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ECO101 Solved Problems Single Price Monopolist Solutions
ECO101 Solved Problems Single Price Monopolist Solutions
1. Ghirmay is a profit-maximizing monopolist constrained to charging the same price for each
unit sold. He is also constrained to integer quantities. His fixed cost of production is $10 per
period, and he faces a marginal cost of $2 for each unit he produces. Assume that all benefits
accrue to the buyer and all costs are borne by Ghirmay.
2 $8.00
3 $7.00
4 $6.00
5 $5.00
6 $4.00
7 $3.00
8 $2.00
9 $1.00
10 $0.00
Table 1: The demand schedule Ghirmay faces. You get to fill in the rest.
(a) Table 1 gives the demand schedule facing Ghirmay’s firm. Complete the rest of the
table. Calculate MR 1 (Marginal Revenue 1) by summing up the quantity and price
effects. Calculate MR 2 (Marginal Revenue 2) by calculating the change in total
revenue from selling one more unit.
Suggested Solution: See Figure 2. Note that Producer Surplus is just total revenue
minus variable costs (i.e., the sum of variable costs).
2. Demand characterized by P (Q) = M W T P (Q) = 200 − 2Q, quantities need not be integers.
For each of the following, calculate marginal revenue, and decompose marginal revenue into
price and quantity effects.
200 − 4Qm = 40
160 = 4Qm
Qm = 40
P m = M W T P (Qm ) = 200 − 2 × 40 = $120
m
Elasticity of demand at profit-maximizing price (using “calculus” method) is ∆Q P
∆P Qm .
∆P
As a one-unit change in quantity results in a two-unit change in price (i.e., ∆Q = 2),
∆Q
a one-unit change in price results in a one-half unit change in quantity (i.e., ∆P = 12 ).
In order to calculate deadweight loss, we are going to need to calculate the efficient
quantity. The efficient quantity Qeffic equates marginal societal benefit and cost.
Qeffic
200 − 2Qeffic = 20 +
2
400 − 4Qeffic = 40 + Qeffic
360 = 5Qeffic
Qeffic = 72
3. Assume quantities must be integers. Demand schedule given by Figure 3, with marginal cost
of production equal to $8 per unit.
Q 1 2 3 4 5 6 7 8 9 10 11
P $32 $29 $27 $23 $21 $19 $17 $14 $11 $7 $3
(a) Assume a profit-maximizing monopolist constrained to charging the same price for each
unit. For each unit from 1 to 11, calculate the quantity effect, the price effect and the
marginal revenue.
4. You are a monopolist facing a demand curve given by M W T P (Q) = 36 − 4Q. Your cost
function is C(Q) = F + 4Q, where F is a per-period fixed cost. Assume that quantities need
not be integers.
1
The fact that unit 9 is only purchased at a price of $11 or lower tells us that M W T P and thus M B must be $11.
(a) In dollars, what is your marginal cost? (Hint: What are your total costs if you produce
0 units? What are your total costs if you produce 1 unit? The marginal cost is the
difference between these two numbers.)
Suggested Solution: $4
(b) Assuming that you produce and are constrained to charging the same price to all cus-
tomers, what quantity do you produce (QM ) and what price do you charge P M ?
Suggested Solution:
36 − 8Q = |{z}
4
| {z }
M R(Q) M C(Q)
M
Q =4
In order to sell 4 units, the profit-maximizing monopolist sets a price of P (4) = 36−4∗4 =
20.
(c) Hopefully, you have found that price is above marginal cost for all QM units. This is
good. Hopefully it will be enough to cover those fixed costs! (Clearly, if fixed costs are
really small, you will want to produce. Likewise, if fixed costs are super huge, you will
not want to enter this market even though you have a monopoly.) Assuming that you
are constrained to charging the same price to all consumers, what is the maximum F at
which your firm can make an economic profit?
Suggested Solution: As the cost per item is 4, the monopolist makes 20 − 4 = 16
per unit, and makes 16 ∗ 4 = 64 before fixed costs. Therefore, as long as fixed costs are
less than 64, our monopolist is making an economic profit.
(d) In a graph, depict:
• the demand curve,
• the marginal revenue curve, and
• the marginal cost curve;
and identify
• the efficient quantity (labelled Qeffic ),
• the quantity selected by the monopolist (labelled QM ),
• the price charged by the monopolist (labelled P M ), and
• the deadweight loss (labelled DWL).
