Solved Problems

Q1. A monopolist has a cost function

TC=10+2 Q

where Q is the units of output. The demand function in this market is given by

Q=14−P

If this monopolist can charge only one price, what is his profit?

Answer:

Demand function:

Q=14−P

Inverse demand function:

P=14−Q

Now,

Total revenue (TR) = Price (P) × quantity (Q)

= (14 – Q) × Q

= 14 Q – Q2

Now,

∂(TR)
MR= =14−2Q
∂Q

Also,

TC = 10 + 2 Q

MC = 2

The equilibrium condition under monopoly is given as:

MR = MC
Hence,

14 – 2 Q = 2

Q=6

Also,

P = 14 – Q

P=8

Profit = TR – TC

= [ 14 (6) – (6)2] – [ 10 + 2 (6)]

= 84 – 36 – 22

= 26

Q2. Suppose only one firm produces tennis rackets in country A. The monopolist’s demand
function and cost function are given as follows:

P=10−Q

2
TC=3+Q+0.5 Q

(i) How many tennis rackets does the monopolist produce? At what price they are
sold?

(ii) What is the monopolist’s profit?

Answer: (i)

The monopolist should produce at that level where its MC equals MR.

Therefore, we need to find MR and MC first.

TR = P × Q

= (10 – Q) × Q
 = 10 Q – Q2

∂(TR)
MR= =10−2 Q
∂Q

Also,

2
TC=3+Q+0.5 Q

MC = 1 + Q

Putting MC = MR,

1+Q=10−2 Q

Q=3

P=10−Q

P=10−3

P=7

(ii). Profits of a monopolist is given by:

π=( P−ATC ) ×Q

Therefore, ATC at Q = 3 is given as:

TC
ATC=
Q

2
3+Q+ 0.5 Q
ATC=
Q
2
3+ 3+0.5 ( 3 )
ATC=
3

ATC=3.5

Hence, profit of the monopolist is equal to:

π=( P−ATC ) ×Q

π=( 7−3.5 ) ×3
 π=10.5

Note: For a monopoly firm, P > MR = MC.

Q3. Suppose the inverse demand function of a monopolistically competitive firm is given by

P = 42 – ½ Q + A0.5 , and the total cost function is given by, TC = 2Q + A.

Calculate the optimal level of advertising for the firm.

Solution:

TC = 2Q + A
MCQ = 2
MCA = 1

TR = P × Q
TR = (42 – ½ Q + A0.5) × Q
TR = 42 Q – ½ Q2 + A0.5 Q

MRQ = 42 – Q + A0.5
MRA = 0.5 A0.5 – 1 Q
= Q / 2 A0.5
Now, for the optimal level of production, these conditions must be fulfilled:

MCA = MRA
1 = Q / 2 A0.5
Q = 2 A0.5 ………….(1)

MCQ = MRQ
2 = 42 – Q + A0.5
2 = 42 – 2 A0.5 + A0.5
A0.5 = 40
A = 1600

Also, Q = 2 A0.5
Q = 2 (40)
Q = 80

And, P = 42 – ½ Q + A0.5
P = 42 – ½ (80) + 40
P = 42
Q4. Suppose a monopolist is able to charge different prices in two market regions. The
demand function of first market is given by Q1 = 14 – P1 and that of the second market is
given by Q2 = 20 – 2 P2 .

If the total cost of the monopolist is equal to C= 3 + 4Q, find the profit-maximizing output
and the prices that are charged in two markets. Also evaluate the total profits made by the
monopolist by opting the strategy of price discrimination.

