Tutorial 5: Market structures

1. Perfect Competition
1. Given the following information for a perfectly competitive market
P = 1000 − 2 Qd (Demand function)
P = 100 + Qs (Supply function)
TC = 100 + q + q2
1.Calculate the equilibrium price and quantity in a perfectly competitive market.
2. What is the firm’s profit-maximizing level of production, total revenue, total cost and profit
at this market equilibrium? Is this a short-run or long-run equilibrium? Explain your answer.
3. Given your answer in part 2, what do you anticipate will happen in this market in the long
run?
4. In this market, what is the long-run equilibrium price and what is the long run
equilibrium quantity for a representative firm to produce? Explain your answer.
5. Given the long run equilibrium price, calculate the long run equilibrium
quantity produced in the market.
Answer:
a. Equilibrium price and quantity in a perfectly competitive market
P = 1000 − 2 Qd = 100 + Qs
Q∗ = 300 and P ∗ = $400
b. Results for a competitive firm
TC = 100 + q + q2
MC = 2q + 1
In a perfect market P ∗ = MR = AR = $400
Thus MC = MR
400 = 2q + 1
q∗ = 199.5 units
Thus, a firm’s optimal output is q∗ = 199.5 units
TR ∗ = 400 × 199.5 = $79800
TC∗ = 100 + q∗ + q∗ 2 = $40100
π∗ = TR∗ − TC∗ = $39700
The firm operates in a short run as there is supernormal profit of $39,700.

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(iii) New firms will enter the market due to existence of supernormal profit in short run that
will increase the supply and will bring down the price. The supernormal profit of $39,700 will
reduce to zero in the long run.
(iv) fort long run MC = AC = ATC
TC = 100 + q + q2
TC 100
ATC = =( + 1 + q)
q q
MC = (2q + 1)
Equating MC = ATC
q∗ = 10 LR output level for an individual firm.
P ∗ = MC = ATC = AR = MR = $21
TR∗ = P ∗ q∗ = 21 × 10 = $210
TC∗ = 100 + q∗ + q∗ 2 = 100 + 10 + 102 = $210
π∗ = TR∗ − TC∗ = 0
The firm does not make economic profit in the long run.
(v) Market output
P = (1000 − 2 Qd )
21 = (1000 − 2 Qd )
Qd = 490 output level for the entire market.
Assuming that all the firms operating in the industry and market are of equal size.
Qd 490
N= = = 49
q∗ 10

Thus, 49 firms are operating in the market.

2. Given a perfectly competitive firm in its long run position find the price, level
of output and overall profits of the company if it is known that its long run total
costs are given by the following equation
Long-run Total Cost: LTC = (500 q − 20 q2 + 2 q3 )

Answer
Minimize LAC and find the optimal long run output
LTC
LAC = = 500 − 20q + 2 q2
q
To minimize LAC

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∂LAC
= 0 → −20 + 4 q = 0
∂q
q∗ = 5
The LAC is minimum at output level of q∗ = 5
Price in long run is equal to MC
∂TC
MC = = 500 − 40 q + 6 q2
∂q
MC = 500 − 40 q + 6 q2 = 500 − 40 × 5 + 6 × 52 = $450
P ∗ = MC = $450
LTC
Or P ∗ = LAC = = (500 − 20 q + 2 q2 ) = 500 − 20 × 5 + 2 × 52 = $450
q

Profits
TR ∗ = P ∗ q∗ = 450 × 5 = $2250
TC∗ = 500 q − 20 q2 + 2 q3 = 500 × 5 − 20 × 52 + 2 × 53 = $2250
Economic profits π∗ = TR ∗ − TC ∗ = 0
Number of firms and their output if the industry demand is given by: P = 1800 − 2 Qd
where Qd is industry output. Given the price $450, we get Q.
450 = 1800 − 2 Q
Q = 675
Q 675
Number of firms N = = = 135
q 5

Thus, the number of firms that operate in the given market are N =135

3. A firm operates in a perfectly competitive market and the prevailing price is

$42. The firm’s total cost curve is:
TC = (10 + 2q + 0.5 q2 )
a. Is the firm operates in the short run or long run?
b. What level of output should the produce?
c. What price should the firm charge in the short-run?
d. Will the firm make any profit? If so, how much?
Answer
a. It operates in short run, because of the existence of fixed costs in the TC function.
TFC = 10

