B+Micro+HA+4++problem+set Unlocked

Business Microeconomics
Problem set 4: Monopoly; Monopolistic Competition and Oligopoly; Regulation and Antitrust.
HOME ASSINGMENT # 4
Textbook chapters: MP: Ch.13, Ch.14, Ch.15
CFO: Ch.13, Ch.14, Ch.15
1. In one of the hottest bars to be seen as belonged to A.V. (Famous Champion of
Kazakhstan) which is open every day from 7 P.M. to 2 A.M. A.V.'s total cost function
for making and serving drinks is TC = $2*X, where X is the number of drinks. Note this
implies his marginal costs are constant and equal to $2.00.
Suppose that a group of economists (with name Rakurs and numbering 100) has
persuaded A.V. to open his saloon exclusively for them from 5 P.M. to 7 P.M. Suppose
that each member of the group of economists has a demand function for drinks X=12-2p
(p is the price of a drink). On a graph, illustrate the Rakurs-100's demand curve; A.V.'s
marginal revenue curve; and A.V.s marginal cost curve. What is the profit maximizing
number of drinks and price charged per drink to these rowdy economists? How much
profit does Tony make? Calculate consumer and producer surplus.
2. You are asked to analyze the shrimp fishing industry off the coast of New Orleans.
Here are the facts. Initially, shrimp fishing is a purely competitive industry. Each shrimp
firm, that is, the owner of a shrimp boat, owns only a single boat and there is only one
size boat that can be used. A boat can make only one fishing trip per day and a trip will
always yield a catch of exactly 1 ton of shrimp. A fishing trip costs $400; there are no
fixed costs to consider. The following is the industry demand curve for shrimp:
$ price per ton
tons demanded per day
$1000
$900
20
$800
40
$700
60
$600
80
$500
100
$400
120
$300
140
$200
160
a) If the industry is in long-run equilibrium, the price of shrimp will be $_____ per ton
and there are ______ firms in the industry, producing a total catch of _______ tons per
day. Each firm earns a profit of $ _________ per day.
b) Now a monopolist contemplates entering the industry and buying up all the existing
firms and erecting an effective barrier against the entry of new firms. There are no
economies or diseconomies of scale, so the monopolist can catch as many tons of shrimp
as he wants for a cost of $400 per ton. As the sole producer of shrimp (no pun intended),
the monopolist will maximize profits by catching a level of ________ tons per day. He
will employ ________ boats and fisherman. His profit is $___________. Should the
monopolist enter the business?
c) Is it accurate to say that the monopolist charges the highest price that the consumer
will pay for shrimp? Explain.
d) The result of the monopolization of shrimp-fishing is a change in the composition of
output and allocation of resources of the economy. In what sense can one argue that the
new composition of output is worse from a social point of view than the original one?
3. The graph below describes the market demand and supply curve of a perfectly
competitive industry. The equilibrium price (pc) and quantity (Xc) are indicated.
a) Assume the industry is monopolized with no change in costs. Draw in the marginal
revenue curve and label the output (Xsm) and price (psm) set by the monopolist.
b) Label the following areas: Consumer surplus under perfect competition; Consumer
surplus under monopoly; Consumer surplus lost after monopolization; Producer surplus
under perfect competition; Producer surplus under monopoly; Producer surplus lost after
monopolization; Producer surplus gained after monopolization; Lost consumer surplus
captured by the monopolist; Lost consumer surplus not gained by the monopolist; Lost
producer and consumer surplus from monopolization not gained by the monopolist.
