ME Problem Set – VIII

PGP 2023 – 25
Solutions
1.
(a) BMW should choose the levels of QE and QU so that MR E  MRU  MC .
To find the marginal revenue expressions, solve for the inverse demand functions:
PE  40,000  0.01Q E and PU  50,000  0.05QU .

Since demand is linear in both cases, the marginal revenue function for each
market has the same intercept as the inverse demand curve and twice the slope:
MR E  40,000  0.02Q E and MRU  50,000  0.1QU .

Marginal cost is constant and equal to $20,000. Setting each marginal revenue
equal to 20,000 and solving for quantity yields:
40,000  0.02Q E  20,000 , or Q E  1,000 ,000 cars in Europe, and

50,000  0.1QU  20,000 , or QU  300 ,000 cars in the U.S.

Substituting QE and QU into their respective inverse demand equations, we may

determine the price of cars in each market:
PE  40,000  0.01(1,000,000 )  $30,000 in Europe, and

PU  50,000  0.05(300 ,000 )  $35,000 in the U.S.

Profit is therefore:
  TR  TC  (30,000)(1,000,000)  (35,000)(300,000)  [10,000,000,000  20,000(1,300,000)]
  $4.5 billion.

(b) If BMW must charge the same price in both markets, they must find total
demand, Q = QE + QU, where each price is replaced by the common price P:
5,000,000 Q
Q = 5,000,000 – 120P, or in inverse form, P   .
120 120
Marginal revenue has the same intercept as the inverse demand curve and twice
the slope:
5,000,000 Q
MR   .
120 60
To find the profit-maximizing quantity, set marginal revenue equal to marginal
cost:
5,000,000 Q
  20,000 , or Q* = 1,300,000 cars.
120 60

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 Substituting Q* into the inverse demand equation to determine price:
5,000,000 1,300,000 
P   $30,833.33.
120  120 

Substitute into the demand equations for the European and American markets to
find the quantity sold in each market:
QE = 4,000,000 – (100)(30,833.3), or QE = 916,667 cars in Europe, and

QU = 1,000,000 – (20)(30,833.3), or QU = 383,333 cars in the U.S.

Profit is  = $30,833.33(1,300,000) – [10,000,000,000 + 20,000(1,300,000)], or
 = $4.083 billion.
U.S. consumers would gain and European consumers would lose if BMW were
forced to sell at the same price in both markets, because Americans would pay
$4,166.67 less and Europeans would pay $833.33 more for each BMW. Also,
BMW’s profits would drop by more than $400 million.

2.
(i) Choose quantity in each market such that marginal revenue is equal to
marginal cost. The marginal cost is equal to 3 (the slope of the total cost curve).
The profit-maximizing quantities in the two markets are:
15 – 2Q1 = 3, or Q1 = 6 on the East Coast, and
25 – 4Q2 = 3, or Q2 = 5.5 in the Midwest.
Substituting into the respective demand equations, prices for the two markets are:
P1 = 15 – 6 = $9, and P2 = 25 – 2(5.5) = $14.

Noting that the total quantity produced is 11.5, then

 = 9(6) + 14(5.5) – [5 + 3(11.5)] = $91.50.
When MC is constant and demand is linear, the monopoly deadweight loss is
DWL = (0.5)(QC – QM)(PM – PC ),

where the subscripts C and M stand for the competitive and monopoly levels,
respectively. Here, PC = MC = 3 and QC in each market is the amount that is
demanded when P = $3. The deadweight losses in the two markets are

DWL1 = (0.5)(12 – 6)(9 – 3) = $18, and

DWL2 = (0.5)(11 – 5.5)(14 – 3) = $30.25.

Therefore, the total deadweight loss is $48.25.

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 (ii) Without price discrimination the monopolist must charge a single price for
the entire market. To maximize profit, we find quantity such that marginal
revenue is equal to marginal cost. Adding demand equations, we find that the
total demand curve has a kink at Q = 5:

 25  2Q, if Q  5
P 
 18.33  0.67Q, if Q  5 .
This implies marginal revenue equations of
 25  4Q, if Q  5
MR  
18.33  1.33Q, if Q  5 .
With marginal cost equal to 3, MR = 18.33 – 1.33Q is relevant here because the
marginal revenue curve “kinks” when P = $15. To determine the profit-
maximizing quantity, equate marginal revenue and marginal cost:
18.33 – 1.33Q = 3, or Q = 11.5.
Substituting the profit-maximizing quantity into the demand equation to
determine price:
P = 18.33 – (0.67)(11.5) = $10.67.
With this price, Q1 = 4.33 and Q2 = 7.17. (Note that at these quantities MR1 =
6.34 and MR2 = –3.68). Profit is
 = 10.67(11.5) – [5 + 3(11.5)] = $83.21.
Deadweight loss in the first market is
DWL1 = (0.5)(12 – 4.33)(10.67 – 3) = $29.41.
Deadweight loss in the second market is
DWL2 = (0.5)(11 – 7.17)(10.67 – 3) = $14.69.
Total deadweight loss is $44.10. Without price discrimination, profit is lower,
but deadweight loss is also lower, and total output is unchanged. The big winners
are consumers in market 2 who now pay $10.67 instead of $14. DWL in market
2 drops from $30.25 to $14.69. Consumers in market 1 and the monopolist are
worse off when price discrimination is not allowed.

