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EC 200
Practice problems for MT3
MONOPOLY
Practice Problems
Answer Key
1. True, false or uncertain? Explain your answer.
a. A decrease in the firm’s fixed cost will change its profits, but will not influence the firm’s
decision about how much good to produce.
True. A one-time change in the size of the fixed cost does not affect any part of the profit
maximization condition (MR=MC). Therefore, the optimal output will remain the same.
On the other hand, Total Profit = TR – TC = P · Q – TC. An increase in fixed cost will
increase total cost, so the profit will decrease.
b. When the fixed cost of a firm increases, the best thing the firm can do is to increase its price in
order to compensate for the cost increase.
False. The change in the fixed cost doesn’t change our profit maximization point (we
should keep producing and selling the same amount as before). So our price shouldn’t
change as well, because otherwise we won’t be able to sell the same amount.
2. If a profit-maximizing firm finds that, at its current level of production, MR > MC, it will
a) earn greater profits than if MR = MC.
b) increase output.
c) decrease output.
d) shut down.
3. Suppose you have found out that the good your firm produces and sells has unit price elasticity
of demand in a wide range of prices. Given that, can you increase your profits by changing the
price of this good? If yes, explain carefully what that change should be. If not, explain why it is
not possible.
Profit = TR - TC.
Since the price elasticity of demand is equal to one, total revenue will not change as a result
of a change in price (and therefore quantity produced). However, we can decrease our total
cost by producing less (and therefore charging higher price according to the law of
demand).
So, if we increase our price, we can produce less. Our TR will stay the same, but TC will
decrease. As a result, profit will increase.
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EC 200
Practice problems for MT3
4. Two tables below contain information about the total cost of the firm and the demand it is facing.
Cost Data
Output Total Cost, $
100
200
300
400
500
Demand Data
Price, $
Quantity
demanded
6
100
5.50
200
5
300
4.50
400
4
500
1500
1550
1650
1800
2250
a. Can you tell whether this firm operates in a perfectly competitive industry? Explain your answer.
Yes, we can, and no, this market is not perfectly competitive. In perfect competition the firm would
be able to sell its entire output at the same price regardless of the number of units it produces (the
demand curve is horizontal). In this case, the demand curve is clearly downward sloping – in order
to sell more the firm has to lower the price.
b. Create and fill marginal revenue and marginal cost columns.
The marginal cost is the difference between the two successive entries in the total cost column. The
marginal revenue is the difference between the two successive entries in the total revenue column.
We need to make one extra step and calculate total revenue, which is equal to the product of
quantity and price.
Cost Data
Output Total Cost, $
100
200
300
400
500
1500
1550
1650
1800
2250
MC, $
Price, $
???
50
100
150
450
6
5.50
5
4.50
4
Demand Data
Quantity
demanded
100
200
300
400
500
TR, $
MR, $
600
1100
1500
1800
2000
600
500
400
300
200
Find the output quantity that is optimal for the firm.
Method 1. The MR-MC approach. The last positive difference between MR and MC is at 400 units
of output.
Method 2. The aggregate approach. Since we now have both TR and TC, we can just subtract TC
from TR to determine the profit. The only output quantity for which the profit does not come out
negative is 400 units. Hence this is the best output quantity.
c. State the size of economic profit the firm earns at this quantity of output.
Profit = TR – TC = 1800 – 1800 = 0
d. Can you tell whether the firm earns accounting profit? Explain.
Probably yes. The economic profit takes into account the opportunity cost of running this business,
which has to be positive due to scarcity of resources. If economic profit is zero, this means the firm
is earning normal accounting profit (does as well as the other firms of a similar size).
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