Advanced Microeconomic Theory II Assignment II

Name ID No:
1. Tegegn Tise------------------GSR/4569/15
14.1. The inverse demand curve is given by p( y )=10− y , and a
monopolist has a fixed supply of 4 units of a good available.
 How much will it sell and what price will it set?
Though, the profit-maximizing level of output is 5 units, the monopolist has a fixed
supply at 4 units, and it will sell all 4 units. To find the price it will set, we can plug the
quantity (4) into the invers demand curve: p (4) = 10 - 4 = 6 So, the monopolist will sell 4
units at a price of $6 each, which is the most profitable at current fixed supply.
 What would be the price and output in a competitive market with these
demand and supply characteristics?
In a competitive market, the equilibrium price and quantity are determined by the
intersection of the demand and supply curves. Since the supply is fixed at 4 units, we can
again plug this quantity into the inverse demand curve: P (4) = 10 - 4 = 6 So, in a
competitive market, the equilibrium price would also be $6, and the equilibrium quantity
would be 4 units. This is the same as the fixed supply Monopoly solution.

 What would happen if the monopolist had 6 units of the good available?
(Assume free disposal.)
Though, the monopolist had 6 units to sell, it would be most profitable to dispose of one
unit and only sell 5 units at a price of 5. By selling only 5 Units and disposing one unit,
since the monopolist has free disposal and can simply discard them without incurring any
additional costs, it will maximize the profit by increasing the revenue from 24 to 25.
See the following explanation
If the monopolist has 6 units available, and if it sells all 6 units available, the price of the
its products declines and however its total revenue remains the same.
At y=6, P (6) = 10 - 6 = 4, which is lower than its previous profit maximizing
level, and however the revenue remained the same at (TR = P*Q = 4*6 = 24)
But if the monopolist has 6 units available, and if it sells 5 units, then he maximizes his
revenue by increasing his revenue.
At y=5, P (5) = 10 - 5 = 5, which is lower than its previous profit maximizing
level, and however the revenue has increased to 25 (TR = P*Q = 5*5 = 25).
Therefore, even though the monopolist had 6 units to sell, it would be most profitable to
dispose of one unit and only sell 5 units at a price of 5, and by doing so, the monopolist
generates $25 Total Revenue, which is the highest from all cases presented above.
14.2. Suppose that a monopolist faces a demand curve of D( p)=10−p
and has a fixed supply of 7 units of output to sell. What is its profit-
maximizing price and what are its maximal profits?
Answer
The profit maximizing price is 5 and the profits are 25. This can be explained as
follows;
The profit-maximizing choice for the monopoly will be to produce at the quantity where
marginal revenue is equal to marginal cost: that is, MR = MC.

First, we need to find the monopolist's revenue function. Revenue (R) is the product of price (p)
and quantity (q), so we have: TR = P* Q. Since the demand curve is given by P = 10 - Q, we can
substitute this into the revenue function to get: TR = Q * (10 - Q) = 10Q -Q 2. From this,
Marginal revenue given as; MR = 10-2Q.

Further, the monopolist has zero marginal costs up until 7 units of output and infinite
marginal costs for any output greater than 7 units. If marginal costs are zero, a
monopolist will maximize profit by producing at the point where total revenue is
maximum. Thus, since marginal costs are zero, the marginal revenue also has to be zero.

MR = 10-2Q= 0 2Q= 10 Q* = 5

Now that we have the profit-maximizing Quantity, we can find the corresponding price by
plugging this Profit maximizing quantity back into the demand curve: P* = 10 - Q* = 10 - 5 = 5.

However, since the monopolist has a fixed supply of 7 units, it can only sell 5 units at the
profit-maximizing price. Therefore, the monopolist will sell 5 units at a price of $5 each.

Finally, to find the maximum profit, we can multiply the profit-maximizing price by the quantity
sold: Maximal Profit = P* Q = 5 * 5 = $25
14.18. There are two consumers who have utility functions
u1 ( x 1 , y 1 )=a1 x 1 + y 1
u2 ( x 2 , y 2 )=a2 x 2 + y 2
The price of the y-good is 1, and each consumer has a "large" initial wealth.
We are given that a 2> a1. Both goods can only be consumed in nonnegative
amounts.
A monopolist supplies the x -good. It has zero marginal costs, but has a
capacity constraint: it can supply at most 10 units of the x-good. The
monopolist will offer at most two price-quantity packages, ( r 1 , x1 ) and ( r 2 , x 2) .
Here r i is the cost of purchasing x i units of the good.
A. Write down the monopolist's profit maximization problem. You should
have 4 constraints plus the capacity constraint x 1+ x2 ≤10 .
The monopolist's profit maximization problem can be written as: max π :r 1+ r 2 Subject to
the following constraints:
'
a1 x1−r 1 ≥ 0 , which is   Consumer 1 s participation constraint
a2 x 2−r 2 ≥ 0 , which is Consumer 2's participation constraint
a1 x 1−r 1 ≥ a 1 x 2−r 2 , Consumer 1' s incentive compatibility constraint
a2 x 2−r 2 ≥a 2 x 1−r 1 , Consumer 2' s incentive compatibility constraint
x 1 + x 2 ≤ 10 ,Capacity constraint
¿

B. Which constraints will be binding in optimal solution?

 The consumers incentive compatibility constraint : a2 x 2−r 2=a2 x1 −r 1,

 Finaly , theCapacity constraint : x 1 + x 2=10

C. Substitute these constraints into the objective function. What is the resulting
expression?
The objective function is the profit function which is given as: π : r 1+ r 2. And from the
binding constraints given above, r 1=a1 x 1 and r 2=a2 x 2−a2 x 1 +a1 x 1. By Substituting the
binding constraints into the objective function, we get:
π : r 1+ r 2=a 2 x 2−a 2 x 1+ a1 x 1 +a1 x 1=a2 x 2+ ( 2a 1−a2 ) x 1
D. What are the optimal values of ( r 1 , x1 ) and ( r 2 , x 2) ?
To find the optimal values of ( r 1 , x1 ) and ( r 2 , x 2) ,we can use the binding constraints and
the simplified profit function: π=a2 x 2 + ( 2 a1−a2 ) x 1, Subject to the constraint that
x 1+ x2=10.
Solve the constraint for x 2=10−x1 and substitute into the objective function to get the
problem

max 10 a2 +2 ( a 1−a2 ) x 1 .
x1

To Maximize this profit function with respect to X1, we need to take the derivative of the
∂π
profit function with respect to X1, and the value become ( =2 ( a1−a2 ) ¿ .
ϑ X1
¿
Since a 2> a1 the coefficient on the first derivative is negative, which means that x 1=0
¿ ¿ ¿ ¿
and, therefore, x 2=10. Since x 2=10, we must have r 2=¿ 10 a2 . Since x 1=0 , we must have
¿
r 1=0.
¿
Since a 2> a1 the coefficient on the second term is negative, which means that x 1=0 and,
¿
therefore, x 2=10.
¿
From the above binding constraints formula, , r 1=a1 x 1 and Since x 1=0 , we must have
¿
r 1=0.
¿
And also as it derived above r 2=a2 x 2−a2 x 1 +a1 x 1 , and the Since x 1=0 , the terms with X1
¿ ¿
will disappear and we will remain with r 2=a2 x 2 ,∧¿ Since x 2=10, we must have r 2=¿ 10 a2 .

Therefore, the optimal values of ( r 1 , x1 ) and ( r 2 , x 2) will be given as follows:

( r 1 , x1 ) = (0, 0) and ( r 2 , x 2) =¿, 10)