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TC = 10 + 2q + 0.5 q2
b. level of output
MC = 2 + q
MR = P = 42
Setting MR = MC gives
q∗ = 40
c. price charged in the short-run P ∗ = $42.
d. yes, profit is possible only in short run.
𝑇𝑅 ∗ = P ∗ q∗ = 42 × 40 = 1680
TC∗ = 10 + 2 q∗ + 0.5 q∗ 2 = 10 + 2 × 40 + 0.5 × 402 = $890
Economic profits π∗ = TR ∗ − TC ∗ =$790
4. Long run cost curve of a firm is given by:
LTC = 120q − 20q2 + q3
a. What will be your price in the long run?
b. What will be your profits?
Answer:
Minimize LAC and find the optimal long run output
TC
LAC = = 120 − 20q + q2
q
Minimize the LAC by
∂LAC
= 0 → −20 + 2 q = 0
∂q
q∗ = 10
Price in long run is equal to MC
∂TC
MC = = 120 − 40 q + 3 q2
𝜕𝑞
MC = 120 − 40 q∗ + 3 q∗ 2 = 120 − 40 × 10 + 3 × 102 = 20
P ∗ = MC = $20
Or Price in long run is equal to LAC
TC
LAC = = 120 − 20 q∗ + q∗ 2 = 120 − 20 × 10 + 102 = $ 20
q

P ∗ = LAC = $20

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c. profit
TR∗ = P ∗ q∗ = 20 × 10 = $200
TC∗ = 120 q∗ − 20q∗ 2 + q∗ 3 = 120 × 10 − 20 × 102 + 103 = $200
The Economic profits π∗ = TR ∗ − TC ∗ = 0
Or π∗ = (P ∗ − MC) q∗ = (20 − 20) × 10 = 0
It proves that the firm earns only economic profit and no profit is earned in the long-run.
5. A perfectly competitive firm faces the following short run cost function:
TC = 3q3 − 48 q2 + 400𝑞 + 1696
What is the lowest price at which the firm will produce a positive output?
Answer:
The lowest price they will produce a positive output is where MC = AVC ( Average variable
cost). At this point, the firm can cover their variable costs, but not their fixed costs. Anything
below this point (MC<AVC) the firm will shut down because they cannot cover even variable
cost AVC.
TC = 3q3 − 48 q2 + 400𝑞 + 1696
TVC = 3q3 − 48 q2 + 400q
TVC
AVC = = 3q2 − 48 q + 400
q
∂TC
MC = = 9 q2 − 96 q + 400
𝜕𝑞
AVC = MC
3q2 − 48 q + 400 = q2 − 96 q + 400
q∗ = 8
MC = 9 q2 − 96 q + 400 = 9 × 82 − 96 × 8 + 400 = 208
P ∗ = MC = $208
The minimum price the company should charge is P ∗ = MC = $208

6. Consider the following market demand and supply curves in a perfectly

competitive industry as
Market Demand: Qd = 25 − 0.5 P
Market Supply: Qs = 10 + P.
Now consider a firm in the industry whose cost function is

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TC (Q) = 25 − 2q + 4 q2 .
(i) What is the market price?
(ii) What is the optimum output level and profit in the short run?
(iii) Shall the firm continue to produce in the short run or shut down?
Answer:
Market demand curves: Qd = 25 − 0.5P
Market demand curves: Qs = 10 + P
The firm total cost function: TC (q) = 25 − 2q + 4 q2
The market equilibrium price is obtained by Qs = Qd
10 + P = 25 − 0.5P
P ∗ = $10
Q∗ = Qs = Qd = 20 (industry output)
TR = total revenue for a competitive firm = P ∗ q = 10 q
∂TR
MR = Marginal revenue for a competitive firm = = 10
∂Q