4. Prove that a monopolist will never choose to operate in the inelastic portion of his
demand curve if he is a profit maximizing simple monopolist.
5. IBM has a monopoly on selling computer diskettes to one American university
students. Suppose it faces the following demand for its product:
$price per disc
quantity demanded
$12
10
The average cost of production is constant and equal to $2.00 per disc. There are no
fixed costs. (Hint: What does this statement imply about the marginal cost and total cost
of disc production?)
a) Determine the profit maximizing level of output and the monopoly price IBM should
charge at University. What are IBM's profits at University?
Ms. N, a new School MBA, points out that there is a market for diskettes at another
College too. Their students have the following demand:
$price per disc
quantity demanded
$20
18
16
14
12
10
b) What is the profit maximizing quantity and price of IBM diskettes at College? What
is IBM's profit from selling the diskettes at College? What is the combined profit from
selling to both University and College?
Suppose IBM realizes that it is a short trip from the College Book Store to the University
Book Store, so that if IBM charges different prices in the two stores, all students will try
to buy from the lower store and problems will develop. To keep everyone happy, it
decides it must charge University and College students the same price.
c) What will be the profit maximizing level of output and the price charged by IBM?
How will output be divided between the two institutions? How does total IBM profit
from selling at one uniform price compare with selling in the two separate markets at two
different prices? Who wins and who loses by the uniform price rule?
6. Answer the question or critically evaluate the statement and explain why or in what
way the statement is true, false, or uncertain.
a) Monopolists are never productively efficient.
b) Monopolists are never allocatively efficient.
c) Monopolists do not cost minimize.
d) Since the level of output produced by a monopolist is less than the output that would
be produced if the industry were perfectly competitive, monopoly creates shortages.
7 and 8. A monopolist faces the following market demand for his monopolized product:
XD=30-P
The monopolist has the following short run total cost function: SRTC(X)=X2/2.
Note: This implies that the monopolist's marginal cost function is: SRMC(X)=X
a. Assume that the monopolist behaves as a simple monopolist. Find the profit
maximizing price and quantity and the resulting profit to the monopolist. Show your
answer in a diagram.
b. Calculate the own price elasticity of the demand at the profit-maximizing price.
c. Calculate consumers' surplus (CS) and producer's surplus (PS). Show CS and PS on
the diagram.
d. Assume that the government puts a price ceiling on the monopolist at Pceiling=$18.
How much output will the monopolist produce? What will be the profit of the
monopolist? Calculate the CS, PS in this case.
e. Instead of the price ceiling, now suppose that the government charges the monopoly
a $130 business fee. The monopolist must pay this fee if he wishes to operate. Find the
profit maximizing price and quantity and the resulting profits to the monopoly.
f. What is the allocatively efficient level of output for this monopoly?
9. Hot Air Balloon Rides, a single-price monopoly, has the demand schedule shown in
columns 1 and 2 of the table and the total cost schedule shown in column 3 of the
table.
Price
(dollars
per ride)
220
200
180
160
140
120
Quantity
demanded
(rides per month)
0
1
2
3
4
5
Total cost
(dollars
per month)
80
160
260
380
520
680
a. Construct Hot Airs total revenue and marginal

