Eco 411 Problem Set 1

July 31, 2018

Due in class on August 14, 2018 or before. Late problem sets will not be
accepted, unless prior permission is given.

Instructions
• Please submit the problem set in groups of 2-3 students.
• Please make sure to write the names of the members of the group on top
of the problem set and staple the pages in the problem set together.
• You can discuss with your classmates (but must mention the names of
people outside of the group you discussed it with), you are also free to
use online resources but proper citation is required. Also remember that
plagiarism is not permitted.

Question 1
Suppose that a firm producing and selling roses faces demand

q = 100–10p
Suppose that to produce any rose, the firm must pay Rs. K and then it costs
Rs. 4 per rose to plant the rose and then pick it. We are assuming that we are
in the long run where the firm can choose whether or not to enter. Solve for the
optimal output of the firm.

Question 2
Suppose that marginal cost is constant at c where 0 < c < a. Suppose that the
inverse demand function facing the monopoly is of the form P = a–bQ.
1. Solve for the monopoly price, quantity and profits.
2. Derive the demand curve Q(P ). Show that it does not matter the monop-
olist sets price instead of quantity.
3. Calculate the deadweight loss of monopoly.

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 4. Derive the price elasticity of demand η for any price. How does η change
with P ?
5. Show that the price elasticity of demand is strictly greater than one at the
monopoly price.

Question 3
If the demand curve is q = 5/p, what is the elasticity of demand? What is total
revenue when p = 1 and when p = 30? If production costs Rs. 1 per unit,
and the smallest production level is 1 unit, how much should the monopolist
produce?

Question 4
A monopoly produces widgets. Demand for widgets is given by

p=9−q
where p is the firm’s price and q is the firm’s total quantity. The monopoly
currently has one plant in which it can produce widgets. The total cost of
producing q1 widgets in this plant is given by C1 (q1 ) = q12 . The monopoly can
choose to build a second plant in which it can produce widgets.
( The cost of
0 if q2 = 0
producing q2 units in the second plant is given by C2 (q2 ) = 2
;
K + q2 if q2 > 0
that is, in order to build this second plant, the monopoly must pay a sunk cost
of K ≥ 0. Solve for the monopoly’s total output as a function of K.

Question 5
Consider a monopoly that faces zero costs of production and the inverse demand
P (Q) = 4 − 2Q, and answer the following questions:
1. What is the corresponding demand function D(p)?
2. What is the monopoly’s profit maximizing price pm ? What is its profit
maximizing quantity Qm ? What is its maximal profit?
3. Suppose now that a price cap p̄ = 1 is imposed by law. What are the
consequences of the price cap on the monopoly’s optimal profit? How
are consumer surplus and aggregate welfare affected? What explains the
quantity effect of the price cap on the monopoly’s optimal behavior?

Question 6
A price discriminating monopoly sells in two markets. Assume that consumers
cannot resell the product so no arbitrage is possible. The demand curve in
market 1 is given by p1 = 50 − q21 . The demand curve in market 2 is given

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by p2 = 50 − q2 . The monopoly’s aggregate production is Q = q1 + q2 . The
monopoly’s cost function depends on total production and is given by C(Q) =
Q2 .
1. Write down the monopoly’s profit function as a function of q1 and q2 .

2. Calculate the monopoly’s profit-maximizing price and the quantity sold

in market 1 and market 2.
3. Suppose now that the CEO’s son takes control of the firm and decides to
try something new. He decomposes the monopoly plant into two plants,
where plant 1 sells in market 1 only and plant 2 sells in market 2 only.
Each plant has the same cost function: C(qi ) = qi2 . Calculate the profit-
maximizing output sold by each plant.
4. Calculate the sum of the profits of the two plants. Does the plant decom-
position increase or decrease profits?

Question 7
A movie theater has two types of consumers: students and non-students: student
demand is Qs = 220–40Ps and non-student demand is Qn = 140–20Pn . The
theater has a fixed nightly cost of Rs. 500 independent of how many people
attend (i.e. M C = 0).

1. Suppose the theater cannot distinguish students from non-students. Find

P ∗ , Q∗ , π ∗ , Q∗s , Q∗n where π is profit and Q is total quantity sold.
2. Now suppose that the theater can distinguish students from non-students
by checking IDs. Find the prices and quantities in both markets. What is
π∗ ?

3. Suppose that the theater only holds 150 people and that the theater can
charge different prices to the different markets. Find prices and quantities
in each market. Also, solve for profit.
4. Suppose that the theater can only hold 150 people, that the theater can
sell at different prices to students and non-students, that students can
resell their tickets to non-students, but that it costs students 0.25 to sell a
ticket to a non-student. Find prices and quantities in each market. Also,
solve for profit.
[For part 3, two questions to think of that might be of help: Will the theater
satisfy the capacity constraint with equality? Will the theater choose to sell a
positive number of tickets to both of the two markets?]

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Question 8
The Mint is considering offering a new service which will send news articles
to readers by email. Their market research indicates that there are two types
of potential users, students and high-level executives. Let x be the number of
articles that a user requests per year. The executives have an inverse demand
function PE (x) = 100 − x and the students have an inverse demand function
PU (x) = 80 − x. Mint has a zero marginal cost of sending articles via email.
1. Suppose that Mint can identify which users are students and which are
executives. It offers each type of user a different all or nothing deal. A
student can either buy access to 80 articles per year or to none at all.
What is the maximum price a student will be willing to pay for access to
80 articles? (Hint: think in terms of consumer surplus.)
2. An executive can either buy access to 100 articles per year or to none at
all. What is the maximum price an executive would be willing to pay for
access to 100 articles?

3. Suppose that Mint can’t tell which users are executives and which are
students. Thus it can’t be sure that executives wouldn’t buy the student
package if they found it to be a better deal for them. In this case, Mint
can still offer two packages, but it will have to let the users self-select the
one that is optimal for them. Suppose that it offers two packages: one
that allows up to 80 articles per year, the other that allows up to 100
articles per year. What’s the highest price that the students will pay for
the 80-article subscription?
4. What is the total value to the executives of reading 80 articles per year?
(Hint: Look at the area under their demand curve and to the right of a
vertical line at 80 articles.)
5. What is the the maximum price that Mint can charge for 100 articles per
year if it wants executives to prefer this deal to buying 80 articles a year
at the highest price the students are willing to pay for 80 articles?
6. Suppose that Mint decides to include only 60 articles in the student pack-
age. What is the most it could charge and still get student to buy this
package?
7. If Mint offers a “student package” of 60 articles at this price, how much net
consumer surplus would executives get from buying the student package?

8. What is the most that Mint could charge for a 100 article package and
expect executives to buy this package rather than the student package?
9. If the number of executives in the population equals the number of stu-
dents, would Mint make higher profits by offering a student package of 80
articles or a student package of 60 articles?

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Question 9
We discussed in class about some of the costs and benefits of monopoly. One of
the supporters of monopoly is the famous entrepreneur and venture capitalist
Peter Thiel, who is associated with the phrase “competition is for losers” and
he suggests that monopoly is not only good for entrepreneurs but also society.
Find out a bit about Mr. Thiel’s reasoning and then write an essay (in less than
2 pages) in which you describe in brief what Mr. Thiel says and then critically
evaluate his opinion about the merits of monopoly as opposed to competition.
Some resources that can you help you get started are:
1) WSJ article by Thiel (available on Piazza as well)
2) Peter Thiel’s CS183: Startup - Class 4 Notes Essay - page 23 of CS 183
Startup Stanford
3) The video on Lecture 5 (Competition is for losers) here - http://startupclass.samaltman.com/