MICROECONOMICS – ADDITIONAL EXERCISES - PROBLEM SET 5

MONOPOLY

First Section – True or false

Decide whether the following statements are true or false. Clearly explain your answers (the
explanation is more important than the initial answer being true or false).

1) Consider a natural monopoly with decreasing average costs. If the state forces the
monopolist to sell his product at a price equal to the marginal cost, the monopolist’s profit
will be equal to zero.

2) Assume that, on the luxury-car market, a monopolist is able to practice first degree price
discrimination. In this case, the social welfare and the consumer surplus will be equal to the
case of perfect competition.

3) Ann is willing to pay no more than €400,000 to buy Bob’s house. Bob is willing to sell the
house for no less than €300,000. After some bargaining, Bob sells it to Ann for €390,000.
This outcome is clearly a Pareto-improvement.

4) The Pearl Theater is a local monopolist in the town of Redcats. Pearl’s marginal cost is
constant and equal to €6. Thus, if it is optimal for Pearl to charge €12 per ticket, then the
elasticity of demand at this price must be equal to -1/2.

5) Suppose that the monopolist ABCD, who produces hats, is able to perfectly price
discriminate. The demand of hats is Q=10-2P and the marginal and average cost of producing
a hat is constant and equal to €1. ABCD profits are €16.

6) In a monopolistic market, first-degree price discrimination always maximizes social

surplus.

7) In a monopoly situation the equilibrium will never correspond to a quantity on the inelastic
section of the demand curve.

8) A firm operating third degree price discrimination sells its product in Milan at a price
equal to 3 and in Palermo at a price equal to 1. The marginal cost is constant and equal in
Milan and Palermo. The price elasticity of demand in Palermo is equal to -2. Therefore, the
price elasticity of demand in Milan is equal to -1.2.

1
9) A monopolist practicing third-degree price discrimination charges different prices to two
groups of consumers. To Group A it sells its product at the price pA =10, while Group B is
charged pB=20 for each unit. This means that the demand of Group A is less elastic than the
demand of Group B.
.

10) The Gem Theater is a local monopolist in the town of Yellowfish. Gem’s marginal cost is
constant and equal to 8€. If it is optimal for Gem to charge 10€ for each ticket, then the
elasticity of the demand at this price must be equal to five.

11) The market demand curve and the long run average cost curve for a particular industry
are shown in the picture below:
p, AC

AC
Q

In such an industry, a perfectly competitive equilibrium where price is equal to marginal cost
would not be sustainable in the long run.

12) A monopolistic firm applies price discrimination of first-degree (i.e.: perfect price
discrimination). In this case, the equilibrium price is such that marginal revenues equal
marginal costs.

13) For a monopolist, increase in quantity produced by one unit results in revenue increase by
the price of the last unit sold.

14) A monopolist sells good X in a market where the elasticity of demand to price is constant
and smaller than -1. The monopolist can increase total revenues by lowering the price.

15) A monopoly sells a good on two markets (region 1 and region 2), by practicing third
degree price discrimination (that is a discrimination based on observable consumer
characteristics). Demand in region 1 is relatively less elastic than demand in region 2.
Therefore, at the equilibrium, the benefit from the last unit supplied in region 1 will exceed
the benefit from the last unit supplied in region 2.

16) Consider a natural monopoly with decreasing average costs. If the state forces the
monopolist to sell his product at a price equal to the marginal cost, the monopolist’s profit
will be equal to zero.

2
 Second Section – Exercises

Exercise 1

Monopolist is facing the following inverse market demand: P = 50 – Q, where P is the price
and Q is the quantity sold in the market. Monopolist’s short run costs are equal to TC = 20Q.

a) Compute marginal revenue and marginal cost. Draw them, together with the market
demand curve, on a graph.

b) Compute the equilibrium quantity (Q*) and price (P*) and represent them on the previous
graph.

c) Calculate monopolist’s profits (Π) and represent them on the previous graph.

d) Calculate demand price elasticity in monopoly equilibrium.

e) Assuming that the profits of the monopolist are as calculated in the point c), how will the
equilibrium price and quantity change if a fixed amount tax of 100 is introduced?

