Extra Problems Sheet 3 - Solution

Ch: 8 - Market Structure: Monopoly and Monopolistic Competition

Ch: 10 - Pricing Strategies for the Firm

Problem 10 (Monopoly)

Consider a monopolist where the market demand curve for the produce is given by P = 520 – 2Q.
This monopolist has marginal costs that can be expressed as MC = 100 + 2Q and total costs that
can be expressed as TC = 100Q + Q2 + 50.

1- Given the above information, what is this monopolist’s profit maximizing price and
output if it charges a single price?

Profit Max Output …MR=MC Trick: D: P=a-bQ

MR = 520 – 4Q MR: MR=a-2bQ
MC = 100 + 2Q
520 – 4Q = 100 + 2Q
Q = 70 units of output
P = 520 – 2Q = 520 – 2(70) = $380 per unit of output

2- Given the above information, calculate this single price monopolist’s profit.
Profit = TR – TC
TR = P*Q = ($380 per unit) (70 units) = $26,600
TC = 100Q + Q2 + 50 = 100(70) + (70) (70) + 50 = $11,950
Profit = $14650

3- At the profit maximizing quantity, what is this monopolist’s average total cost of
production (ATC)?
To answer this question we first need to write an expression for ATC.
ATC = TC/Q = 11950/70=$170.71
Then replace Q with 70 to find the average total cost of producing 70 units of output.
ATC= 100 + 70 + (50/70) = $170.71 per unit

4- At the profit maximizing quantity, what is the profit per unit for this single price
monopolist?
Profit per unit = Price per unit – ATC per unit when producing 70 units of output
Profit per unit = 380 –170.71 = $209.29 per unit
To verify your answer, check that profit per unit times number of units yields the same profit as
you got initially. Thus, Profit = (profit per unit) /(number of units produced) =
$14650/70=209.29
Problem 11 (Monopoly)

Use the below table to answer the following:

Profit=TR-
P Q TR MR=∆TR/∆Q TC MC=∆TC/∆Q
TC
17 3 17*3=51 - 56 - 51-56=-5
16 4 64 (64-51)/(4-3)=13 63 =(63-56)/(4-3)=7 1
15 5 75 11 71 8 4
14 6 84 9 80 9 4
13 7 91 7 90 10 1
12 8 96 5 101 11 -5

1 - Fill in the table (TR, MR & MC).

2 - Is the firm a perfect competitive one?
No, because MR is decreasing
3 - What quantity of output should the firm produce? Explain.
Golden Rule => MR=MC=9 => Q=6 (profit-maximizing output) then the price is =14$
4 - Calculate the profit at each output level to verify your answer in the previous question.
Indeed at Q=6, the profit is at its maximum =4$

Problem 12 (Monopoly)

The figure below shows the demand and cost curves for a monopolist;

1- What is the profit-maximizing/loss-minimizing output level?

Q=600 where MR=MC
2- What is the price charged for the profit-maximizing output level?
P=$34
 3- What is the amount of the monopoly’s profit?
Profit/ Loss= (P-ATC)*Q= (34- 29.5)*600=$2700
4- If the company were perfect competitive one, what is the quantity that maximizes profit?
Is there a profit or loss at that quantity?
Q=940 where MC intersects Demand curve where p=21, loss ( P< ATC)

Problem 13 (Monopoly)

The figure below shows the demand and cost curves facing a monopolist

Refer to the figure above shows the demand and cost curves facing a monopolist.

1- What is the profit maximizing/loss-minimizing output level? Explain.

Profit maximizing: MR= MC point of intersection between the MR and MC curves = 630 units
2- What is the price charged at the profit-maximizing/loss-minimizing output level?
Price= $68
3- What is the profit/loss per unit? Profit= TR- TC=Qmax(P-ATC)=630(68-75)=-4410
TR=P*Q TR= 68*630= $42,840
TC= 75*630 TC= $47,250
Profit= 42,840-47250=-$ 4,410
Per unit loss= $-7

4- If the industry was perfectly competitive, what quantity and price would maximize its profit?

In this case MC=d theus Q=800 , and the price is at the intersection P=54

Under perfect competition there is higher Q and lower price when compared to monopoly.

Problem 14 (Monopolistic Competition)

The following diagram shows the structure of cost and demand facing a monopolistically
competitive firm in the short run.
a. Identify the following on the graph and calculate each one.
i. Profit-maximizing output level
MR=MC…Qmax=15
ii. Profit-maximizing price
Substitute q in D…P/unit=$ 13
iii. Total revenue
TR= P*Q= 13* 15=$ 195
iv. Total cost
TC=ATC*Q=15*15=$ 225
v. Total profit or loss
Loss= Q(P-ATC)=15(15-13)= - 30$
b. What is likely to happen in this industry in the long run?

In LR….D=ATC=MC….econ profit equals zero

Problem 15: (HHI)

The following table represents the market share percentage for each firm in a hypothetical
industry.
Firm A B C D E F G
Market Share 12 8 20 25 4 25 6

a. Calculate the Herfindahl-Hirschman Index (HHI) for this industry.

HHI= ∑share2= 144+64+400+625+16+625+36=1910 competitive market

b. What is the HHI and what is its range?

HHI measures the market power and ranges between 0 for perfect competition (no market
power) and 10,000 for a monopolist (full market power) .
Monopoly share= 100%

HHI= 1002= 10,000 max

Perfect compt= firm is small relative to the market=0

HHI=02+ 02 = 0

Problem 18 (Optimal Markup)

Given each of the following price elasticities, calculate the optimal markup.
1- −15 highly elastic demand
2- −8 less elastic
3- −3

1- m = −1/[1 + (−15)] = 1/14 or 7%

2- m = −1/[1 + (−8)] = 1/7 or 14% higher markeup
3- m = −1/[1 + (−3)] = 1/2 or 50%

Problem 19 (Price Discrimination)

An airline estimates that the price elasticity of demand for business travelers (who travel on
weekdays) is –2, while the price elasticity of demand for vacation travelers (who travel on
weekends) is –5. If the airline price discriminates (and costs are the same), what will be the ratio
of weekday to weekend prices?

