ECO101A: Introduction to Economics
Tutorial 5 Solution
1. A firm has two factories for which costs are given by:
Factory #1: 𝑪𝟏 (𝑸𝟏 ) = 𝟏𝟎 𝑸𝟐𝟏
Factory # 2: 𝑪𝟐 (𝑸𝟐 ) = 𝟐𝟎 𝑸𝟐𝟐
The firm faces the following demand curve: P = 700 - 5Q
where Q is total output, i.e. Q = Q1 + Q2.
a. On a diagram, draw the marginal cost curves for the two factories, the average and
marginal revenue curves, and the total marginal cost curve (i.e., the marginal cost of
producing Q = Q1 + Q2). Indicate the profit-maximizing output for each factory, total
output, and price.
b. Calculate the values of Q1, Q2, Q, and P that maximize profit.
c. Suppose labor costs increase in Factory 1 but not in Factory 2. How should the firm
adjust the following (i.e., raise, lower, or leave unchanged): Output in Factory 1?
Output in Factory 2? Total output? Price?
An increase in labor costs will lead to a horizontal shift to the left in MC1, causing MCT to
shift to the left as well (since it is the horizontal sum of MC1 and MC2). The new MCT curve
intersects the MR curve at a lower quantity and higher marginal revenue. At a higher level
of marginal revenue, Q2 is greater than at the original level for MR. Since QT falls and Q2
rises, Q1 must fall. Since QT falls, price must rise.
2. Dayna’s Doorstops, Inc. (DD), is a monopolist in the doorstop industry. Its cost is C =
100 - 5Q + Q2, and demand is P = 55 - 2Q.
a. What price should DD set to maximize profit? What output does the firm produce?
How much profit and consumer surplus does DD generate?
b. What would output be if DD acted like a perfect competitor and set MC = P? What
profit and consumer surplus would then be generated?
Consumer surplus is
CS = (0.5)(55 - 25)(15) = $225.
c. What is the deadweight loss from monopoly power in part (a)?
The deadweight loss is equal to the area below the demand curve, above the marginal cost
curve, and between the quantities of 10 and 15, or numerically
DWL = (0.5)(35 - 15)(15 - 10) = $50.
d. Suppose the government, concerned about the high price of doorstops, sets a
maximum price at $27. How does this affect price, quantity, consumer surplus, and
DD’s profit? What is the resulting deadweight loss?
With the imposition of a price ceiling, the maximum price that DD may charge is $27.00.
Note that when a ceiling price is set above the competitive price the ceiling price is equal
to marginal revenue for all levels of output sold up to the competitive level of output.
Substitute the ceiling price of $27.00 into the demand equation to determine the effect on
the equilibrium quantity sold:
27 = 55 - 2Q, or Q = 14.
Consumer surplus is
CS = (0.5)(55 - 27)(14) = $196.
Profits = (27)(14) - (100 - (5)(14) + 142) = $152.
The deadweight loss is $2.00 This is equivalent to a triangle of
(0.5)(15 - 14)(27 - 23) = $2
e. Now suppose the government sets the maximum price at $23. How does this affect
price, quantity, consumer surplus, DD’s profit, and deadweight loss?
With a ceiling price set below the competitive price, DD will decrease its output. Equate
marginal revenue and marginal cost to determine the profit-maximizing level of output:
23 = - 5 + 2Q, or Q = 14.
With the government-imposed maximum price of $23,
profits = (23)(14) - (100 - (5)(14) + 142) = $96.
Consumer surplus is realized on only 14 doorsteps. Therefore, it is equal to the consumer
surplus in part d., i.e. $196, plus the savings on each doorstep, i.e.,
CS = (27 - 23)(14) = $56.
Therefore, consumer surplus is $252. Deadweight loss is the same as before, $2.00.
f. Finally, consider a maximum price of $12. What will this do to quantity, consumer
surplus, profit, and deadweight loss?
With a maximum price of only $12, output decreases even further:
12 = -5 + 2Q, or Q = 8.5.
Profits = (12)(8.5) - (100 - (5)(8.5) + 8.52) = -$27.75.
Consumer surplus is realized on only 8.5 units, which is equivalent to the consumer
surplus associated with a price of $38 (38 = 55 - 2(8.5)), i.e.,
(0.5)(55 - 38)(8.5) = $72.25
plus the savings on each doorstep, i.e.,
(38 - 12)(8.5) = $221.
Therefore, consumer surplus is $293.25. Total surplus is $265.50, and deadweight loss
is $84.50.
