Tutorial Chapter 10

Antonio Curcio∗

April 17, 2024

Multiple Answer Choices

Question 1

For the monopolist shown in this diagram, the profit maximizing level of output is:

1. Q1
2. Q2
3. Q3
4. Q4
5. Q5
∗
Master Student in Economics, Collegio Carlo Alberto & University of Turin.
if needed, don’t hesitate to email me at email: [email protected]

1
Answer

The answer is Q1, which corresponds to the point in which M R = M C, the equilibrium at
which monopolists maximize their profits.

Question 2

Compared to the equilibrium price and quantity sold in a competitive market, a monopolist
will charge a higher/ lower price and sell a higher/ lower quantity.

Answer

Compared to the equilibrium price and quantity sold in a competitive market, a monopolist
will charge a higher price and sell a lower quantity. For example, in the figure of question 1,
the competitive equilibrium is in point Q3, while the equilibrium quantity of the monopolist
is in Q1, and it is possible to notice that for the monopolist, price is higher and quantity is
lower.

Question 3

The monopolist power depends on the ability to

1. set price equal to marginal cost

2. set price equal to marginal cost plus average variable cost

3. set price above average variable cost

4. set price above marginal cost

Answer

The correct answer is ”to set price above marginal cost”. Indeed the monopolist pricing
rule is: P −M
P
C
= −1
Ed
MC
, or alternatively P = 1+ 1 .
Ed

2
Question 4

A monopolist firm faces a demand with constant elasticity of -1.5. It has a constant marginal
cost of $20 per unit and sets a price to maximize profit. If marginal cost should increase by
25%, would the price charged also rise by 25%?

1. Yes
2. No

Answer

P −M C −1 MC
The monopolist pricing rule is: P
= Ed
, or alternatively P = 1+ E1
. Therefore, price
d
MC
should be set so that P = 1+ 1 = 3M C.With M C = 20$, the optimal price is P = 60$. If
1.5
M C increases by 25% to 25$, the new optimal price is P = 3M C = 75$ a 25% increase. So,
if marginal cost increases by 25% also the price increases by 25%.

Question 5

The revenue and cost curves in the diagram above are those of a natural monopoly. If the
monopolist is not regulated, the price will be set at:

1. P1

3
 2. P2
3. P3
4. P4

Answer

The answer is P2, which corresponds to the price, given the demand curve, at which the
quantity corresponds to the equilibrium at which monopolists maximize their profits (M C =
M R).

Question 6

The situation in which buyers are able to affect the price of a good is referred to as the
monopoly/monopsony/purchasing power.

Answer

The situation in which buyers are able to affect the price of a good is referred to as the
monopsony power.

Exercises

Question 1

The function Q = 20−P represents the market demand. The cost function of the monopolist
is C = 4Q. Find quantity, price and profit of the monopolist.

Answer

Find the inverse demand, which is P = 20 − Q

∂C
MC = =4
∂Q

4
 T R = P Q = (20 − Q)Q = 20Q − Q2
∂T R
MR = = 20 − 2Q
∂Q
The equilibrium is given by the equation “MC=MR”, therefore:

4 = 20 − 2Q

Q=8
Then we have that P = 20 − Q, hence P = 12. Profit are given by the following formula:
π = T R − T C. Hence
π = (P Q) − C = 64

1 Question 2

What would the social gain be if this monopolist were forced to produce and price at the
competitive equilibrium? Who would gain and lose as a result?

Answer

Graphically we can see that restoring a competitive equilibrium the price decreases from $14
to $10. This change produce a reallocation of surplus from producer to consumer to con-
sumer of $32 ( A+B = 8(14−10) = $32) → the units sold under monopoly are now cheaper).

5
 At the same time, also the quantity sold now increases from 8 to 16 units: new consumers
now can access the market given the lower price. Hence, there is a net increase of consumer
surplus by: (0.5)(16 − 8)(14 − 10) = $16

To sum up:

1. Consumer surplus increase by 32+16=$48

2. Producer surplus decrease by $32
3. Total surplus increase by $16

Question 3

Suppose that an industry is characterized as follows:

• C = 100 + 2Q2 each firm’s total cost function

• P = 90 − 2Q industry demand curve

Questions

1. If there is only one firm in the industry, find the monopoly price, quantity, and level
of profit.
2. Find the price, quantity, and level of profit if the industry is competitive.

Answer

If there is only one firm in the industry, then the firm will act like a monopolist and produce
at the point where marginal revenue is equal to marginal cost:
MR = MC
90 − 4Q = 4Q
Q = 11.25

The firm will charge a price of

P = 90 − 2Q

6
 P = 90 − 22.5 = 67.50
The costs are determined as follows:

C = 100 + 2Q2

C = 100 + 2(11.25)2
C = 353.25
Then the profits are given by the following formula:

π = TR − TC

π = PQ − C
π = 759.375 − 353.25 = 406.25
If the industry is competitive, price will equal marginal cost.

P = MC

90 − 2Q = 4Q
6Q = 90
Q = 15
At a quantity of 15, price is equal to

P = 90 − 2(15) = 60

The costs are determined as follows:

C = 100 + 2Q2

C = 100 + (30)2
C = 100 + 450
C = 550
Then the profits are given by the following formula:

π = TR − TC

π = PQ − C
π = 900 − 550 = 350

To sum up Pm > Pc =⇒ πm > πc

7
Question 4

Suppose a profit-maximizing monopolist is producing 800 units of output and is charging a

price of $40 per unit.

1. If the elasticity of demand for the product is −2, find the marginal cost of the last unit
produced

2. What is the firm’s percentage markup of price over marginal cost?

Answer
1. The monopolist pricing rule is
P − MC −1
=
P Ed
or alternatively
MC
P =
1 + E1d
Substitute −2 for the elasticity and 40 for the price, and then solve for M C = $20
P −M C (40−20)
2. P
= 40
= 0.5, so the markup is 50 % of the price.

Question 5

The function Q = 40−P represents the market demand. The cost function of the monopolist
is C = 4Q2 . Find quantity, price and profit of the monopolist.

Answer

Find the inverse demand, which is P = 40 − Q

∂C
MC = =4
∂Q

T R = P Q = (40 − Q)Q = 40Q − Q2

∂T R
MR = = 40 − 2Q
∂Q

8
The equilibrium is given by the equation “MC=MR”, therefore:
8Q = 20 − 2Q
Q=4
Then we have that P = 40 − Q, hence P = 36. Profit are given by the following formula:
π = T R − T C. Hence
π = (P Q) − C = 80

Question 6

A monopsonist market has inverse supply and demand functions

P s = 48 + Q
P d = 498 − Q
Find the equilibrium

Answer

In order to buy quantity Q of one particular good, the monopsonist will face a total expen-
diture (TE)
T E = (48 + Q)Q = 48Q + Q2
The marginal expenditure (ME) will be
∂T E
ME = = 48 + 2Q
∂Q
The equilibrium in this market will be given by
P d = ME
498 − Q = 48 + 2Q
3Q = 450
Q∗ = 150
If you insert Q∗ into equation P s = 48 + Q you get
P ∗ = 48 + 150 = 198