Tutorial Exercise (Week 10)

1. A profit-maximizing monopoly has two plants that it can use to produce its goods.
The inverse demand function is P(Q) = 10 – 0.5Q. The two plants are identical, with
each plant i having total cost function TCi(qi) = 1 + qi + 0.5qi2, for i=1,2.

a. Fill in the blanks. Suppose the firm produces using both plants. Then, the firm will
produce _____ units using plant 1, and _____ units using plant 2. It will sell each units
at ____ dollars. Its total profit is _____.

Answer:
q1 = 3
q2 = 3
P = 7.
Total profit = 25.

b. What is the monopoly’s profit if it produced 2.9 units using one plant and 3.1 units
using the other?

Total profit = 24.99.

2. The BCY Corporation provides accounting services to a wide variety of customers,

most of whom have had a business association with BCY for more than five years.
BCY's inverse demand function is P = 10,000 - 10Q, and its marginal cost of service
is MC = 5Q.

a. If BCY charges a uniform price for a unit of accounting service, Q, what price
must it charge per unit, and how many units must it produce per time period in order
to maximize profit? Calculate the consumer surplus.
b. If BCY could enforce first-degree price discrimination, what would be the lowest
price that it would charge and how many units would it produce per time period?
c. With perfect price discrimination and ignoring any fixed cost, what is total profit?
How much additional consumer surplus is captured by switching from a uniform price
to first-degree price discrimination?

Answer:
a.
P = 6,000
Q = 400
CS = 800,000
b.
P = 3,333,33
Q = 666.67
c.
profit = 3,333,333.33
Captured CS = 800,000

3. Which of the following statements about natural monopolies is true?

A) Natural monopolies are only found in the markets for natural resources (like crude
oil and coal).
B) For natural monopolies, marginal cost is always below average cost.
C) For natural monopolies, average cost is always increasing.
D) Natural monopolies cannot be regulated.

Answer: B

4. A monopolist practicing third degree price discrimination charges $3 per unit for one
segment and $2 per unit for a second segment. The demand elasticity of the second
segment is -2. Assume it maximizes profits. What is the demand elasticity of the other
segment?
A) -0.5
B) -0.67
C) -1.0
D) -1.5

Answer: D

5. The entry and exit of firms in a monopolistically competitive market guarantee that
A) marginal revenue equals marginal cost and average total cost is minimized.
B) firms can earn economic profits in the long run.
C) price equals average total cost in the long run.
D) firms can earn economic profits in the short run.

Answer: C

6. In the Bertrand dupoly model with homogenous products, if the firms have identical
marginal costs, then
A. the firm with the lower price may capture all the market
B. the Nash equilibrium is the competitive outcome
C. both firms set price equal to marginal costs
D. All of the above

Answer: D

7. Two firms compete in a market to sell a homogeneous product with inverse demand
function P = 400 − 2Q. Each firm produces at a constant marginal cost of $50 and has
no fixed costs. Use this information to compare the output levels, profits and welfare
loss in settings characterized by Cournot and collusive behaviour.

Answer:
Under Cournot:
Qc1 = Qc2 = 175/3
P = 500/3
Q = 350/3
Profit of each firm = 61250/9
Welfare loss = 30625/9.

Under collusion:
Q1=Q2=175/4
Profit of each firm = 30625/4
Welfare loss = 30625/4