3.
(a) If price discrimination is impossible the firm will set MR  MC .
20  2Q  2Q
Q5

At this quantity, price will be P  15 , total revenue will be TR  75 , total cost will be
TC  49 , and profit will be   26 . Producer surplus is total revenue less non-sunk cost, or,
in this case, total revenue less variable cost. Thus producer surplus is 75  52  50 .

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(b) With perfect first-degree price discrimination the firm sets P  MC to determine the
level of output.
20  Q  2Q
Q  6.67

The price charged each consumer, however, will vary. The price charged will be the
consumer’s maximum willingness to pay and will correspond with the demand curve. Total
revenue will be the area underneath the demand curve out to Q = 6.67 units, or 0.5(20 –
13.33)(6.67) + 13.33(6.67) = 111.16. Since the firm is producing a total of 6.67 units, total
cost will be TC  68.49 . Profit is then   42.67 , while producer surplus is revenue less
variable cost, or 111.16  6.67 2  66.67 .

(c) By being able to employ perfect first-degree price discrimination the firm increases
profit and producer surplus by 16.67.

4.
(a) With demand P  20  Q , MR  20  2Q . A profit-maximizing firm charging a
uniform price will set MR  MC .
20  2Q  2Q
Q5

At this quantity, price will be P  15 . At this price and quantity profit will be

  15(5)  ( F  52 )
  50  F

Therefore, the firm will earn positive profit as long as F  50 .

(b) A firm engaging in first-degree price discrimination with this demand will produce
where demand intersects marginal cost: 20 – Q = 2Q or Q = 6.67 units. Its total revenue will
be the area underneath the demand curve out to Q = 6.67 units;
TR  .5(20  13.33)(6.67)  13.33(6.67)  111.16 . Profit will be
  111.16  ( F  6.67 2 )
  66.67  F

Therefore, profit will be positive as long as F  66.67 . Comparing the solution to parts (a)
and (b), for values of F between 50 and 66.67 the firm would be unwilling to operate unless it
is able to practice first-degree price discrimination.

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5.
(a) The firm would maximize profit by producing until MR = MC, or 40 – 6Q = 2Q.
Thus Q = 5 and the profit-maximizing price is P = 25. With MC = 2Q and no fixed costs, its
total costs are C = Q2, so  = 25(5) – 52 = 100.

(b) With perfect first degree price discrimination, the firm will charge a price on the
demand curve for all units up to the quantity at which the demand curve intersects the
marginal cost curve. The demand curve intersects the marginal cost curve when 40 – 3Q =
2Q, or when Q = 8. Total revenue will be the area under the demand curve, or 0.5(40 – 16)8
+ 16(8) = 224. Total variable cost is the area of the triangle under its marginal cost curve up
to the quantity produced, that is, 0.5(16)(8) = 64. Economic profit will be 224 – 64 = 160. So
by price discriminating, the firm will be able to earn an extra profit of (160 – 100) = 60.

6.
(a) When the firm sets a uniform price, it sets MR = MC: 100 – 2Q = 20. The quantity
that maximizes profit is therefore Q = 40. The profit maximizing uniform price is P = 100 –
Q = 100 – 40 = 60. Profit is PQ – F -20Q = (60)(40) – F – (20)(40) = 1600 – F. So the firm
could earn at least zero economic profit as long as F < 1600.

(b) With perfect first degree price discrimination, the firm will charge a price on the
demand curve for all units up to the quantity at which the demand curve intersects the
marginal cost curve. The demand curve intersects the marginal cost curve when 100 – Q =
20, or when Q = 80. Total revenue will be the area under the demand curve, or 0.5(100 –
20)80 + 20(80) = 4800. Total cost will be F + 20(80) = F + 1600. Economic profit will be
4800 – F – 1600 = 3200 – F. So the firm will be able to earn at least zero economic profit as
long as F < 3200.

7.
(a) The firm’s total revenue when it produces 2 units is 19 euros (10 from the first unit and 9
from the second).