Suggested Solution: See figure 3.
Price
40
36
32
D
em
an
28
d
MR
24
PM 20
16
12
DWL
8
MC
4
0
0 2 4 6 8 10
M Qeffic
Q
Quantity
Q
5. Assume MWTP for the a Graphing Calculator iPhone app is M W T P (Q) = 10 − 10,000 . As-
suming that Apple has already provided sufficient bandwidth for the App Store, the marginal
cost of producing one more unit is $0.00.
(a) What is the price that maximizes producer surplus?
Suggested Solution:
M B(Q) = M RQ = M C(Q) = 0
Q
10 − =0 the twice-as-steep rule
5, 000
Q∗M = 50, 000 solving for PS maximizing quantity
∗ 50, 000
PM = M W T P (50, 000) = 10 − =5 solving for PS maximizing price
10, 000
(b) What is elasticity of demand at the price that maximizes monopolist profits? (Use the
“calculus” method to calculate elasticity at a particular point.)
Suggested Solution: 1. Even before we explicitly calculate it, note that we want the
quantity where M R = M C = 0, which means we want to maximize total revenue. We
know that total revenue is maximized when elasticity=1 . . .
Pm
If you insist on calculating elasticity ( ∆Q
∆P Qm ), note that a one-unit change in quantity
∆P 1
results in a 1/10,000 change in price ∆Q = 10,000 , meaning a 1 unit change in price results
in a 10,000 unit change in quantity ( ∆Q 1
∆P 10,000 ). We thus have 10, 000 ×
5
50,000 = 1. Told
you so.
(c) Given that the Graphing Calculator app has already been written, what is the price that
maximizes Total Surplus?
Suggested Solution: P = 0 ensure that everyone who values it at marginal cost or
higher purchase the app.
(d) Instead of the price that maximizes producer surplus, the actual price is P = 1. What
is the exact deadweight loss with a price of $1?
Suggested Solution: At a price of $1, 90,000 consumers purchase, but 10,000 who
value at least at marginal cost do not. These 10,000 would have received consumer
surplus of 10,000∗1
2 = 5, 000. Thus the deadweight loss is 5,000.
(e) Suppose Apple announced that starting today and continuing forever, the price of all
iPhone apps will the the price you identified 5c, and this in no way affects marginal
costs. Argue that this policy may not, in fact, maximize Total Surplus. (Hint: Think in
the long run.)
Suggested Solution: Given that an app has been produced, with marginal cost equal
to $0.00, the price that delivers the optimal number of consumers is $0.00. Producer
surplus is thus $0.00. Let me ask you, how much time are you going to devote to
producing iPhone apps if you know that your revenue will be $0.00? While the surplus
generated at P > 0 is less than maximal, it is a lot larger than if the app were never
written.
(f) Explain why with M C = 0, the single-price monopolist chooses the price where demand
is unit elastic, whereas with M C > 0, the single-price monopolist chooses a price where
demand is elastic.
Suggested Solution: It might be helpful to look at a standard single-price monopolist
graph (e.g., Figure 3). Let us start at the price/quantity where demand is unit elastic. At
this point, marginal revenue will equal zero.2 Let us now contemplate a slight reduction
in quantity (i.e., a slight increase in price). Marginal revenue is positive for all units
smaller than the quantity where marginal revenue equals zero. This means by not selling
this unit, total revenue has decreased. So, was this quantity reduction a good thing?
In the case where M C = 0 this quantity reduction was unprofitable, as you reduced
revenues and did not reduce costs. We thus want to produce where M R = 0 (i.e.,
demand is unit elastic).
In the case where M C > 0, this slight quantity reduction was profitable. Sure, my
revenue decreased, but because I am producing less, my costs went down as well. At
any point where my marginal revenue curve is beneath my marginal cost curve, quantity
reductions will be profitable as the loss in revenue is smaller than the decrease in costs.
I keep decreasing quantity until M R = M C. As I am now at a quantity where M R > 0,
I am on the elastic portion of the demand curve.
6. Currently, patents in the U.S. and Canada last 20 years from the date on which the application
for a patent is filed. The effective patent on a new prescription drug is about 8 years, as it
takes about 12 years to test a new drug for safety and efficacy and get approval from the U.S.
Food and Drug Administration or Health Canada. When the patent on a drug expires, any
approved manufacturer can produce and sell the drug. (In general, when a drug comes off
patent, there are many manufacturers who are approved to sell a generic version. You can
assume a competitive market after the drug comes of patent.) True, False, or Uncertain:
2
This is a result you should know.