revenue schedules.
b. Draw a graph of the demand curve and Hot
Airs marginal revenue curve.
c. Find Hot Airs profit-maximizing output and
price and calculate the firms economic profit.
d. If the government imposes a tax on Hot Airs
profit, how does its output and price change?
e. If instead of taxing Hot Airs profit, the government imposes a sales tax on
balloon rides of $30 a ride, what are the new profit-maximizing quantity, price,
and economic profit?
10. Figure 13.6 illustrates the situation facing the publisher
of the only newspaper containing local news in an
isolated community.
a. On the graph, mark the profit-maximizing quantity
and price.
b. On the graph show the publishers total revenue per
day
c. At the price charged, is the demand for this
newspaper elastic or inelastic? Why?
d. What are consumer surplus and deadweight loss?
Mark each on your graph.
e. Explain why this market might encourage rent
seeking.
f. If this market were perfectly competitive, what would
be the quantity, price, consumer surplus, and
producer surplus? Mark each on your graph.
a) Under monopolistic competition, a firm's fixed costs will generally decline with
increases in output.
b) If a monopolistically competitive firm raises its price from the price that maximizes
profit (given its demand curve), total revenue will normally be expected to fall.
c) For a monopolistically competitive firm in long-run equilibrium, p = mc = lratc, i.e.,
zero profits are earned, and x is allocatively efficient.
d) If entry into a monopolistically competitive industry occurs, then the industry demand
curve shifts to the right.
e) In the long-run, profits must be greater or equal to zero for the monopolistically
competitive firm.
f) Under perfect competition the industry demand curve is horizontal, whereas under
monopolistic competition it is downward sloping.
g) Monopolistically competitive firms, in the long-run, are allocatively inefficient, but are
productively efficient.
12. The Chrome Corporation is a monopolistically competitive firm with no fixed costs.
Currently, in the short-run, it is producing x' units of output. At x' its marginal revenue
equals $4, its total revenue $21, and its marginal revenue function is MR = 10 - 2x. At x',
its short run average total cost is at its minimum value. Assuming it is maximizing its
profit at x', what do each of the following equal.
a) the firm's output level;
b) the firm's price;
c) the firm's short-run average total costs;
d) the firm's total cost;
e) the firm's marginal cost;
f) the firm's short-run profit.
13. Assume Microsoft is a monopolist. Microsoft is planning on issuing a new Office
software package to educational institutions and businesses. Based on old sales data,
Microsoft estimates the demand for educational institutions and businesses to be
described in the tables below. The marginal cost of each Office package is constant at
$40. Microsoft incurred approximately $300,000,000 in fixed costs to develop the Office
program.
(a) Assume Microsoft behaves as a simple monopolist: it combines the business and
education markets into one market and uses a single market price for the Office program.
What price will Microsoft charge and how many units will it sell in each market? What
is Microsoft's profit from the optimal single price for the combined business and
education markets? Show your work.
(b) If Microsoft practices third degree price discrimination, what is Microsoft's profit
maximizing price and quantity for the separate business and educational markets? (MC =
$40 for both markets.)
(c) What are Microsoft's combined economic profits when it price discriminates?
Price
per
package
700.00
670.00
640.00
610.00
580.00
550.00
520.00
490.00
460.00
430.00
400.00
370.00
340.00
310.00
280.00
250.00
220.00
190.00
160.00
130.00
100.00
70.00
14.
15.
Quantity
demanded:
business
700,000
750,000
800,000
850,000
900,000
950,000
1,000,000
1,050,000
1,100,000
1,150,000
1,200,000
1,250,000
1,300,000
1,350,000
1,400,000
1,450,000
1,500,000
1,550,000
1,600,000
1,650,000
1,700,000
1,750,000
Quantity
demanded:
education
0
10,000
20,000
30,000
40,000
50,000
57,500
67,500
77,500
110,000
125,000
150,000
200,000
250,000
300,000
350,000
400,000
450,000
500,000
550,000
600,000
650,000
Dariga teaches singing. Her fixed costs are $1,000 a month, and it costs her $50 of
labor to give one class. The table shows the
Price
Quantity demanded
(dollars per
(lessons
demand schedule for Darigas singing lessons.
lesson)
per month)
a. Calculate Darigas profit-maximizing output
0
250
, price, and economic profit.
50
200
100
150
b. Do you expect other firms to enter the singing
150
100
lesson business and compete with Dariga?
200
50
c. What happens to the demand for Darigas lessons
250
0
in the long run? What happens to Darigas
economic profit in the long run?
The figure shows the situation facing Well Done, Inc., a producer of steak sauce.
a.
b.
c.
d.
What quantity does Well Done produce?