TC (Q) = 25 − 2q + 4 q2
∂TC
MC = = −2 + 8 q
∂Q
Setting MR = MC gives the optimal level of output a competitive firm produces that
maximizes its profit (or minimizes the loss)
10 = − 2 + 8 q
q∗ = 1. 5
TC (q∗ ) = 25 − 2 q∗ + 4 q∗ 2 = 25 − 2 × 1.5 + 4 × 1.52 = 31
TR = total revenue for a competitive firm = 10 q = 15
π = TR − TC = 15 − 31 = − 𝟏𝟔 (negative, it a loss)
The firm is producing q∗ = 1. 5 and incurring a loss of 16.
The firm can continue if it can recover average variable cost. The TC (Q) has total variable
cost TVC (q) = 4 q2 − 2q. The average variable cost (AVC)
TVC
AVC = = (4 q − 2)
q
AVC = (4 q − 2) = (4 × 1.5 − 2) = $4

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The marginal revenue (= market price) of 10 is more than the AVC of 4 i.e. the AVC of $4 is
fully recovered and remaining surplus of $6 over the AVC is used to recover some part of the
fixed cost. It should continue to produce in short run.
7. The market for green vegetables is Perfectly competitive. Reliance Fresh ones is
a firm in this market. The long run cost function of the firm is given as
𝐋𝐀𝐂 (𝐪) = 𝟒𝟎𝟎 − 𝟐𝐪 + 𝟎. 𝟎𝟓 𝐪𝟐 . Find the profit maximizing output in the long
run. Also verify whether LAC and LMC are equal at this point.
Answer:
LAC (q) = (400 − 2q + 0.05 q2 )
∂LAC
The LAC is minimum at = 0
∂q

∂LAC
= 0 → −2 + 0.1 q = 0 gives q∗ = 20
∂q

𝜕2 LAC
The second order condition for minimization is satisfied as ∂𝑞2
= 0.1 > 0 positive for all q.

LAC (q∗ ) = 400 − 2 q∗ + 0.05 q∗ 2 = 400 − 2 × 20 + 0.05 (20)2 = 400 − 40 + 20 = $380

The selling price P = LAC = $380
TR = 380 q
∂TR
LMC is minimum at = 380
∂q

Thus, at this point LMC = LAC = 380

2. Monopoly Market Structure

1. Suppose the monopolist’s demand curve is P = 306 – 6 Q and its cost

function is TC = 15 + 6 Q. Determine the profit maximizing price and
quantity and the maximum profits.
(b) Suppose the government gets involved and mandates that the monopoly compete like a
perfectly competitive firm. Now, what are the new profit maximizing price and quantity.
Answer:
a. profit maximizing price and output.
TC = 15 + 6 Q ( note that firm price and output is same as of the industry and market, hence
Q is used for firm output level)
MC = 6
MR = 306 − 12 Q

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Equating MR= MC
Q∗ = 25
Substituting Q∗ = 25 in P = 306 − 6 Q gives
P ∗ = $156
π = (P ∗ − MC)Q∗ = $3750
Or
π = TR − TC = P Q − TC = 156 × 25 − (15 + 6 x 25) = $3750
(b) perfectly competitive market P ∗ = AR = MC = $6
P = 306 – 6 Q viz. 6 = 306 – 6 Q
Q∗ = 50 (output is doubled)

2. A monopoly firm faces the following Inverse demand function and total
cost function:
P = 85 − 4 q

TC = 24 + 13 q

Determine the optimal price, output and profit

Answer:
Another approach in obtaining optimal price and output. Maximizing profit:
π = TR − TC = P q − TC
π = (85 − 4 q) 𝑞 − (24 + 13q)
= 72q − 4𝑞 2 − 24
Equating the first differential w.r.t. q to 0 gives profit maximum q
∂π
= 0 ⟹ 72 − 8 q = 0
∂q
Optimal output: q∗ = 9
Optimal price P ∗ = 85 − 4 q∗ = 85 − 4 × 9
= $49
Optimal profit π∗ = (72 q∗ − 4q∗ 2 − 24) = (72 × 9 − 4 × 92 − 24)
=$300
Thus, the monopoly firm produces q∗ = 9 and sells at P ∗ = $49 and earns optimal profit of
π∗ = $300

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3. A monopoly firm faces the following inverse demand function and cost
𝐏 = (𝟏𝟎𝟎 − 𝐪)
𝐓𝐂 = 𝟒 𝐪𝟐
Find profit maximizing price, output and profit
Answer
TR = P q = (100 − q)q = 100q − q2
MR = (100 − 2 q )
MC = 8 q
Setting MR = MC gives
Optimal output: q∗ = 10 units
The optimal price P ∗ = (100 − q∗ ) = $90
TR∗ = P ∗ q∗ = $900
TC∗ = 4 q∗ 2 = 4 × 102 = $400
π∗ = TR∗ − TC∗ = 900 − 400 = $𝟓𝟎𝟎

