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Econ 22060 Principles of Microeconomics
Fall, 2005
Dr. Kathryn Wilson
Due: Thursday, Oct. 27
Homework #4 – Answer Key
1. The graph below depicts the demand curve and cost curves of a monopolist.
$110
$100
$90
$80
$70
$60
$50
$40
$30
$20
$10
$0
MC
ATC
200
160
140
120
100
80
60
40
20
180
D
MR
0
Price
Monopoly
Quantity
a) Draw the marginal revenue curve. If the monopolist were to sell 40 units, what price would it charge?
What would be the marginal revenue associated with the 40th unit of output? Explain why the two (price
and marginal revenue) are not the same. The marginal revenue curve crosses the X axis at half the
point where demand crosses. The marginal revenue of the 40th unit is $60, which means if the
monopoly sells 40 it will receive $60 more than if it sold 39 units. The price the monopoly would
charge is $80. Marginal revenue is less than the price the monopolist charges because in order to
sell one more, the monopolist must lower the price and thus receives less from other customers.
b) What output would a monopolist produce at to maximize profit? Where MR = MC, which is a
quantity of 80.
c) What price would a monopolist charge to maximize profit? Go up to demand to fine price, which is
$60.
d) What would be the monopolist’s profits if it is maximizing profit? Profits = (price – ave total cost) *
quantity = ($60 - $30) * 80 = $240
e) Would the monopolist’s level of output be efficient (no deadweight loss)? If not, what level of output
would be efficient? Explain. No. The monopolist sells 80, but the 80th one is worth $80 to someone
(we know this because the demand curve shows someone is willing to pay $80) but the marginal cost
of making it is only $20. Since MB > MC, we need to have more be produced in order to be
efficient. The efficient quantity, where MB = MC, is 120, where MC crosses the demand curve.
2. The table below shows the demand for a product. Assume that the marginal cost of producing the
product is zero.
Quantity
0
1
2
3
4
5
6
7
8
9
10
11
12
price
$60
55
50
45
40
35
30
25
20
15
10
5
0
TR (and total profit)
$0
$55
$100
$135
$160
$175
$180
$175
$160
$135
$100
$55
$0
a) If the product were supplied by firms in perfect competition, what quantity would be sold, what would
be the price, and what would be the profits for the industry? We know firms maximize profit where
MR = MC. Since in perfect competition price and marginal revenue (MR) are the same thing, they
maximize profit where Price = MC. The marginal cost is zero, so price will be zero and the quantity
will be 12. The profits for the industry would be zero.
b) If the product were supplied by a monopoly, what quantity would be sold, what would be the price,
and what would be the profits for the firm? A monopoly will sell a lower quantity and charge a higher
price than what we see in perfect competition (part a). The monopoly chooses the price/quantity
combination that gives it the largest possible profit. In this case, that is a quantity of 6 and a price
of $30, giving a profit of $180. There is no price/quantity combination that can give a higher profit.
c) If the product were supplied by two firms in oligopoly who worked as a cartel and split everything
evenly, what would be the quantity sold, what would be the price, and what would be the profits for the
firms? If the oligopoly were working as a cartel, they would act just like the monopoly in part b.
They would each produce 3 (a total of 6) and price would be $30. The combined profits would be
$180, which is $90 per firm.
d) Suppose one of the firms in part c if the firm increased its quantity by one. What would happen to the
price in the industry, the profit of the firm that sold the additional one, and the profit in the industry? If a
firm sold 4 instead of 3 then a total of 7 would be sold. For a quantity of 7, the price falls to $25.
The firm that sold 4 would get profits of $25*4 = $100, while the firm that sells 3 would get profits
of $25*3 = $75. The firm that sold the additional one would have a higher profit than in part c, but
the combined profits would be lower than part c.
e) Based on your answer in part d, explain why it is hard for an oligopoly to work as a cartel. It is hard
for an oligopoly to work as a cartel because there is this incentive to sell more than the quantity that
maximizes industry profits. By selling more, the individual firm increases its profits.
3. The following graph is for a firm in an industry characterized by Monopolistic Competition.
MC
D
ATC
DWL
ATC
110
100
90
80
70
60
50
40
30
20
10
MC
0
Price
Monopolistic Competition
$24
$22
$20
$18
$16
$14
$12
$10
$8
$6
$4
$2
$0
Quantity
a) What are the assumptions that characterize this market (what makes it monopolistic competition)?
many buyers and sellers, easy entry and exit, and differentiated product
b) What does the firm’s marginal revenue curve look like? (draw it on the graph)
Like for a monopoly, since demand is downward sloping, we draw in the marginal revenue curve as
shown above.
c) What quantity and price would the firm produce at in short run equilibrium? Quantity where MR =
MC, which is 30. The price is from the demand curve, about $16.
d) What would be the firm’s profits in the short run? Profits = (P – ATC) * Q = ($16 - $13) * 30 = $90.
e) What would we expect to happen to the firm’s demand curve over time (in the long run)? Why?
Since this firm is earning profits, new firms will enter. This will shift out industry supply and drive
down market price. This will shift the firms demand curve in since at any given price, people will
be willing to purchase less from this firm. In other words, new firms will enter. Thus, if your price
stays exactly the same, people will be willing to buy less indicating demand shifts in.
f) Will the firm in a market of monopolistic competition be efficient (no deadweight loss)? If there is
deadweight loss, draw it on the graph. No, the firm produces where MR = MC but this is not where
the value of the last good (MB) equals the cost of making it (MC). At a quantity of 105, the last one
is worth $19.50 to someone and costs about $9 to make it – to be efficient we need to produce more
(the efficient quantity is 180). The deadweight loss is shown on the graph (it should be the triangle
from quantity of 30 to quantity of 45 and price of 10 to price of 16 – I couldn’t get the triangle to fit
exactly).
4. Answer the following statements true or false and explain.
a. Ceteris paribus, consumer surplus will be larger if an industry is monopolistic competition than if it is
monopoly. True. With monopolistic competition there are many firms competing which pushes
price lower than what it would be if there were a monopoly. This results in more consumer surplus.
b. If there is deadweight loss with a monopoly then the monopoly must not be maximizing profits.
False. A monopoly maximizes profit by selling the quantity where marginal revenue = marginal
cost, which is a lower quantity than where marginal benefit = marginal cost.
c. Ceteris paribus, price will be higher if an industry is oligopoly than if it is perfect competition.
True. With oligopoly firms limit the amount they sell so they can charge a higher price. Thus the
price with oligopoly is higher than the price with perfect competition.
d. If a firm in an oligopoly does what is in its best interest, then the profits for the entire industry will be
maximized.
False. In order for profits for the industry to be maximized, all firms must cooperate. However, if
any given firm sells more than the agreed to amount, it can increase its profit but at the cost of
profits to other firms. See question 2.
e. If there are many firms and a homogenous product then the firms will be “price takers”.
True. If there are many firms and a homogeneous product then consumers do not care who they
buy from. If a firm tries to charge a price higher than the market price no one will buy from them.
Thus they are price takers who sell at the market price.
f. The only time the market will give us the efficient outcome (no deadweight loss) is if the industry is
perfect competition.
True. In every other market structure marginal benefit (which we measure based on what people
are willing to pay…price) is greater than marginal cost. The firms sell less than the efficient
amount because doing so causes them to have higher profits.