Solution:

Q1 = 14 – P1
P1 = 14 – Q1

Similarly,
Q2 = 20 – 2 P2
P2 = 10 – Q2/2

Profits are maximized in case of price discrimination, when MR1 = MR2 = MC

TR in first market = P1 Q1
= 14 Q1 – Q12
MR in first market = 14 – 2 Q1

TR in second market = P2 Q2
= 10 Q2 – Q22/2
MR in second market = 10 – Q2

TC = 3 + 4Q
MC = 4

By putting MR1 = MC, we get

14 – 2 Q1 = 4
Q1 = 5

also, by putting MR2 = MC, we get

10 – Q2 = 4
Q2 = 6

Accordingly, P1 = 14 – Q1 = 14 – 5 = 9
and, P2 = 10 – Q2/2 = 10 – 3 = 7

Total profits = (TR1 + TR2) – TC

= (P1Q1 + P2Q2) – (3 + 4Q)
= (45 + 42) – [3 + 4 (11)]
= 87 – 47
= 40
Q5. Suppose that a monopolist sells in two markets with demand curves:

Q A =100−10 P A

QB =8−2 P B

a. Suppose that the monopolist produces at zero marginal cost. How much does he
supply in each market, and what prices does he charge?
b. Suppose that the monopolist’s marginal cost curve is given by: MC=Q / 21. How
much does he supply in each market and what price does he charge?

Solution:

a) Market A: PA = 10 – 0.1 QA => MR = 10 – 0.2 QA

MC =0

10−0.2Q A =0Q A =50P A =5

Market B: PB = 4 – 0.5 QB => MR = 4 – QB

MC =0

4−Q B=0QB =4 PB =2

b) Market A: PA = 10 – 0.1 QA => MR = 10 – 0.2 QA

MC=Q A / 21

10−0.2Q A =Q A / 21

10=.25Q A Q A =40P A =6

Market B: PB = 4 – 0.5 QB => MR = 4 – QB

MC=Q B / 21

4−Q B=0.05 Q BQB =3PB =2.5Q6. Bharat wood company produces particular type of material

for door and window panels, which is not available anywhere in the country. The marketing
head and the production head of the company jointly wanted to find out the profit
maximizing unit price of the material and the corresponding output. Also, they are keen to
know the economic profit with respect to the profit maximizing output level. So, they
employed a consultant to design the demand function and the total cost function by providing
access to the data of the company coupled with primary data collection by that consultant and
provide solutions to the company. The demand function of the furniture material is given
below:

P=5000−0.16 Q

Where Q is the quantity per tons per month and P is the price per ton. The cost function of the
furniture material is as given below:

2
TC=1500000+270 Q+0.05 Q

a. Assume yourself as the consultant and find the profit maximizing price and output of
wood material.
b. Find the corresponding economic profit (total profit)

Solution:

MR = 5000 – 0.32 Q

MC = 270 + .1Q

For profit maximization:

MR = MC

5000 – 0.32 Q = 270 +0.1Q

Q = 11262

P = 3198

Q7. Consider the pricing of first-class and economy class tickets of an airline that enjoys
monopoly power. Let the marginal cost of operation is fixed at 100. The airline faces
following demand functions in both the markets:

P = 1000 – 5Q for first-class tickets

P = 500-Q for economy class tickets.

 a. What should be the optimal pricing for first-class tickets and economy class
tickets.
b. Calculate the demand elasticity for first-class and economy class passengers at the
profit maximizing prices you found in part (a)? How does these values relate to
pricing?

Solution:
a) First-class:
MR = MC
1000 – 10Q = 100
Q = 90. P = 550
Economy class:
MR = MC
500 – 2Q = 100
Q = 200. P = 300

b) ( P−MC ) / P=1 /∨ϵ ∨¿

First Class:
( 550−100 ) / 550=1 /∨ϵ∨¿

ϵ=1.22
Or, Use price elasticity of demand formula to calculate elasticity.

Economy class:
( 300−100 ) / 300=1 / ϵ
ϵ=1.5
Economy class demand is more elastic. Therefore, the profit maximizing price
charged for economy class is lower. Price is inversely related to elasticity.

Q8. The demand function (inverse) for cement is given as P = 400 – 2 Q, where Q is the total
output of industry. There are two cement companies in the market (competing in terms of
quantity), each having the marginal cost of production of Rs.40.

