Dr. Shishkin
ECON 2106
Assignment #22
Fall 2010
ANSWERS
Monopoly, Part I
1. Is a monopolist a price taker or not? Explain.
Answer: A monopolist is not a price taker because it can manipulate the market price at
which it is selling its good.
2. Explain under what conditions a natural monopoly will arise.
Answer: A natural monopoly arises when the economy of scale occurs over the whole
range of demand for the good. In this situation, one company will be able to produce
goods at lower average cost than two or more firms.
3. Explain why a profit-maximizing, single-price monopoly will never produce the
amount of output that corresponds to the inelastic section of the demand curve? (Use a
diagram to illustrate your answer).
When demand is inelastic, marginal
revenue is negative. As for a profit
maximizing monopolist MR=MC
(unless p<min AVC, in which case
the firm should shut down), and MC
is always non negative, MR should be
non negative too. If MC=0, then
elasticity = 1. If MC>0, elasticity >1.
Email me at [email protected], and text at (678) 524-5535 if I don’t respond
1
Dr. Shishkin
ECON 2106
Fall 2010
4. A single-price monopoly can sell 2 units for $8.50 per unit. In order to sell 3 units, the
price must be lowered to $8.00 per unit. What is the marginal revenue from selling the
third unit?
MR = ΔTR/ΔQ = (TR2 – TR1)/(Q2 - Q1) = (8x3 - 8.50x2)/(3 - 2) = 24 - 17 = $7
Q
P
TC
MC
TR
MR
ATC
0
24
20
1
22
26
6
22
22
26
-4
2
20
34
8
40
18
17
6
3
18
46
12
54
14
15.3
8
4
16
64
18
64
10
16
0
92
28
70
6
18
-22
5
14
0
profit
-20
A single-price monopoly has the demand and total cost schedules given in the above
table.
5. Based on this information, calculate marginal cost, total revenue, marginal revenue,
and average total cost. Answer: see the table above
6. Plot P, MC, MR, and ATC on the template below (remember that marginal values
should be positioned between other values). Answer: see the graph below
7. Use marginal analysis to find out the profit maximizing output.
The profit maximizing output is achieved at Q = 3 because this is where the last step for
which marginal benefit exceeds marginal cost. Also, at this level of output, MC and MR
are getting as close to each other as possible, thus the condition for profit maximization
MR=MC is approximately satisfied.
8. Refer to MR and MC to explain why moving away from this level of output will
reduce the amount of profit.
We don’t want to move farther than Q=3 because the next step to Q=4 will produce MC
that is larger than marginal revenue ($18 and $12 respectively). Similar logic can be
applied to see why we don’t want to go step down from Q=3 to Q=2: in this case,
reducing the output by one unit will take more in lost MR ($14) than will give us in saved
MC ($12).
Email me at [email protected], and text at (678) 524-5535 if I don’t respond
2
Dr. Shishkin
ECON 2106
Fall 2010
9. Calculate profit at the level of output that you found at (7) referring to the price,
average total cost, and Q. Show your work.
Profit = (P – ATC)xQ = (18-15.3)x3 = 8.1
10. Double check your results by calculating profit as the difference between total
revenue and total cost. Does the company’s profit achieves the maximum at the same
level of output that you found in (7)?
See the table: profit is at its max of 8, when Q = 3.
Email me at [email protected], and text at (678) 524-5535 if I don’t respond
3
Dr. Shishkin
ECON 2106
Fall 2010
Suppose the Busy Bee Café is the monopoly producer of hamburgers in Hugo,
Oklahoma. The above figure represents the demand, marginal revenue, and marginal cost
curves for this establishment. Refer to this figure to answer four questions below:
11. What quantity will the Busy Bee produce to maximize its profit?
Q=20
12. What price will the Busy Bee charge to maximize its profit?
$3.00
13. What is the average total cost at the profit maximizing level of output?
$2.00
14. How much profit the Busy Bee will be able to earn?
Profit = (p – ATC)xQ = (3-2)x20 = $20 per hour
Email me at [email protected], and text at (678) 524-5535 if I don’t respond
4