What does it charge?
How much profit does Well Done make?
If all steak sauce firms have identical cost curves
and face identical demand curves, what happens
to the number of firms in the market in the long
run?
e. In the long run, will the price of steak sauce rise,
fall, or not change?
16. Use the three conditions for monopolistic competition

discussed in the chapter to decide which of the following firms are likely to be operating
as monopolistic competitors. If they are not monopolistically competitive firms, are they
monopolists, oligopolists, or perfectly competitive firms?
a. A local band that plays for weddings, parties, and so on
b. Minute Maid, a producer of individual-serving juice boxes
c. Your local dry cleaner
d. A farmer who produces soybeans
17. The restaurant business in town is a monopolistically competitive industry in long-run
equilibrium. One restaurant owner asks for your advice. She tells you that, each night, not
all tables in her restaurant are full. She also tells you that if she lowered the prices on her
menu, she would attract more customers and that doing so would lower her average total
cost. Should she lower her prices? Draw a diagram showing the demand curve, marginal
revenue curve, marginal cost curve, and average total cost curve for this restaurant to
explain your advice. Show in your diagram what would happen to the restaurant owners
profit if she were to lower the price so that she sells the minimum-cost output.
18. The market structure of the local gas station industry is monopolistic competition.
Suppose that currently each gas station incurs a loss. Draw a diagram for a typical gas
station to show this short-run situation. Then, in a separate diagram, show what will
happen to the typical gas station in the long run. Explain your reasoning.
19. In the long run, there is no difference between monopolistic competition and perfect
competition. Discuss whether this statement is true, false, or ambiguous with respect to
the following criteria:
a. The price charged to consumers
b. The average total cost of production
c. The efficiency of the market outcome
d. The typical firms profit in the long run
20. The accompanying table shows the HerfindahlHirschman Index (HHI) for the
restaurant, cereal, movie, and laundry detergent industries as well as the advertising
expenditures of the top 10 firms in each industry in 2006. Use the information in the table
to answer the following questions.
8
a. Which market structureoligopoly or monopolistic competitionbest characterizes

each of the industries?
b. Based on your answer to part a, which type of market structure has higher advertising
expenditures? Use the characteristics of each market structure to explain
why this relationship might exist.
21. McDonalds spends millions of dollars each year on legal protection of its brand
name, thereby preventing any unauthorized use of it. Explain what information this
conveys to you as a consumer about the quality of McDonalds products.
22. Consider the following two-player games where each player is given a set of cards
and each card has a number on it. The players are Antonia and Bob. Antonias cards have
the following numbers: 0, 1, 2, 3 and 4, whereas Bobs cards are: 0, 1 and 2. Each player
chooses a card without knowing the other players choice. The outcome depends on the
sum of the points of the cards chosen.
For each of the following variations, represent the game in matrix form.
A) If the sum is greater than 3, Antonia gets $10 and Bob gets nothing. If the sum is less
than or equal to 3, Bob gets $10 and Antonia gets nothing.
B) If the sum is greater than 2, and it turns out to be an even number, Antonia gets $10
and Bob gets nothing. If the sum is greater than 2 and it is an odd number Antonia pays
$5 and Bob gets nothing. If the sum is less than or equal to 2, and it turns out to be an
even number, Bob gets $5 and Antonia gets 0; if it is an odd number Bob gets $10 and
Antonia gets nothing.
C) Now suppose that Antonias cards are changed to: 2, 4 and 6. (Bobs cards are still 0,1
and 2). If the sum of points is greater than or equal to 5, Antonia gets $10 minus the total
number of points; otherwise (ie., if the sum is less than 5) she gets nothing. The outcome
for Bob is as follows: if the sum of points is an odd number, Bob gets as many dollars as
the total points; if the sum of points turns out to be an even number and is less than or
equal to 6, Bob gets $2; otherwise he gets nothing.
a) If OPEC could include all oil producing countries in their cartel and could strictly
enforce price and quantity targets, then the price of gasoline would be unlimited.
b) Oligopolistic industries are both allocatively and productively efficient.
c) Given a fully described game, a dominant strategy for a player will also be a best
response strategy for that player, furthermore, all best response strategies are dominant
strategies.
d) The incentive to cheat in a cartel will be greater when the cartel produces a
homogeneous good.
e) A member of a cartel has no incentive to violate the rules of the cartel since the cartel
equates marginal revenue to marginal cost, thereby maximizing the profit of each
member.
24 . Graphically show the demand and marginal revenue curves for a: i) perfectly
competitive firm; ii) monopolist; iii) monopolist that is able to perfectly price
discriminate; iv) Sweezy oligopolist. How would a small increase in factor prices affect
output and price in each case?
25. In a typical New York Times article (5/9/XX) entitled, "April Output by OPEC UP,"
the International Energy Agency reported that "oil production by OPEC rose to 18.2
million barrels/day in April from 17.7 m. barrels in March." Part of this increase was
attributed to Iraq's refusal to sign the group's production sharing program and its
subsequent increase in output to 2.6 m. barrels/day. OPEC's other 12 members however
cooperated with their agreements and produced close to their agreed upon quota.
a) Explain why oligopolists have an incentive to collude (i.e., what are the advantages to
the oligopolists from cartelization?), and graphically describe how the cartel determines
the cartel's profit maximizing level of output and target price. How are production quotas
for the individual cartel members determined.
Suppose we could model this issue as a game between