(i) What are the reaction functions, equilibrium price & quantities, and profits of
each firm?
(ii) What is the profit-maximizing output of a monopolist, who faces the same
demand and the same cost of production?

Solution:
(i) The aggregate demand function can be rewritten as
P = 400 – 2 (q1 + q2)

Now, for firm 1, the output of firm 2 is constant, hence the demand function
for firm 1 becomes
P=( 400−2 q2 )−2 q 1
Hence,
TR = (( 400−2 q 2 )−2 q1 ) × q1
= ( 400−2 q 2 ) q1−2 q 12
MR = ( 400−2 q 2 )−4 q1

Putting MR = MC
( 400−2 q 2 )−4 q1=40

q 1=90−0.5 q2 ……………………………….(1)

Since firm 2 is identical to firm 1, both have the same demand function.
Therefore, the demand function of firm 2 becomes

q 2=90−0.5 q1 ……………………………….(2)

Substituting the value of (1) into (2)

q 2=90−0.5(90−0.5 q 2)
q 2=60

Similarly,
q 1=60

Also, P = 400 – 2 (q1 + q2)

= 400 – 2 (120)
= 160

Profit for firm 1 = Profit for firm 2 = TR - TC

= [(160) (60)] – [(40) (60)]
= 7200

(ii) For the monopolist, demand function is

P = 400 – 2Q

Therefore, TR = P × Q
= 400Q – 2Q2
Now, MR = 400 – 4Q

Putting MR = MC
400 – 4Q = 40
 Q = 90
P = 400 – 2 (90) = 220

Profit = TR – TC
= [(220) (90)] – [(40) (90)]
= 16200
Q 9. The inverse demand curve for cereals is represented by P = 200 – 2 Q, where Q is the
total output of industry. There are two cereal manufacturers in the market, having the same
marginal cost of Rs. 8.

(i) Evaluate the equilibrium quantity & price, and their respective profits, keeping
in mind that both the manufacturers compete in quantity.
(ii) How the answer changes, if the cost of one of the firms rises to Rs.10?
(iii) Repeat the part (a) and part (b), assuming that both the manufacturers are now
competing in terms of prices.

Solution:

(i) Demand function: P=200−2 ( Q1 +Q2 )

Profit Maximizing condition for Firm 1:

TR1 = [ 200−2 ( Q1+Q 2) ] Q 1 M R 1=200−4 Q1−2 Q2 MC=8

200−4 Q1−2Q2=8

Q1=( 192−2Q 2) / 4 ---------------(1) Reaction function of Firm 1

Profit Maximizing condition for Firm 2:

M R 2=200−2Q1−4 Q2
MC=8

200−2Q1 −4 Q2=8Q2=( 192−2Q 1) / 4 ---------------(2) Reaction function of Firm 2

Solving equation 1 & 2:

Q1=Q2=32

P ¿ 200−2 ( 32+32 ) =72

(ii) Demand function: P=200−2 ( Q1 +Q2 )

Profit Maximizing condition for Firm 1:
 TR1 = [ 200−2 ( Q1+Q 2) ] Q1 M R 1=200−4 Q1−2 Q2 MC=10

200−4 Q1−2Q2=10

Q1=( 190−2 Q2 ) / 4 ---------------(1) Reaction function of Firm 1

Profit Maximizing condition for Firm 2:

M R 2=200−2Q1−4 Q2

MC=8

200−2Q1 −4 Q2=8Q2=( 192−2Q 1) / 4 ---------------(2) Reaction function of Firm 2

Solving equation 1 & 2:

Q1=31
Q2=32

P ¿ 200−2 ( 31+32 ) =74

(iii) Equilibrium when MC for both firms are equal:
P = MC = 8, Q = 96

Equilibrium when MC is different for both firms:

P = slightly below the MC of high cost firm, i.e. P = 9 and Q = 95. Firm with MC
= 10 will go out of business.