Faculty of Arts and Sciences – Department of Economics

ECONOMICS 211 – SPRING 2013 – RAMZI MABSOUT – Sections 13 & 16

Chapter 13 – Review Exercises

I- Review Exercises
1. Problem 4:
Willy's Widgets, a monopoly, faces the following demand schedule (sales in widgets per month):

Price $20 $30 $40 $50 $60 $70 $80 $90 $100

Quantity
40 35 30 25 20 15 10 5 0
Demanded

a) Calculate marginal revenue over each interval in the schedule - for example, between q = 40 and q =
35. Recall that marginal revenue is the added revenue from an additional unit of production/sales
and assume that MR is constant within each interval.
b) If marginal cost is constant at $20 and fixed cost is $100, what is the profit-maximizing level of
output (Choose one of the specific levels of output from the schedule)? What is the level of profit?
Explain your answer using marginal cost and marginal revenue.
c) Repeat the exercise for MC = S40.

ANSWER:

a) Refer to the following table:

Price $20 $30 $40 $50 $60 $70 $80 $90 $100

Quantity
40 35 30 25 20 15 10 5 0
Demanded

Marginal
$50 $30 $10 ($10) ($30) ($50) ($70) ($90)
Revenue

b) Profit maximization occurs when MR = MC. This is at a point between 30 and 25 units. At 30
units, TC = $100 + $20 * 30 = $700. TR = 30 * $40 = $1,200. Economic Profit = TR – TC =
$1,200 - $700 = $500. At 25 units, TC = $100 + $20 * 25 = $600. TR = 25 * $50 = $1,250.
Economic Profit = TR – TC = $1,250 - $600 = $550. Produce at 25 units.
c) MR = MC at a point between 30 and 35 units. At 30 units, TC = $100 + $40 *30 = $1,300. TR =
30 * $40 = $1,200. Economic Profit = TR – TC = $1,200 - $1,300 = ($100). At 35 units, TC =
$100 + $40 * 35 = $1,500. TR = 35 * $30 = $1,050. Economic Profit = TR – TC = $1,050 -
$1,500 = ($450).The company would not produce and shut down.
2. Problem 8:
In Taiwan, there is only one beer producer; a government owned monopoly called Taiwan Beer. Suppose
that the company were run in a way to maximize profit for the government. That is, assume that it behaved
like a private profit-maximizing monopolist.
a) Assuming demand and cost conditions are given on the following diagram, at what level would
Taiwan Beer target output and what price would it charge?
Now suppose Taiwan Beer decided to begin competing in the highly competitive American market. Assume
further that Taiwan maintains import barriers so that American producers cannot sell in Taiwan but that
they are not immediately reciprocated. Assuming Taiwan Beer can sell all that it can produce in the
American market at a price PUS.
 ($)

MC
AC

PUS

D
Ta
iw
an

0 Q
MR

Indicate the following:

b) Total output
c) Output sold in Taiwan
d) New price in Taiwan
e) Total sold in the United States
f) Total profits on Taiwan sales
g) Total profits on U.S. sales
h) Total profits

ANSWER: Consider the following graph:

($)

MC

AC

A
PTaiwan
E B
PUS
AC
C D

D
Ta
iw
an

0 QUS Q
MR

QTaiwan

Page 2 of 9
 a) A profit-maximizing monopoly will produce at MR = MC. The level of output is therefore
QTaiwan. Demand at that level of output (point A) corresponds to price PTaiwan.
b) The “world” (US & Taiwan) demand as seen by Taiwan Beer is the line for DTaiwan until it
intersects with the demand for US which is perfectly elastic and a horizontal line at PUS. The
world MR curve, similarly, is the MRTaiwan curve until it intersects the US Price line, then it
follows the US price line. The profit-maximizing output is when MR = MC (point B which in
fact also corresponds to the perfectly competitive formula of P = MC). This corresponds to an
output of QUS.
c) Taiwan Beer can sell its production in Taiwan until an output of QTaiwan at a higher price
PTaiwan. It will therefore price-discriminate in Taiwan and keep output there at QTaiwan and
price at PTaiwan.
d) See (c), price in Taiwan is PTaiwan.
e) It will sell in the US only QUS – QTaiwan.
f) In Taiwan, Total Profit is (PTaiwan – AC) x QTaiwan. This is the rectangle PTaiwan-A-C-AC.
g) In the US, Total Profit is (PUS – AC) x (QUS – Qtaiwan). This is the rectangle E-C-D-B.
h) Total Profit is (PTaiwan – AC) x QTaiwan + (PUS – AC) x (QUS – QTaiwan). This is the sum of rectangles
PTaiwan-A-C-AC and E-C-D-B.
3. In 2012, the U.S. airline industry is radically transformed. Following a vicious price war and a series of
mergers, one company (Unison Airlines) has emerged as the sole survivor. Unison adopts a new slogan (Fly
in Unison - or Walk) and hires you as a consultant on pricing policy.
Unison offers a one-way trip from Atlanta to Washington. The marginal cost for each passenger is $40. Fixed
cost is $500,000. Demand information is shown in the following table. Note: The demand and marginal
revenue curves are linear.