(b) The firm’s total revenue when it produces 3 units is 27 euros (10 from the first unit, 9
from the second, and 8 from the third).

(c) They are equal, as we would expect with perfect first-degree price discrimination. The
price of the third unit is 8 euros. The marginal revenue of the third unit is also 8 euros (27
euros – 19 euros).

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(d) By similar reasoning, the price and the marginal revenue of the fourth unit will also be
equal to each other (in this case 7 euros).

8.
(a) We can represent the marginal willingness to pay for each unit beyond Q1 = 20 as P =
100 – (20 + Q2) = 80 – Q2. The associated marginal revenue is then MR = 80 – 2Q2, so the
profit maximizing second block is MR = MC: 80 – 2Q2 = 10. Thus Q2 = 35 and P2 = 80 – 35
= 45. So the firm sells the first 20 units at a price of $80 apiece, while the firm sells any
quantity above 20 at $45 apiece. The firm’s total profit will be (80 – 10)*20 + (45 – 10)*35
= $2625.

(b) The marginal willingness to pay for each unit beyond Q1 = 30 is P = 70 – Q2. So MR
= 70 – 2Q2 and we have MR = MC: 70 – 2Q2 = 10. Thus Q2 = 30 and P2 = 40. The firm’s
total profit will be (70 – 10)*30 + (40 – 10)*30 = $2700.

(c) The marginal willingness to pay for each unit beyond Q1 = 40 is P = 60 – Q2. So MR
= 60 – 2Q2 and we have MR = MC: 60 – 2Q2 = 10. Thus Q2 = 25 and P2 = 35. The firm’s
total profit will be (60 – 10)*40 + (35 – 10)*25 = $2625.

(d) The option in part (b) yields the highest profits, of $2700.

9. When the P = 30, the demand function shows that Q = 30.

At that price, profit = 0 = PQ – C = (30)(30) – F – 20(30); therefore F = 300.
So total cost is C = 300 – 20Q.
Now find the quantity that maximizes profit. Set MR = MC. MR = 60 – 2Q and MC = 20.
60 – 2Q = 20 implies that Q = 20 and P = 40.
So, the profit-maximizing profit will be PQ – C = (40)(20) – 300 – (20)(20) = 100.

10. a) If demand is given by P  300  Q then MR  300  2Q . To find the optimum set
MR  MC .
300  2Q  Q
Q  100

At Q  100 price will be P  300  100  200 . At this price and quantity total revenue will be
TR  200(100)  20, 000 and total cost will be TC  1200  .5(100)2  6, 200 . Therefore, the firm
will earn a profit of   TR  TC  13,800 .

b) The price elasticity at the profit-maximizing price is

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 Q P
 Q,P 
P Q

With the demand curve Q  300  P , Q

P  1 . Therefore, at the profit-maximizing price

 200 
 Q , P  1  
 100 
 Q , P  2

The marginal cost at the profit-maximizing output is MC = Q = 100. The inverse elasticity pricing
rule states that at the profit-maximizing price

P  MC 1

P  Q,P

In this case we have

200  100 1

200 2
1 1

2 2

Thus, the IEPR holds for this monopolist.

11.

a) With demand P  210  4Q , MR  210  8Q . Setting MR  MC implies

210  8Q  10
Q  25

With Q  25 , price will be P  210  4Q  110 . At this price and quantity total revenue will be
TR  110(25)  2, 750 .

b) If MC  20 , then setting MR  MC implies

210  8Q  20
Q  23.75

At Q  23.75 , price will be P  115 . At this price and quantity total revenue will be
TR  115(23.75)  2, 731.25 . Therefore, the increase in marginal cost will result in lower total
revenue for the firm.

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c) Competitive firms produce until P = MC, so in this case we know the market price
would be P = 10 and the market quantity would be:
210  4Q  10
Q  50

d) In this case, the market price will be P  MC = 20, implying that the industry quantity
is given by
210  4Q  20
Q  47.50

At this quantity, price will be P  20 . When MC  10 , total industry revenue is 10(50)  500 .
With MC  20 , total industry revenue is 20(47.50)  950 . Thus, total industry revenue increases
in the perfectly competitive market after the increase in marginal cost.

12.
a) The firm’s total revenue when it produces 2 units is 19 euros (10 from the first unit and 9 from the
second).
b) The firm’s total revenue when it produces 3 units is 27 euros (10 from the first unit, 9 from the
second, and 8 from the third).
c) They are equal, as we would expect with perfect first-degree price discrimination. The price of the
third unit is 8 euros. The marginal revenue of the third unit is also 8 euros (27 euros – 19 euros).
d) By similar reasoning, the price and the marginal revenue of the fourth unit will also be equal to
each other (in this case 7 euros).