4. Demand curve of a monopolist is given by 𝐏 = (𝟏𝟏𝟎 − 𝟒𝐐). Marginal cost

for the monopolist is constant and is equal to 10.
a. What are the profit-maximizing price and output?
b. If the industry is perfectly competitive, what would be the price and output?
Answer:
a. Monopolist profit-maximizing price and output
P = (110 − 4Q)
TR = P Q = (110 − 4Q) Q = 110 Q − 4 Q2
∂TR
MR = Marginal revenue for a competitive firm = = 110 − 8 Q
∂Q

MC = 10
Setting MR = MC gives the optimal level of output a competitive firm produces that
maximizes its profit (or minimizes the loss)
10 = 110 − 8 Q
Q∗ = 12.5 units
P ∗ = 110 − 4 Q∗ = $60

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b. Price and output with competitive industry.
In the case of a perfectly competitive market,
P = selling price = MR = MC =10. The output level is determined by
P = 110 − 4Q
10 = 110 − 4 Q
Industry output Q∗ = 25
Thus, in perfectly competitive market, price is P = 10 and output is Q∗ = 25. It may be noted
that in the case of perfect competitive market, the output is always double of monopoly.

5. The cost function of a monopolist is 𝐓𝐂 (𝐐) = (𝟏𝟎𝟎𝟎 + 𝟐𝟎 𝐐) . The

demand function for the monopolist is estimated to be 𝐏 = (𝟐𝟎𝟎 − 𝟒𝐐)
a. Compute the profit-maximizing output and the profit at that level of output for the
monopolist.
b. If the industry transforms into a duopoly, what would be the equilibrium output for
the industry?
Solution:
a. profit-maximizing output and profit as monopolist
The demand faced by the monopolist is market demand.
TC (Q) = (1000 + 20 Q )
∂TC
MC = = 20
∂Q

P = (200 − 4Q)
TR = total revenue = PQ = (200 − 4Q) Q = 200 Q − 4 Q2
∂TR
MR = Marginal revenue for a monopolist firm = = 200 − 8 Q
∂Q

MR = MC gives the optimal level of output a monopolist firm produces that maximizes its
profit (or minimizes the loss)
20 = (200 − 8 Q )
Q∗ = 22. 5 units
P ∗ = 200 − 4 Q∗ = 200 − 4 × 22.5 = $110
TR∗ = P ∗ Q∗ = 110 × 22.5 = 2475
TC (Q∗ ) = 1000 + 20 Q∗ = 1000 + 20 × 22.5 = 1450
π∗ = TR∗ − TC∗ = 2475 − 1450 = $1025

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b. equilibrium output for the duopolistic industry
In the case of a duopoly, the monopolist demand function would be shared between the two
Duopolist.
P = (200 − 4Q)
Thus, the market demand curve Q = (50 − 0.25 P)
Assuming that the two Duopolist have equal share in the demand, therefore for each
firm will have half demand.
Q
qi = = (25 − 0.125 P)
2
i.e. The inverse demand function for each
P = (200 − 8 qi )
TR = total revenue = P qi = (200 − 8 qi ) qi = 200 qi − 8 qi 2
∂TR
MR i = Marginal revenue for each duopoly firm = = (200 − 16 qi )
∂Q

The TC (q i ) = 1000 + 20 q i
Since TC remains same, MCi = 20
MR i = MCi gives the optimal level of output a duopoly firm produces that maximizes its profit
(or minimizes the loss)
20 = 200 − 16 qi

qi ∗ = 15
P ∗ = 200 − 8 q∗ = 200 − 8 × 15 = $80
TR i ∗ = P ∗ q∗ = 80 × 15 = $1200
TR∗ = 2 TR i = $2400
Industry output Q ∗ = 2 qi ∗ = 𝟑𝟎 units

The minimum TC for the industry

TC ∗ = 1000 + 20 Q ∗ = 1000 + 20 × 30 = $1600
Industry profit: π∗ = TR∗ − TC∗ = 2400 − 1600 = $800
The monopoly firm output is lower but profit is higher than the duopoly.