A policy that increased the length of patents for new drugs from 20 to 32 years would result
in a decrease in Total Surplus.
Suggested Solution: Uncertain. There would definitely be static inefficiency. That is, for
drugs which are already under development and would have its effective patent life increased
from 8 to 20 years, this policy change would result in twelve more years of monopoly inef-
ficiency. There may however be dynamic efficiencies. That is, there may be drugs that are
not developed because the firm feels that 8 years of monopoly profits is insufficient to recover
development costs, but might be profitable and therefore developed if the firm had 20 years
of monopoly profits.
7. While riding the subway in NYC recently, I noticed that there were some advertisement
locations where there no advertisements. While it might be the case that these advertisements
were stolen by passengers looking for cheap home decorating, let us assume that the quantity
of advertisements the MTA3 sold was less than the total space for advertising. True, False
or Uncertain: The MTA could have increased profits by selling more advertisements.
Suggested Solution: Well, if we assume that the MTA is profit maximizing, then the
answer is of course false. Let’s see whether we can do better than this.
First, let us assume that the market is perfectly competitive.4 In this case, the MTA can sell
as many advertisements as it wants at the market price, and thus the MTA is not maximizing
profits.
Second, let us assume that the MTA has market power. In particular, let us assume that it is
a monopolist constrained to charging the same price for each unit with Q units of advertising
space available. If it did not face space constraints, it would choose Qm the quantity where
M R = M C. If its available advertising space is greater than Qm (i.e., Q > Qm ), it would only
sell Qm units, meaning it would be profit maximizing to leave some spaces unsold (in order to
keep the price high). If its available advertising space is less than Qm (i.e., Q < Qm ), it would
sell Q at a price equal to M W T P (Q). In this case, there would be no unsold advertising
locations.
For those preferring numbers over variables, let us assume 100 advertising spaces per train.
The MTA solves for the quantity maximizing profits (Qm ) without considering that it only
has room for 100 per train. If its profit maximizing quantity is less than 100 (e.g., 80), then
it only sells 80 and leave 20 spaces blank. If its profit maximizing quantity is more than 100,
in this case it sets the price so that exactly 100 units are sold.
8. At P = 10, the monopolist sells 100 units. At P = 9, the monopolist sells 115 units. TFU:
If the profit-maximizing monopolist must choose either P = 10 or P = 9, she chooses P = 9.
Suggested Solution: Uncertain. While it is true that total revenues are greater under
P = 9 (1035 versus 1000), it is only worthwhile to choose this lower price if the cost of
producing these additional 15 units is less than 35.
9. At P = 10, the monopolist sells 100 units. At P = 11, the monopolist sells 95 units. TFU: If
the profit-maximizing monopolist must choose either P = 10 or P = 11, she chooses P = 11.
Suggested Solution: True. Increasing price increases revenues (1045 versus 1000) and
will not increase costs and quantity has decreased.
3
The Metropolitan Transportation Authority, the agency that runs the NYC subways.
4
For example, other forms of advertising are perfect substitutes.
10. You know two things: 1) you are a single-price monopolist; and 2) demand is characterized
Q
by P (Q) = 200 − 1000 . Your pricing manager suggests setting P = $75. TFU: You should
fire your pricing manager.
Suggested Solution: True. As a single-price monopolist, you know that you price on the
elastic portion of the demand curve.5 With a linear demand curve, you know that demand
is unit elastic at the midpoint of the demand curve: halfway between 0 and 200, or P = 100.
For you linear demand curve, demand will be inelastic at prices less than the midpoint, such
as P = $75. Profits must increase as you increase price from P = $75: total revenues increase
as demand is inelastic and costs go down as quantity decreases. Your pricing manager is
incompetent and should be fired.
11. A monopolist constrained to charging the same price for each unit has T C(Q) = 250 + 2Q
and faces demand M W T P (Q) = 12 − Q8 . Assuming it is required to pay its fixed costs, what
are its economic profits?
Hint you will not get on a term test: Each time you increase quantity by one unit, but
how much does total cost increase? This sounds conspicuously like marginal cost.
Q
Suggested Solution: The twice-as-steep rule gives us M R = 12 − 4. We set M R(QM ) =
QM
M C(QM ), or 12 − 4 = 2. Solving, we get QM = 40. The price is thus M W T P (QM ) =
40
M W T P (40) = 12 − 8 = $7.6
We can calculate profits in two ways. First, total revenues are P M × QM = $7 × 40 = $280.