One-Way Trips Demanded per

Price of One-Way Trip Ticket Year (Thousands) Marginal Revenue

$140 6

$130 8

$120 10

$110 12

$100 14

$90 16

$80 18

$70 20

a) Complete the table. Remember that demand is linear.

b) Give the demand equation in the form P = X - YQd, where X and Y are numbers and Qd is the quantity
demanded.
c) Calculate the quantity demanded when the price is zero.
d) Give the marginal revenue equation in the form MR = X - ZQd, where X and Z are numbers.
e) Calculate the quantity demanded when the marginal revenue is zero. Careful!
Suppose that Unison's corporate chiefs wish to charge a single, profit-maximizing ticket price for all their
Atlanta-Washington customers.
f) Which price will maximize profits?
g) Calculate Unison's total cost at the profit-maximizing output level.
h) Calculate Unison's economic profits.
i) Draw a diagram showing the demand, marginal revenue, and marginal cost curves.
Page 3 of 9
j) Calculate the consumer surplus and interpret your finding for Unison's top brass.
k) Determine the efficient output level and price.
l) A noted economist, Dr. Faircase, who is opposed to Unison's monopoly position, has claimed that
the loss in social welfare caused by Unison has a monetary value of $300,000. How would you advise
Unison to reply?
m) Is it coincidental that the welfare loss and the consumer surplus values are identical?
n) A campaign is being waged to split up Unison into smaller independent units. The management
wants to know the maximum amount they should allocate to a "war chest" to lobby and to buy
political favors.
o) Calculate Unison's economic profits at the efficient output level.
p) If the government required that Unison price tickets at the efficient price, what would be Unison's
long-run response?
q) Suppose the government requires that the price be set at the efficient level, but will offer Unison a
subsidy to maintain the flight. How great a subsidy per passenger would the government have to
offer Unison to induce them to keep the flight open?
r) The firm is able to practice perfect price discrimination. Determine the firm's total economic profit.

ANSWER:

a) See the following table:

One-Way Trips Demanded per

Price of One-Way Trip Ticket Year (Thousands) Marginal Revenue

$170 0

$160 2 $160

$150 4 $140

$140 6 $120

$130 8 $100

$120 10 $80

$110 12 $60

$100 14 $40

$90 16 $20

$80 18 $0

$70 20 ($20)

b) P = 170 - 5Qd. The slope is rise/run. As price falls by $10, quantity rises by 2 - the slope is 5.
The vertical intercept, i.e., when Qd is zero, occurs when price is $170.
c) Given P = 170 - 5Qd, when P = 0, 170 = 5Qd, therefore Qd = 34.
d) MR = 170 - 10Qd. Recall that the marginal revenue curve has the same vertical intercept as
the demand curve, i.e., $170. The slope is twice as steep as that of the demand curve, i.e. 10.
e) Given MR = 170 - 10Qd, when.MR = 0, 170 = 10Qd, therefore Qd = 17. Comment: Note that the
table seems to give the value as 18. This apparent discrepancy is because the table reports
the marginal revenue in the range from 16 to 18. The table reports discrete values, whereas
the formula is a continuous function.
f) Set MR = MC, i.e. 170 -10Qd = 40. Qd = 13. When Qd = 13, P = $105.
g) TC = TFC + TVC. TFC is given as $500,000. To get TVC, recall that MC is the addition to total
cost as extra units are produced, i.e. variable cost. TVC = $40 x 13,000 = $520,000. TC =
$500,000 + $520,000 = $1,020,000.
h) Economic profits = TR – TC. TR = P x Q = $105 x 13,000 = $1,365,000. TC = $1,020,000.
Economic profits= $345,000.
i) Refer to the following diagram.