6. ABC Company, a monopolist firm, supplies power to households and

industries, faces the following total cost function. 𝐓𝐂 (𝐐) = 𝟐𝟐𝟎𝟎𝟎 + 𝟏𝟎𝟎 𝐐

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The demand for power by the two separable sets of consumers is given by the following
demand functions.
Household: P1 = 300 − 0.5 Q1
Industries: P2 = 200 − 0.5 Q2
Required:
a. If price discrimination is not permitted, determine the price charged by the company and the
profit earned at that price.
b. If price discrimination is legalized, determine the price charged by the company and the
profit earned at that price.
Answer:
a. price and profit earned without price discrimination
Develop a combined demand function from both the demand function, which would be the
total demand function of the industry.
Household:
Price function: P1 = 300 − 0.5 Q1
Demand function: Q1 = 600 − 2 P1
Industries:
Price function: P2 = 200 − 0.5 Q2
Demand function: Q2 = 400 − 2 P2
The total market demand at price P:
Q = Q1 + Q2 = (600 − 2 P) + (400 − 2 P)
= (1000 − 4P)
Inverse demand function
P = (250 − 0.25 Q)
TR = total revenue = PQ = (250 − 0.25Q) Q = 250 Q − 0.25 Q2
∂TR
MR = Marginal revenue for a monopolist firm = = (250 − 0.5 Q)
∂Q

TC (Q) = 22000 + 100 Q

∂TC
MC = = 100
∂Q
Setting MR = MC gives the optimal level of output a monopolist firm produces that maximizes
its profit (or minimizes the loss)
100 = 250 − 0.5 Q

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Q∗ = 300 units
P ∗ = 250 − 0.25 Q∗ = 250 − 0.25 × 300
= $175
TR = P ∗ Q∗ = 175 × 300 = $52500
TC (Q∗ ) = 22000 + 100 Q∗ = 22000 + 100 × 300 = $52000
Optimal profit π∗ = TR∗ − TC∗ = 52500 −52000 = $500
Result: P ∗ = 175 , Q∗ = 300 and optimal profit π∗ = 500
b. price and profit earned with price discrimination
Determine P and Q separately for both the markets using MR = MC rule. And then calculate
the profit.
(i) Household segment separately
P1 = 300 − 0.5 Q1
TR1 = total revenue = P1 Q1 = (300 − 0.5 Q1 ) Q1 = 300 Q1 − 0.5 Q1 2
∂TR
MR1 = Marginal revenue for a monopolist firm = = (300 − Q1 )
∂Q

TC (Q1 ) = 22000 + 100 Q1

∂TC
MC1 = = 100
∂Q1
MR1 = MC1 gives the optimal level of output a monopolist firm produces that maximizes its
profit (or minimizes the loss)
100 = 300 − Q1
Q∗1 = 200
P1∗ = 300 − 0.5 Q∗1 = 300 − 0.5 × 200
= $200
TR1 ∗ = P1∗ Q∗1 = 200 × 200 = $40,000
(ii) Industries segment separately
Industries: P2 = 200 − 0.5 Q2
Demand function: Q2 = 400 − 2 P2
TR 2 = total revenue = P2 Q2 = (200 − 0.5 Q2 ) Q2 = 200 Q2 − 0.5 Q2 2
∂TR2
MR 2 = Marginal revenue for a monopolist firm = = 200 − Q2
∂Q2

∂TC
MC2 = = 100
∂Q

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MR 2 = MC2 = gives
100 = 200 − Q2
Q∗2 = 100
P2∗ = 200 − 0.5 Q∗2 = 200 − 0.5 × 100
= $150
TR 2 ∗ = P2∗ Q∗2 = 150 × 100 = $15000
(iii) combined results
TR∗ = TR1 + TR 2 = 40000 + 15000 = $55000
Total output Q∗ = Q∗1 + Q∗2 = 200 + 100 = 300 units
TC∗ = 22000 + 100 Q∗ = 22000 + 100 × 300 = $52000
Optimal profit π∗ = TR∗ − TC∗ = = 55000 − 52000 = $3000
The more profit of $2500 ($3000 -$1000) is earned with price discrimination though selling
same number of seats i.e. 300.