In the business market, the markup (over marginal cost) will be –1/[1 + (–2)] = 100%. In the
vacation market, the markup will be –1/[1 + (–5)] = 25%. Thus, the ratio of weekday to weekend
prices will be 100/25, or 4. Weekday prices will be four times higher than weekend prices.

Problem 20 (Price discrimination)

The following graph shows a firm’s demand curve, marginal revenue curve, marginal cost curve,
and average total cost curve.
 1 - If the firm charges a single price, what will be the firm’s output and profit, as well as the
consumer surplus?

If the firm charges a single price, the firm will produce 60 units of output. As the price is $15
per unit, the firm will make a profit of 60 × ($15− $10) = $300.
The consumer surplus = [($20 − $15) × 60]/2 = $150.
CS= area bounded between D and Market price = how much savings consumers gain from a
given market price (since they are willing to pay more)

2 - If the firm engages in first-degree price discrimination, what will be the firm’s output and
profit, as well as the consumer surplus?

If the firm engages in first-degree price discrimination, the firm will produce 120 units of output.
As the price of each unit equals the maximum price that consumers are willing to pay, the firm
will make a profit of [($20 − $10) × 120]/2 = $600.
The consumer surplus is zero.

Problem 21 (Price Discrimination)

Consider a monopoly that faces a market demand curve given as P = 100 – Q. The marginal cost
of production for this monopolist is MC = 10 and the monopolist has fixed costs equal to zero.
The monopolist has asked you to compare what happens if the monopolist is a single-price
monopolist and a perfect price discriminating monopolist. At the end of this question, you will
be asked to fill out a table to summarize your findings.

1- Single-price monopolist:

Suppose the monopolist charges a single-price for its product. Given this assumption, find the
answers to the following questions:

a. What is the profit maximizing quantity and price for this single-price monopolist?
To find the profit maximizing quantity and price we first need the MR curve for the monopolist.
MR = 100 – 2Q
Then, set MR = MC to solve for Q:
100 – 2Q = 10 or Q = 45
When Q = 45, then P = 100 – Q = 100 – 45 or P = $55

b. What is total revenue (TR) equal to for this monopolist?

TR = ($55 per unit)(45 units) = $2475

c. What is total cost (TC) equal to for this monopolist?

TC = ($10 per unit)(45 units) = $450
Hint form given: the monopolist has fixed costs equal to zero, MC=ATC
d. What are the economic profits for this single-price monopolist?
Profits = TR – TC = $2475 - $450 = $2025 this industry secures profits of 2020 USD more than
other industries.

e. Provide a graph of this single-price monopolist indicating D, MR, MC, the profit maximizing
quantity, and the profit-maximizing price.

105
MR MC D

100
95
90
85
80
75
70
65
60
Pm 55 Deamand
50
45 MR
40
35 MC
30
25
20
15
10
5
0
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100 105
Qm Q

2- Perfect price discriminating monopolist:

Suppose the monopolist practices perfect price discrimination. Given this assumption, find the
answers to the following questions:

a. How many units will the perfect price discriminating monopolist produce?
The perfect price discriminating monopolist will produce that quantity where its MR = MC. For
the perfect price discriminating monopolist its MR curve is the same as its demand curve since
for every unit of the good it produces it charges a price equal to the price on the demand curve
associated with that quantity. Hence, the perfect price discriminating monopolist will produce
where 100 – Q = 10 or where Q = 90 units.

b. Describe the price(s) the perfect price discriminating monopolist will charge.
The perfect price discriminating monopolist will charge many, different prices. For example, for
the first unit of the good the monopolist will charge a price of $99 since P = 100 – Q and Q = 1.
For the second unit of the good the monopolist will charge a price of $98 since P = 100 – Q’ and
Q’ = 2. When producing the ninetieth unit the monopolist will charge a price of $10.

c. What do economic profits equal for this perfect price discriminating monopolist? Show your
work to get this answer.
TR =The area under the demand curve = 90*90/2+10*90= 4050+900
Economic profit = TR – TC = ($4050 + $900) – ($10 per unit)(90 units) = $4050
Profit= [(Intercept-MC)*Qmax ]/2 =[ (100-10)*90] / 2
105
100
95
90
85
80
75
70
65
MR MC D

60
55
50 Deamand
45
40 MC
35
30
25
20
15
10
5
0
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100 105
Q

3- Fill in the comparative table.

Single-price monopolist: Perfect price discriminating monopolist:

Price Charged P=55$ Each unit a different price

Quantity Sold Q=45 Q=90

TR TR=2,475$ TR=4,950$
TC TC=450$ TC=900$
Profit Profit= 2,025$ Profit= 4,050$
 MR=20 D=40

Problem 15: (HHI)

The following table represents the market share percentage for each firm in a hypothetical
industry.
Firm Ana Beta Col Dol Eol
Market Share 20 15 15 40 10

a. Calculate the Herfindahl-Hirschman Index (HHI) for this industry.

HHI= ∑share2= 202+ 152+152+402 + 102 = 400 + 225+225+1600+100=2,550

b. What is the HHI and what is its range?

HHI measures the market power and ranges between 0 for perfect competition (no market
power) and 10,000 for a monopolist (full market power) .