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(PGP I)

Problem Set VI

1. Assume that a monopolist sells a product with a total cost function TC = 1,200 + 0.5Q2 and

a corresponding marginal cost function MC = Q. The market demand curve is given by the

equation P = 300 - Q.

a) Find the profit-maximizing output and price for this monopolist. Is the monopolist

profitable?

b) Calculate the price elasticity of demand at the monopolists profit-maximizing price.

2. A monopolist faces a demand curve P = 210 - 4Q and initially faces a constant marginal

cost MC = 10.

a) Calculate the profit-maximizing monopoly quantity and compute the monopolists total

revenue at the optimal price.

b) Suppose that the monopolists marginal cost increases to MC = 20. Verify that the

monopolists total revenue goes down.

c) Suppose that all firms in a perfectly competitive equilibrium had a constant marginal cost

MC = 10.Find the long-run perfectly competitive industry price and quantity.

d) Suppose that all firms marginal costs increased to MC = 20. Verify that the increase in

marginal cost causes total industry revenue to go up.

3. Suppose a monopolist faces the market demand function P = a - bQ. Its marginal cost is

given by MC = c + eQ. Assume that a > c and 2b + e > 0.

a) Derive an expression for the monopolists optimal quantity and price in terms of a, b, c,

and e.

b) Show that an increase in c (which corresponds to an upward parallel shift in marginal cost)

or a decrease in a (which corresponds to a leftward parallel shift in demand) must decrease

the equilibrium quantity of output.

c) Show that when e 0, an increase in a must increase the equilibrium price.

4. Imagine that Gillette has a monopoly in the market for razor blades in Mexico. The market

demand curve for blades in Mexico is P = 968 - 20Q, where P is the price of blades in cents

and Q is annual demand for blades expressed in millions. Gillette has two plants in which it

can produce blades for the Mexican market: one in Los Angeles and one in Mexico City. In

its L.A. plant, Gillette can produce any quantity of blades it wants at a marginal cost of 8

cents per blade. Letting Q1 and MC1 denote the output and marginal cost at the L.A. plant, we

have MC1(Q1) = 8. The Mexican plant has a marginal cost function given by MC2(Q2) = 1 +

0.5Q2.

a) Find Gillettes profit-maximizing price and quantity of output for the Mexican market

overall. How will Gillette allocate production between its Mexican plant and its U.S. plant?

b) Suppose Gillettes L.A. plant had a marginal cost of 10 cents rather than 8 cents per blade.

How would your answer to part (a) change?

5. Suppose that you are hired as a consultant to a firm producing a therapeutic drug protected

by a patent that gives a firm a monopoly in two markets. The drug can be transported

between the two markets at no cost, so the firm must charge the same price in both markets.

The demand schedule in the first market is P1 = 200 - 2Q1, where P1 is the price of the

product and Q1 is the amount sold in the market. In the second market, the demand is P2 =

140 - Q2, where P2 is the price and Q2 the quantity. The firms overall marginal cost is MC =

20 + Q1 + Q2. What price should the firm charge?

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