7. The demand equation of local Eros movie theatre in Mumbai for balcony
seats and dress circle seats are given respectively as:
Balcony Demand : Q1 = 60 − 2 P1
Dress circle Demand: 3Q2 = 56 − P2

The total cost of running the show by multiplex is TC (Q) = 40 + 20 Q. What would be
the price of tickets with price discrimination? What would be the price of Multiplex decides to
charge the same price across both types of seats?
Answer:
Total cost function: TC(Q) = 40 + 20 Q
Balcony:
demand function: Q1 = (60 − 2 P1 )
P1 = (30 − 0.5 Q1 )
Dress Circle:
demand function: 3Q2 = (56 − P2 )
P2 = 56 − 3 Q2

a. price of tickets with price discrimination

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Determine P and Q separately for both the markets using MR = MC rule and then calculate the
profit.
(i) Balcony:
P1 = 30 − 0.5 Q1
TR = total revenue = P1 Q1 = (30 − 0.5 Q) Q = 30 Q1 − 0.5 Q1 2
∂TR
MR = Marginal revenue for a monopolist firm = = 30 − Q1
∂Q1

TC (Q) = 40 + 20 Q
∂TC
MC = = 20
∂Q
MR = MC gives the optimal level of output that maximizes its profit (or minimizes the loss)
20 = 30 − Q1
Q∗1 = 10 seats
P1∗ = 30 − 0.5 Q∗1 = 30 − 0.5 × 10
= $25
TR1 ∗ = P1∗ Q∗1 = 25 × 10 = $250
(ii) dress circle
Industries: P2 = 56 − 3 Q2
TR 2 = total revenue = P2 Q2 = (56 − 3 Q2 ) Q2 = 56 Q2 − 3 Q2 2
∂TR2
MR 2 = Marginal revenue for a monopolist firm = = 56 − 6 Q2
∂Q2

MC2 = 20
Setting MR 2 = MC2 gives
20 = 56 − 6 Q2
Q∗2 = 6
P2∗ = 56 − 3 Q∗2 = 56 − 3 × 6
= $ 38
TR 2 ∗ = P2∗ Q∗2 = 38 × 6 = $228
(iii) combined results
TR∗ = TR1 ∗1 + TR 2 ∗ = 250 + 228 = $ 478
Total output = Q∗1 + Q∗2 = 10 + 6 = 16
TC = 40 + 20 Q = 40 + 20 × 16 = $360
Profit π = TR − TC = 478 − 360 = $118

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b. price and profit with single-uniform pricing (without price discrimination)
Develop a combined demand function from both the demand function, which would be the
total demand function of the industry.
demand function: Q1 = 60 − 2 P1
1
Dress Circle: demand function: Q2 = 3 (56 − P2 )
56 P
The market demand Q = Q1 + Q2 = (60 − 2 P) + ( 3 − 3)

1
Q= (236 − 7P)
3
1
P = (236 − 3Q)
7
1 1
TR = total revenue = P Q = 7 (236 − 3Q) Q = (236 Q − 3Q2 )
7
∂TR 1
MR = Marginal revenue for a monopolist firm = ∂Q
= 7
(236 − 6Q)

MC = 20
MR = MC gives the optimal level of output that maximizes its profit (or minimizes the loss)
1
20 = (236 − 6Q)
7
Q∗ = 16
1
P ∗ = 7 (236 − 3Q∗ ) = $26.9

TR∗ = P ∗ Q∗ = 26.9 × 16 = $430

TC (Q∗ ) = 40 + 16 Q∗ = $360
Optimal profit π∗ = TR∗ − TC∗ = 430 − 360 = $70
Result: P ∗ = $26.9 , Q∗ = 16 and optimal profit π∗ = $70
Comparing these two cases shows that profit earned with price discrimination is more than
uniform-single pricing though the level of output in both the cases is same.

8. A local concert provider has a monopoly over the provision of heavy metal
rock concerts. The firm has estimated that its market demand curve can be
drawn from the following equation (where P = price and Q = quantity demanded):
P = 130 − 2Q.
The total cost of running the show by multiplex is TC = 10 Q.

