony power.
If the market were competitive, the intersection of the market demand curve and the market supply
curve would determine the competitive equilibrium where buyers purchase at
Thus, the monopsony hires fewer workers than a competitive market and pays a lower wage.
7.6 If a firm has a monopoly in the output market and is a monopsony in the labor market, its profit is
where Q(L) is the production function, p(Q)Q is its revenue, and wL—the wage times the number of
workers—is its cost of production. The firm maximizes its profit by setting the derivative of profit
with respect to labor equal to zero (if the second-order condition holds):

Rearranging terms in the first-order condition, we find that the maximization condition is that the
marginal revenue product of labor,
equals the marginal expenditure,
where  is the elasticity of demand in the output market and  is the supply elasticity of labor.
8.1 As long as the shift in the brand-name drug’s demand curve means that MR < MC at the original
price, the price of brand-name drugs will rise after their patents expire.
8.2 A parallel shift in the demand curve will mean that now demand is more elastic at that price than on
the original demand curve. Thus, keeping the same price would imply that MR > MC, and so the
monopolist will lower price.
8.3 If monopolies are already maximizing profit, they cannot increase that profit by charging a higher
price during the patent period.

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Answers To Exercises Ch. 11

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 Answers to Exercises in the Text

Revenue is price multiplied by quantity:

©2018 Pearson Education, Ltd.

Substituting the demand equation for p,

Taking the derivative of R with respect to Q, marginal revenue is

Revenue is price multiplied by quantity:

Substituting in the demand function for p,

Thus, marginal revenue is

then marginal revenue is

©2018 Pearson Education, Ltd.

1.5 Set MC  MR and solve:

1.6 Set MC  MR and solve:

1.7 Total revenue is: therefore marginal revenue is:

Marginal cost function is:

©2018 Pearson Education, Ltd.

Profit function is: the F.O.C. is:

The S.O.C. is:

Therefore the S.O.C. is satisfied at i.e., the profit-maximizing output is

1.8 The revenue function for the monopolist is Its marginal

The marginal cost function for the monopolist is

©2018 Pearson Education, Ltd.

Mathematically, assume the firm's profit function (π(Q)) is

The firm's revenue function (R(Q)) is maximized where

©2018 Pearson Education, Ltd.

The profit-maximizing quantity is less than the revenue-maximizing quantity because

1.10 The revenue function is: then the F.O.C. is:

The revenue-maximizing price is $5.

The F.O.C. is:

The optimal price is $3.

©2018 Pearson Education, Ltd.

©2018 Pearson Education, Ltd.

©2018 Pearson Education, Ltd.

MC)/p = [400 – 200]/400 = . According to Equation 11.11, a profit-maximizing monopoly operates

learn that 1/, or   2.

©2018 Pearson Education, Ltd.

The first-order condition is

3.2 A monopoly will maximize profits by picking a price, p, such that

If marginal cost equals m, then

©2018 Pearson Education, Ltd.

The per-unit tax raises marginal cost by $1, so

If ε equals –2, then the change in price is

©2018 Pearson Education, Ltd.

marginal cost and marginal revenue. Revenue is and

©2018 Pearson Education, Ltd.

©2018 Pearson Education, Ltd.

©2018 Pearson Education, Ltd.

©2018 Pearson Education, Ltd.

©2018 Pearson Education, Ltd.

©2018 Pearson Education, Ltd.

©2018 Pearson Education, Ltd.

©2018 Pearson Education, Ltd.

7.5 The monopsony’s total expenditure on labor is Its marginal

curve would determine the competitive equilibrium where buyers purchase at

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equals the marginal expenditure,

©2018 Pearson Education, Ltd.

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