CESEM 1 Microeconomics 2021

Problem Set 4

Q1. Suppose a monopolist has a demand curve that can be expressed as P=90-3Q. The monopolist’s
marginal revenue curve can be expressed as MR=90-6Q. The monopolist has constant marginal costs
and average total costs of $30.

(1) Solve for the monopolist’s optimal level of output, Q*, and the optimal level of price, P*.

Q*: MR=MC (red dot)

So 90 – 6Q = 30
So Q*=10
Price is on the demand curve (green dot), so P*=90 – 3Q*=90 – 30=60

(2) Calculate the monopolist’s profit. In the long run, should the monopolist stay in the market or
exit?

Profit=TR – TC
=P* x Q* – ATC x Q*
=60 x 10 – 30 x 10
=300
Stay.

(3) What is the consumer surplus in this market?

The CS is the area of the triangle below the demand curve and above the price.

So (90-60)*10*(1/2)=150

(4) What is the producer surplus in this market?

There is one single producer in this market, so the PS is simply the profit of the monopolist.
(5) Total surplus?

TS=CS+PS=450

(6) If there were a social planner in this economy, what quantity would the planner demand to be
exchanged?

The socially efficient Q: Demand intersects MC (blue dot)

 90 – 3Q = 30
 Q_eff = 20
DWL= (60 – 30) x (20 – 10) x (1/2)
= 150

(6) How much deadweight loss does the monopolist market cause?

The DWL is the area of the grey triangle.

DWL= (60 – 30) x (20 – 10) x (1/2) = 150

(7) Suppose the monopolist acquired access to private data that contain all customers’ reservation
prices (i.e. highest willingness to pay) in this market. As a result, the monopolist is able to achieve
perfect price discrimination. Now what are the CS, PS, and TS?

Consumers’ surplus is all extracted by the monopolist’s price discrimination practice, all consumers
pay their reservation prices, so CS is zero. Monopolist’s profit is now the entire area of the big
triangle below the demand curve (which is now also the prices) and above the cost curve, so (90-
30)*20*(1/2)=600. This is also the total surplus. Notice the quantity exchanged can achieve the
socially efficient quantity, and there is no DWL. The outcome is in fact efficient.

Q2. The Chicken Game is named for a stupid contest in which two drivers test their courage by
driving straight at each other. John and Paul have a common interest to avoid crashing into each
other, but they also have a personal, competing interest to not turn first to demonstrate their
courage to those observing the contest. The payoff table for this situation is provided below. The
payoffs are shown as (John, Paul).

Paul
Turn=”Chicken out” Drive Straight
Turn=”Chicken out” (10, 10) (0, 20)
John
Drive Straight (20, 0) (-10, -10)

Find the Nash Equilibrium (or equilibria, if there is more than one) of this game.
To find the Nash Equilibria, the easiest way is to underline the best reponses: Suppose Paul chooses
to chicken out, then John compares the payoff of 10 for chickening out and 20 for driving straight. Of
course, he would choose to drive straight, which is his best response to Paul’s choice of chickening
out. Then, if Paul chooses to drive straight, John would compare the payoffs 0 for chickening out and
-10 for driving straight. This time, his best response is to chicken out.

Now, let’s turn to Paul’s best responses. When John chooses to chicken out, Paul compares, again, 10
for chickening out and 20 for driving straight, so he would choose to drive straight. If John chooses to
drive straight, then Paul would choose to chicken out.

Look at the underlinings and notice that there are two strategy sets that got underlined for both
players. This means, in those strategy sets, both are playing their best responses to each other’s best
response. Hence, the two Nash Equilibria of this game are (chicken out, drive straight), and (drive
straight, chicken out).

Q3. Suppose you and your roommate are deciding who gets the last piece of pie. You both value the
piece at a utility of 3, and either of you would feel upset about not eating the piece and receive a
utility of -2. If you share the piece equally, you both get a utility of 1. Now you decide to let fate
decide, so you play a round of “rock paper scissors”. Try to construct a payoff matrix of this game
that you play with your roommate. Is there any (pure strategy) Nash Equilibrium in this game?

Your Roommate
Rock Paper Scissors
Rock (1, 1) (-2, 3) (3, -2)
You Paper (3, -2) (1, 1) (-2, 3)
Scissors (-2, 3) (3, -2) (1, 1)

No pure strategy NE.