Page 4 of 9
 $170

($) $105

$40 MC

Dem
MR

and

Q
0 13 17 26 34

j) Consumer surplus is the area between price and the demand curve, i.e. 0.5 * (170 - 1 05) *
13,000 = $422,500. Consumer surplus refers to difference between the value of the extra
benefits derived by customers and the price they paid.
k) The efficient output level is where P = MC. Because MC is constant at $40, P must equal $40.
Substituting that price into the demand equation, we get output to be 26.
l) The social loss is 0.5 * ($105 - $40) * (26,000 - 13,000), or $422,500. This, in fact, is greater
than the value given by Faircase, so it's probably best to not comment. If comment is
required, either Unison should not dispute Faircase's claim or, in an attempt to confuse the
issue, mention the consumer surplus value, which exceeds $300,000. This, of course, is a
complete red herring!
m) Given straight-line curves, it's not a coincidence. Because the MR curve is twice the slope of
the demand curve, it bisects MC. From that point, geometry requires identical triangles for
the two concepts. Other examples, and the real world, are not so clear cut.
n) Rent-seeking behavior tells us that the firm can allocate all of their economic profits
($345,000) to defeat the campaign.
o) Economic profits = TR - TC. TR = P * Q = $40 * 26,000 = $1,040,000. TC = TFC + TVC. TFC =
$500,000. TVC = $40 * 26,000 = $1,040,000. TC = $500,000 + $1,040,000 = $1,540,000.
Economic profits= -$500,000.
p) Unison would stop offering this flight - no firm will make an economic loss indefinitely.
q) The economic loss is -$500,000 to fly 26,000 passengers. The subsidy would be $19.23
(approximately).
r) Given perfect price discrimination, the firm's economic profit is the triangular area between
price and the demand curve, i.e. 0.5 * (170- 105) * 26,000 = $845,000.

II- Select the option that provides the single best answer.
1. A pure monopoly is best defined as a firm
a) Selling a product for which there are no close substitutes.
b) Making short-run economic profits.
c) With a degree of market power.
Page 5 of 9
 d) With a downward-sloping demand curve.

Answer: (a) Monopoly means “single seller.”

2. Which of the following is not a barrier to entry?

a) Ownership of patent rights
b) Ownership of private property
c) The possession of a government franchise
d) Substantial economies of scale

ANSWER: (b) There are no barriers to entry into a perfectly competitive industry, although the means
of production may be privately owned.

3. Monty the Monopolist is seeking to maximize profits. Currently, he is producing where marginal revenue is
less than marginal cost. He should
a) Increase production.
b) Reduce price.
c) Reduce production.
d) Produce where price is equal to marginal cost.

ANSWER: (c) To maximize profits, the firm should produce where MR = MC. When marginal revenue
is less than marginal cost, too much is being produced.

4. The profit-maximizing monopolist must decide all of the following EXCEPT

a) Output level.
b) Price level.
c) The wage level.
d) The combination of inputs.

ANSWER: (c) The labor market determines the wage level, and this market may be perfectly
competitive. The monopolist would be a wage taker with no control.

5. A monopolist is currently maximizing profits. We can conclude that

a) He is maximizing total revenue and minimizing total cost.
b) He has reduced the difference between marginal revenue and marginal cost to zero.
c) He is maximizing total revenue and marginal revenue.
d) He is producing where marginal revenue equals average cost.

ANSWER: (b) To maximize profits, the firm must be producing where MR = MC.

6. Manuel the Monopolist sells at a price of $4. His marginal cost is $3 and the price elasticity of demand is –
0.6. We can conclude that Manuel
a) Is maximizing profit.
b) Should increase output.
c) Should decrease output.
d) Should decrease price.

ANSWER: (c) Recall from Chapter 5 that when the absolute value of price elasticity of demand is less
than 1, demand is inelastic. Then, as price drops, quantity demanded increases and total revenue
drops. Therefore MR is negative. And MC must exceed MR, and Manuel should reduce output.

Page 6 of 9
7. Mandy the Monopolist operates a firm that is not a natural monopoly. Relative to a perfectly competitive
industry, we would expect Mandy to have
a) Lower prices and lower output.
b) Lower prices and higher output.
c) Higher prices and higher output.
d) Higher prices and lower output.

ANSWER: (d) With the exception of a natural monopoly, we would expect a monopoly to produce less
and charge more than a perfectly competitive industry. In fact, the monopoly reduces the welfare of
their customers and undermines the efficiency of the marketplace.

Use the following diagram to answer questions 8 -15. The cost information and the industry demand
curve apply in both perfect competition and monopoly. There is no price discrimination, unless
mentioned explicitly

8. This perfectly competitive industry becomes a monopoly. Price will _ _ _ _ _, and quantity will _ _ _ _ _.
a) Fall to E; fall to G
b) Fall to E; rise to H
c) Rise to F; rise to H
d) Rise to F; fall to G

ANSWER: (d) In the perfectly competitive industry, output is established where P = MC. In the
monopoly, output is where MR = MC. Given the demand curve, price will rise.

