Chapter 15 monopoly question and applica

Thus, the quantity produced and sold by a monopoly is below the socially efficient level, in which the quantity that marginal-cost curve touches the minimum point of average-total-cost c

Chapter 15 Monopoly

Question and application

1 The Sejati Furniture Sdn Bhd has a monopoly in the sale of bookshelves and faces the following demand schedule

The firm has fixed costs of RM 60,000 The marginal cost of each bookshelf is a constant RM 15 per bookshelf

a) Compute total revenue, total cost, and profit at each quantity What quantity would a profit-maximizing manufacturer choose? What price would it charge? b) Compute marginal revenue (Recall that.) How does marginal revenue compare to the price? Explain

c) Graph the marginal revenue, marginal cost, and demand curves At what quantity

do the marginal-revenue and marginal-cost curves cross? What does this signify? d) In your graph, shade in the deadweight loss Explain in words what this means e) If fixed costs rise to RM 70,000, how would this affect the firm’s decision about what price to change? Explain

Solutions:

a) Fixed cost: RM 60,000

Marginal cost is constant, at RM 15 per bookshelf

Price

(RM) Quantity demanded (bookshelf) Total revenue (RM) Total cost (RM) Variable cost (RM) Profit (RM)

5 70,000 350,000 1,110,000 1,050,000 (760,000)

)

*

Profit-maximization occurs at the quantity where marginal revenue equals marginal cost (MR=MC)

Profit-maximizing quantity is 30,000 bookshelves

The price would be charged at RM 25.00

b)

Price

(RM)

Quantity

demanded

(bookshelf)

Total revenue (RM)

Total cost (RM)

Variable cost (RM)

Profit (RM) Marginal

revenue (RM)

10 60,000 600,000 960,000 900,000 (360,000) (15)

5 70,000 350,000 1,110,000 1,050,000 (760,000) (25)

0 80,000 0 1,260,000 1,200,000 (1,260,000

Marginal revenue is always less than the price of the bookshelves

c) The quantity where marginal-revenue and marginal-cost curves cross is 25,000 bookshelves It signifies the quantity that can maximize the profit of monopoly From that quantity, we can also find out the price that monopoly should charge to get the maximum profit

d) Deadweight loss is represented by the area of the triangle between the demand curve (which reflects the value of the bookshleves to customers) and the marginal-cost curve (which reflects the costs of the monopoly producer)

Deadweight loss occurs in monopoly because a monopoly charges a price above marginal cost, not all consumers who value the bookshelf at more than its cost buy it

Thus, the quantity produced and sold by a monopoly is below the socially efficient level, in which the quantity that marginal-cost curve touches the minimum point of average-total-cost curve

e) If fixed costs rise to RM 70,000, the price charged remains unchanged at RM 25.00 This is because before we determine which price of a bookshelf to charge,

we need to identify the profit-maximizing quantity at which the marginal revenue equals to marginal cost Since the marginal revenue and the marginal cost do not change, the profit-maximizing quantity stays same as that before Therefore, the rise of fixed costs does not change the firm’s decision by charging the same price

as before, which is RM 25.00

5 Mawi has just finished recording his latest CD His record company’s marketing department determines that the demand for the CD is as follows:

The company can produce the CD with no fixed cost and a variable cost of RM 5 per CD a) Find the total revenue for quantity equal to 10,000, 20,000 and so on What is the marginal revenue for each 10,000 increase in the quantity sold?

b) What quantity of CDs would maximize profit? What would the price be? What would the profit be?

c) If you were Mawi’s agent, what recording fee would you advise Mawi to demand from the record company? Why?

Solutions:

a) Variable cost is RM 5 per CD

Price

(RM)

Number

of CDs

Total revenue (RM)

Marginal revenue (RM)

Total cost (RM)

Marginal cost (RM)

Average total cost (RM)

b) The monopolist’s profit-maximizing quantity of output is determined by the intersection of the marginal-revenue curve and the marginal-cost curve

The quantity of CDs that would maximize profit is 57,500 CDs

The price would be at RM 14.50

The profit would be

= RM 546,250

c) If I were Mawi’s agent, I would advise Mawi to demand the recording fee at RM 14.00 per CD from the record company because it provides the maximum

revenue, which is RM 840,000

6 A company is considering building a bridge across a river The bridge would cost RM 2 million

to build and nothing to maintain The following table shows the company’s anticipated demand over the lifetime of the bridge

Price per crossing Number of crossings in thousands

a) If the company were to build the bridge, what would be its profit-maximizing price? Would that be the efficient level of output? Why or why not?

b) If the company is interested in maximizing profit, should it build the bridge? What would be its profit or loss?

c) If the government were to build the bridge, what price should it charge?

d) Should the government build the bridge? Explain

Solutions:

a) Total cost = Fixed cost = RM 2 million

Price per

crossing (RM) crossings in Number of

thousands

Total revenue (RM) revenue (RM) Marginal cost (RM) Marginal total cost Average

(RM)

If the company were to build the bridge, its profit-maximizing price would be RM 3.50 while the profit-maximizing quantity is 450,000 crossings

That is not the efficient level of output

This is because the efficient level of output should be 800,000 The profit-maximizing quantity always less than the efficient quantity of output

The price per crossing is always more than the marginal cost at the profit-maximizing quantity in monopoly

b) The company should not build the bridge if the company is interested in

maximizing profit, because it would suffer from a loss

The loss would be RM 425,000

At 450,000 crossings, Profit = Total revenue - Total cost

= = -RM 425,000 (loss)

c) If the government were to build the bridge, it should charge the price at RM 3.50 per crossing This is because it brings the maximum total revenue

d) The government should not build the bridge because there is a big loss which is

RM 425,000

13 You live in a town with 300 adults and 200 children and you are thinking about putting on a play to entertain your neighbors and make more money A play has a fixed cost of RM 2000, but selling an extra ticket has zero marginal cost Here are the demand schedules for your two types

of customers

a) To maximize profit, what price would you charge for an adult ticket? For a children’s ticket? How much profit do you make?

b) The city council passes a law prohibiting you from charging different prices to different customers What price do you set for a ticket now? How much profit do you make?

c) Who is worse off because of the law prohibiting price discrimination? Who is better off? (If you can, quantity the changes in welfare.)

Solutions:

a)

Price (RM) Adults Children Total Revenue (RM) Marginal Revenue (RM)

Adults Children Adults Children

-0 300 200 0 0 -

-The price I would charge for an adult ticket to maximize profit is RM 7 while the price I would charge for a child’s ticket is RM 4

The profit will be made is RM 900

0

b) The price I would set for a ticket is RM 7 which will produce profit of RM 100

= RM 100

At the price of RM 7, the total revenue from adults is RM 2,100 while the total revenue from children is RM 0 The profit obtained is equal to the sum of these both revenues after deducting the total cost incurred

c) Children are worse-off because the price of children is increased from RM 4 to

RM 7 I will better off because I still can earn a profit of RM 100

Course Code : SE 2013

Course Name : Introduction to Microeconomics Lecture group number : Group 4