Iraq and the rest of OPEC. Each player has two
strategies: Low quantities of oil production and high
quantities of oil production. In "tree form" we can write
this game as follows.
NOTE: The payoffs are written as (rest of OPEC's
payoff, Iraq's payoff). Also note that the game is played
simultaneously, that is neither the rest of OPEC nor
IRAQ can observe the other country's strategy before
choosing their own strategy.
10
b) Write the game in its "box" form, a.k.a. normal or matrix form.
c) Do there exist any dominant strategy equilibria to this game? Is so what are they?
d) Do there exist any Nash equilibria to this game? If so what are they?
e) If you were to advise the OPEC ministers, could you suggest an outcome that is better
for the group than the outcome(s) you found above? Explain. What terms would you
suggest be written into any contracts the two parties endorse. Is it necessary that these
contracts be enforceable? Why or why not?
f) Presumably, contracts like the one you suggested in your answer to part (h) are written
up and signed by the OPEC countries, eventually. Why is it then that we consistently
observe oil selling at prices below the OPEC target price?
26. Assume that Coke and Pepsi are the only two manufacturers of cola soft drinks.
Assume they happen to be endowed with the following marginal cost schedules. Coke
and Pepsi are thinking about colluding with each other in spite of its illegality and
implementing the "multi-plant monopoly solution."
COKE
PEPSI
gallons
marginal cost
in $
gallons
marginal cost
in $
---
---
$1
$2
$2
$4
$3
$6
$4
$8
$5
$10
$6
$12
a) What is the cost minimizing way to allocate the production of 1 gallon of syrup
between Coke and Pepsi? What is the marginal cost of producing this first gallon of
syrup?
b) What is the cost minimizing way to allocate the production of 2 gallons of syrup
between Coke and Pepsi? What is the marginal cost of producing the second gallon of
syrup?
c) What is the cost minimizing way to allocate the production of 3 gallons of syrup
between Coke and Pepsi? What is the marginal cost of producing this third gallon of
syrup?
11
d) Based on your answers to a., b., and c., above, determine the cartel's marginal cost
schedule and graph it.
e) Suppose you are given the following market demand information for cola syrup.
Determine marginal revenue and graph it along with marginal cost and demand.
price: $15 $14 $13 $12 $11 $10 $9 $8 $7 $6 $5 $4 $3 $2 $1 $0
demand: 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
f) What is the cartel's profit maximizing level of output. What price should the cartel set
for its output? Show on your graph. What production quota should be given to the two
members of the cartel? What is cartel profit? Without side payments, what is the profit of
each cartel member?
g) Would your answer to part f. change if Coke and Pepsi were to horizontally merge into
Coksi-cola? Explain.
h) Suppose industry output was set to be allocatively efficient. If so, what quantity should
be produced? At what price should syrup be sold? How much syrup will each company
produce?
27. The price at which Wal-Mart can buy flat panel TVs has fallen, and it is making a
decision about whether to lower its selling price. Wal-Mart believes that if it cuts
its price, all its competitors will cut their prices, but if it raises its price, none of its
competitors will raise theirs.
a. Draw a figure to illustrate the situation that Wal-Mart believes it faces in the
market for flat panel TVs.
b. Do you predict that Wal-Mart will lower its price of a flat-panel TV? Explain and
illustrate your answer.
28.
Suppose that Firefox and Microsoft each develop their own versions of an amazing
new Web browser that allows advertisers to target consumers with great precision.
Also, the new browser is easier and more fun to use than existing browsers. Each
firm is trying to decide whether to sell the browser or to give it away. What are the
likely benefits from each action? Which action is likely to occur?
12

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Business Microeconomics

tons demanded per day

a. Construct Hot Airs total revenue and marginal

What quantity does Well Done produce?

16. Use the three conditions for monopolistic competition

a. Which market structureoligopoly or monopolistic competitionbest characterizes

Suppose we could model this issue as a game between

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