9. With a profit-maximizing monopolist, the net loss of social welfare is shown by area
a) FBCE.
b) BAC.
c) EABF.
d) BCD.

ANSWER: (b) Review the social cost of monopoly in Chapter 13. Review as well the concept of
deadweight loss.

10. To preserve the monopoly, this firm would be willing to spend up to

a) FBCE.
b) BAC.
c) EABF.
d) ABDC.

ANSWER: (a) The monopolist’s economic profit is (P – AC) × Q. The firm would be willing to sacrifice
all of this in order to maintain the monopoly.

Page 7 of 9
11. If this industry was initially perfectly competitive and subsequently became a monopoly, then the amount of
consumer surplus transferred to the monopolist is shown by the area
a) DBC.
b) ABC.
c) FBCE.
d) FBAE.

ANSWER: (c) Review the social cost of monopoly in Chapter 13. Review as well the concept of
consumer and producer surplus.

12. If this industry were perfectly competitive, consumer surplus would be shown by the area
a) ABC.
b) JEA.
c) FBCE.
d) FBAE.

ANSWER: (b) Review the social cost of monopoly in Chapter 13. Review as well the concept of
consumer surplus.

13. If this industry were a monopoly, consumer surplus would be shown by the area
a) ABC.
b) HEA.
c) JFB.
d) ECBH.

ANSWER: (c) Review the social cost of monopoly in Chapter 13. Review as well the concept of
consumer surplus.

14. If this industry were a monopoly practicing perfect price discrimination the firm’s economic profit would be
a) JEA.
b) EFBC.
c) EFBA.
d) EJBC.

ANSWER: (a) With perfect price discrimination, the firm will produce up to the point where P = MR.
Economic profit is the triangle between the demand curve and the average cost curve.

15. If this industry were a monopoly practicing perfect price discrimination the deadweight loss, relative to
perfect competition, is
a) ABC.
b) GBAH.
c) FJB.
d) Zero.

ANSWER: (d) With perfect price discrimination, the monopoly produces at the efficient output level
and there is no loss in welfare.

16. Mike the Monopolist produces where marginal revenue equals marginal cost equals average total cost. His
economic profits will be
a) Positive.
b) Negative.
c) Zero.

Page 8 of 9
 d) Indeterminate — it depends on demand conditions too.

ANSWER: (a) For the monopolist, the demand curve is above the MR curve. If MR = ATC, the price
exceeds ATC and Mike is earning an economic profit.

17. A monopoly produces where marginal revenue exceeds marginal cost.

a) The firm could increase profits by increasing output.
b) The firm could increase profits by decreasing output.
c) The firm is making an economic profit.
d) The firm is earning a negative economic profit (loss).

ANSWER: (a) The firm should produce at the output level where MR = MC.

NOTE: Because we don’t know anything about the relationship between price and ATC we can’t say
whether or not a profit is being made (Option (c)).

18. Use the following information for Firm A. Total revenue = $1,200. Total cost = $400. Price = $12. MR = $10.
Total Variable Cost = $300. MC = $6. This is a _ _ _ _ _ firm, currently in a _ _ _ _ _ situation.
a) Perfectly competitive; short-run
b) Monopolistic; short-run
c) Monopolistic; long-run
d) Perfectly competitive; long-run

ANSWER: (b) Price is not equal to MR — Firm A is not perfectly competitive. Because total costs are
greater than variable costs, there must be fixed costs — a short-run phenomenon.

19. Molly the Monopolist faces an elastic demand curve. If she decreases price, marginal revenue will be _ _ _ _
and total revenue will _ _ _ _.
a) Positive; rise
b) Positive; fall
c) Negative; rise
d) Negative; fall

ANSWER: (a) A decrease in price represents a movement down Molly’s demand curve. When demand
is elastic, marginal revenue (addition to total revenue) is positive and, given a decrease in price, total
revenue will increase.

20. The long-run average cost curve of a natural monopoly is

a) Upward sloping at the output level where it crosses the market demand curve for the good.
b) Upward sloping at all levels of output.
c) Downward sloping at all levels of output.
d) Downward sloping at the output level where it crosses the market demand curve for the good.

ANSWER: (d) The hallmark of a natural monopoly is that it experiences such substantial economies of
scale that one firm can service market demand. Long-run average costs decrease when economies of
scale are present.

Page 9 of 9