3
Exercise 2

Consider a monopoly where the (inverse) demand curve has the following form: p=100 – x
and the total costs function of the monopolist is: C=250 + x2.

A) Calculate the equilibrium price, the quantity produced by the monopolist and its profit.

B) A tax in the amount of 20 is imposed on each unit produced by the monopolist. What is
the new equilibrium quantity, price, and monopolist’s profit?

C)What is the amount of taxes effectively paid by the monopolist, and what is the part born
by the consumers?

4
Exercise 3

Firm Ecis is a monopolist producing sewing machines. The market inverse demand function
is p =100 – 4q, where q denotes the quantity produced and p the price. The cost function of
the monopolist is C = 20q.

a) Give the analytical expression for the marginal revenue function (MR) and the marginal
cost function (MC). Represent them graphically together with the demand function.

b) Find the market equilibrium (quantity and price) and represent it in the previous graph.

c) Assume our monopolist may invest in R&D, so that it can produce with a new technology
and have a new cost function C = 12q. Find the new market equilibrium (quantity and price).

d) Calling I the cost of investment in R&D, compute the maximum level of I for which the
firm will choose to invest in R&D.

5
Exercise 4

In a monopolistic market, the market demand function is given by X=8-p/2. The total cost
function of the unique firm operating in the market is C(X) = 4X + X2.

a) Derive analytically the marginal cost and the marginal revenue curves for the monopolist.

b) Compute the equilibrium quantity and price.

Assume now that, after collecting information about consumers, the monopolist is able to
apply a perfect (or first-order) price discrimination.

c) What is the equilibrium quantity in case of perfect price discrimination?

d) In case of perfect price discrimination, what are the monopolist’s total revenues? (To
answer this question a graph might help).

6
Exercise 5

Given the following demand function: p = 90 – 10y.

A) Determine the level of production and profit-maximizing price of a monopolist, which has
constant marginal costs equal to 40.

B) What will be the equilibrium if this were a perfectly competitive market (assume many
firms with the same marginal cost structure MC=40)?

C) Calculate and demonstrate graphically the change in the social welfare when moving from
monopoly to a perfectly competitive market. Show clearly on a graph gains and losses for
consumers and producers.

7
Exercise 6

Mesa company is a monopolist in the market for ping pong tables. Its total cost function is
given by C=10q. The inverse demand curve of the market is given by P= 100 – 3q, where q is
the quantity produced and p is the price.

1) Derive the marginal revenue curve (MR) and marginal cost curve (MC) and represent them
together with the demand curve on a graph.

2) Compute the equilibrium quantity and price and represent them on the previous graph

3) Suppose that government subsides the production with a subsidy equal to 6 euro for each
unit produced. Compute the new equilibrium price and quantity.

4) Suppose that the government offers Mesa a fixed transfer of 100 instead of a unit subsidy.
Will the firm accept this proposal?

8
Exercise 7

The market demand curve for a type of gasket used in refrigerators is p=90-y. These gaskets
are produced by one firm whose total production costs are equal to C(y)=10y-y2, where y is
the quantity produced.

a) Compute the marginal cost and marginal revenue of the producer and represent them in a
graph along with the demand function, clearly indicating the intercepts and slopes.

b) What is the quantity of gaskets supplied by the firm in equilibrium? And the price?
Represent the equilibrium point in the graph above.

c) Compute profits and consumer surplus.

d) Assume that the government introduces a tax on gaskets equal to 4 on each unit of gasket
sold. How does the equilibrium change?

9
Exercise 8

Consider a monopoly producing a good Q and serving two markets (market A and market B)
characterized by different demand curves. Marginal revenues in market A are MR A=12-2QA,
while marginal revenues in market B are MRB=9-QB. The cost function is C(Q)=(1/2)Q2
where Q=QA+QB, so that marginal cost is MC=Q=QA+QB .

1) Derive the inverse demand function in market A and B

2) Suppose that the monopoly is allowed to fix different prices in the two markets (i.e. it can
adopt third-order price discrimination, i.e., discrimination based on observable customers’
characteristics). Find the equilibrium output, and prices

3) Given the results at point (2), which group of clients (the one located in market A or the
one located in market B) has a more elastic demand? Motivate your answer.

10