Total costs are T C(QM ) = T C(40) = 250+2×40 = $330. Profits are thus $280−$330 = −$50.
Alternatively, we can first calculate producer surplus. Because both price and marginal cost
are constant, this will be a rectangle with height equal to P M − M C = $7 − $2 = $5 and
width equal to QM = 40 for a grand total of $200. This is the amount of money left over
after paying variable costs. Unfortunately, fixed costs are $250, meaning a loss of −$50.
12. While constant MC (i.e., a natural monopoly) will usually lead to a monopoly, a monopolist
can have increasing marginal cost.
A monopolist constrained to charging the same price for each unit has M C(Q) = 40 + Q4 and
faces demand M W T P (Q) = 100 − Q8 .
(a) Find the profit-maximizing quantity and price. (Note that because marginal cost is not
constant, we can not use our shortcuts to find either the monopolist’s price or quantity.)
Suggested Solution: The twice-as-steep rule gives us M R(Q) = 100 − Q4 . Now, a
5
If marginal costs are zero, you then want to price at the unit elastic point. When marginal costs are zero, profit
maximization implies revenue maximization.
6
Alternatively, because we have constant marginal cost, we could have just used the shortcut that tells us P M is
halfway between the vertical-intercept of the demand curve (12) and the marginal cost (2).
little math:
M R(QM ) = M C(QM )
QM QM
100 − = 40 +
4 4
400 − QM = 160 + QM
240 = 2QM
QM = 120
120
P M = M W T P (QM ) = 100 − = $85
8
(b) At what per-period fixed cost does this monopolist earn zero economic profits.
Suggested Solution: We calculate the amount of money the monopolist has left over
after paying variable costs. That is, we calculate producer surplus: the area between the
monopolist’s price and marginal cost. Figure 2 shows the case for the monopolist faced
with increasing marginal cost. There will be a triangle with base equal to the difference
between the marginal cost of the last unit (M C(120) = $70) the vertical-axis intercept
of the marginal-cost curve: 70-40=30. The height of the triangle is QM = 120. The
area is thus bh
2 =
120×$30
2 = $1, 800. There is also a rectangle: base equal to QM = 120,
height equal to the difference between the monopolists price and the marginal cost of
the last unit ($85 − $70 = $15), for another $1,800.
Therefore, if per-period fixed costs are $3,600, economic profits are exactly equal to zero.
(Likewise, if per-period fixed costs are less than $3,600, this monopolist earns positive
economic profits.)
13. Table 5 shows the supply and demand schedules in a particular labour market. Assume all
benefits accrue to the buyer and all costs are borne by the supplier. There are two possible
assumptions about the market.
Assumption 1 Table 5 depicts the supply and demand schedules resulting from eight work-
ers each willing to supply up to one unit of labour and eight firms each of which demands
up to one unit of labour.
Assumption 2 Table 5 depicts the supply and demand schedules resulting from eight work-
ers each willing to supply up to one unit of labour and one firm demanding up to eight
units of labour. The firm must pay each worker it hires the same wage.
Q 1 2 3 4 5 6 7 8
MWTP $35.5 $30.5 $27.5 $25.5 $23.5 $21.5 $19.5 $17.5
MC $11 $12 $14 $16 $18 $20 $23 $26
Suggested Solution: Summing up consumer surplus when paying $16 for the each of
the first six units gives ($35.5 − $16) + ($30.5 − $16) + ($27.5 − $16) + ($25.5 − $16) = $55.
This is greater than the consumer surplus under the assumption of a competitive labour
market.
(h) If Assumption 2 holds, what is the equilibrium deadweight loss?
Suggested Solution: The monopsonist hires four workers while the efficient quantity
is six workers. Hiring worker five would have created $23.5 − $18 = $5.5 in surplus.
Hiring worker six would have created $21.5 − $20 = $1.5 in surplus. Deadweight loss is
$5.5 + $1.5 = $7.
(i) If under either Assumption 1 or 2 there is equilibrium deadweight loss, what price control
maximizes total surplus?
Suggested Solution: Under Assumption 2 (monopsony), there is deadweight loss
without government intervention as the equilibrium quantity is less than the efficient
quantity. The efficient quantity (six units) is both supplied and demanded for any wage
between $21.5 and $20, meaning a minimum wage in this rate would maximize total
surplus.
14. You manage a software development firm that currently has 100 computer programmers,
each of whom earns $100 per hour. A client offers you a project. Your only cost would be
programmers. With 1000 hours of programmer time you will certainly complete it, and upon
completion the client will pay you $125,000. Elvis say, “Even if you need to hire additional
programmers, doing the project will be profitable.” Agree, Disagree or It Depends.
Suggested Solution: It depends. If you hire programmers in a competitive market, it
means that you can hire as many programmers as you want at $100 per hour. In this case,
your costs will be $100,000, meaning you will profit. However, if you have monopsony power,
you face an upward sloping supply curve for programmers. You will have to pay more than
$100 per hour for these 1000 hours—and may have to increase the pay of the programmers you
already use—which means your costs will be greater than $100,000. While the cost increse is
greater than $100,000, it is uncertain whether it is more or less than $125,000.
15. You manage a software development firm that develops software for financial services firms.
Assume your only cost is wages for computer programmers. You currently hire 20 computer
programmers, paying each $200,000 per year. If you start to develop software for healthcare
firms, you would need to hire 10 programmers, paying each $225,000 per year. Healthcare
software development guarantees you revenues of $2,500,000 per year. True, False or Un-
certain: It is profitable to enter the market for healthcare software development.
Suggested Solution: (Likely) false. Just looking at healthcare, $2.25 million in costs,
$2.5 million in revenues. It seems like profits of $250k. However, assuming there is just one
market for computer programmers (as opposed to different markets for programmers who can
develop for financial services and those who can develop for healthcare), your firm faces an
upward-sloping labour supply curve. If you have to pay the same wage for every programmer
you employ, you need to give your 20 current programmers a $25,000 per-year raise, which
increases your costs by $500k. This turns your $250k gain into a $250k loss.
However, this is assuming that you have to pay the same wage for every programmer you
employ. This might not be the case if there are different markets for programmers who can
develop for financial services and those who can develop for healthcare. Alternatively, even if
there is one market for programmers and you have monopsony power, in theory you could pay
some programmers more than others. Good luck with paying your most recent hires more
than your longtime employees!
16. Tigist works a total of 40 hours each each week. She can work as many hours as she likes as
a programmer earning $40 per hour. She also does personal training, with demand for her
services given by Q(P ) = 60 − P2 . For her personal training business, she rents a studio for
$100 per week, but does not pay herself a wage. That is, each week she gets all of the personal
training revenue left over after paying for the studio plus her earnings as a programmer.
(a) Assume that Tigist incorrectly uses only explicit costs in calculating her optimal hourly
rate for personal training. How much money does she make each week from all sources?
Suggested Solution: Maximizing personal-training profits when she incorrectly uses
$0 as her marginal cost.
P (Q) = 120 − 2Q
M R(Q) = 120 − 4Q
120 − 4Qm = |{z}
0
| {z }
MR MC
m
Q = 30
m
P = P (Qm ) = 120 − 2 × 30
P m = 60
Each week, her personal training puts 30 × $60 = $1800 into her bank account. Working
as a personal trainer for 30 hours per week, she has 10 hours a week for programming.
Programming puts 10 × $40 = $400. She is putting $2200 into her bank account each
week, which means she is making $2100 each week after paying for her studio.
(b) Assume that Tigist correctly calculates her optimal hourly rate for personal training.
How much money does she make each week from all sources?
Suggested Solution: Maximizing personal-training profits when she correct uses $40
as her marginal cost.
120 − 4Qm = 40
| {z } |{z}
MR MC
Qm = 20
P m = P (Qm ) = 120 − 2 × 20
P m = 80
Each week, her personal training puts 20 × $80 = $1600 into her bank account. Working
as a personal trainer for 20 hours per week, she has 20 hours a week for programming.
Programming puts 20 × $40 = $800. She is putting $2400 into her bank account each
week, which means she is making $2300 each week after paying for her studio.
(c) What is the most that she is willing to pay each week to rent a studio for her personal-
training side hustle?
Suggested Solution: If she just works as a computer programmer, she puts 40×$40 =
$1600 into her bank account each week. If she works the optimal number of hours as a
personal trainer, she puts $2400 into her bank account each week. As long as her studio
is $800 or less, the net amount of money from 20 hours a week at both programming
and training is at least as large as 40 hours per week as a programmer.