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Determine (a) single price and number of tickets sold without price discrimination
(b) Price discrimination: firm has information that younger consumers (under 50) are willing
to pay up to $80 per ticket for an upcoming heavy metal band concert and that older consumers
(50 or older) are willing to pay up to $30 per ticket to rock on at this concert.
Answer
(a) Single pricing
Marginal revenue (MR), in this case, would be MR = 130 - 4Q. The firm’s average and marginal
costs are constant, in that the AC and MC equations are both always equal to $10. These
equations appear as follows:
MR = 130 − 4 Q
MR = AC = $10
Setting MR = MC, gives
Q∗ = 30
P ∗ = 130 − 2 Q∗ = $70
π = (P ∗ − MC) Q∗ = (70 − 10) × 30 = $1800
If the firm charges single price for every ticket it sells, the firm would sell 30 tickets at a price
of $70 per unit and make supernormal profit of $1800.
(b) with price discrimination
The firm has enough information on its market to utilize a price discrimination pricing strategy.
To be a price discriminating monopolist, this firm must do two things:
i. Separate consumers into different groups, based on differences in their maximum
willingness to pay for the firm’s product
ii. Prevent the resale of the firm’s product between these different groups
Further, the firm has determined that younger consumers (under 50) are willing to pay up to
$80 per ticket for an upcoming heavy metal band concert and that older consumers (50 or older)
are willing to pay up to $30 per ticket to rock on at this concert. If the firm uses price
discrimination, based on age differences, the price discrimination is:
The monopolist sets a price of $80 i.e. 𝑃 = 80, and obtains 𝑄.
P = 130 − 2Q
80 = 130 − 2Q
Q = 25 tickets
Thus, number of tickets sold at P = $80 are Q = 25. Thus, the younger consummers will buy
25 tickets.

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If the firm sets a price of $30, then the number that would be sold at P = $30.
P = 130 – 2 Q
30 = 130 – 2 Q
Q = 50 tickets
Thus, at lower price of $30, the number buyers would be 50, which also includes 25 tickets that
would be purchased buy younger consumers. The younger consumer would buy 25 tickets out
of 50 and net 25 would be purchased by older consumers.

Therefore, as the graph shows below, the $80 price will result in 25 tickets being sold to the
younger group whereas charging the older consumers a price of $30 will cause the overall sales
to increase to 50 tickets (i.e., 25 additional tickets are sold).

Profits (𝜋) are measured as the net revenue generated from the sales of this good at the two
prices given above (where the "1" subscript denotes the younger group, and the "2" subscript
corresponds with the older group). The pink area corresponds with the profits derived from
sales to group 1, and the green area corresponds with the profits derived from sales to group 2.
π = pink area (younger) + green area (older)
π = (P1 − AC) × 25 + (P2 − AC) × (50 − 25)
= (80 − 10) × 25 + (30 − 10) × (50 − 25)
= $2250
The firm can obviously make more profits now than what would have been attained in the
single-price system.
Note that we could have chosen a different pair of prices to work with, and that our profits from
price discrimination could go up or down, depending on which prices we chose. For example,
prices of $90 and $10 would yield total profits of $1600; whereas prices of $75 and $30 would
yield total profits of $2287.50.

18
9. The demand equation of Falcon Airlines for its two segments: domestic
and foreign are given respectively as:
Domestic segment demand: Q d = 110 − Pd
Foreign segment demand: Q f = 30 − Pf
TC = 100 + 10 Q

Determine the price and output with price discrimination and single pricing
Answer:
Total cost function: TC = 100 + 10 Q
Domestic segment:
demand function: Qd = 110 − Pd and hence Pd = 110 − Qd
Foreign segment:
demand function: Qf = 30 − Pf and hence Pf = 30 − Qf

a. price discrimination case

Determine P and Q separately for both the markets using MR = MC rule. And then calculate
the profit.
(i) Domestic Segment:
TC = 100 + 10 Q
MC = 10
Pd = 110 − Qd
MR = 110 − 2 Qd
Setting MR = MC gives the optimal level of output that maximizes its profit (or minimizes the
loss)
Q∗d = 50 seats
Pd∗ = 110 − Q∗d = $ 60
TR = Pd∗ Q∗d = 60 × 50 = $3000
(ii) Foreign segment
MC = 10
Pf = 30 − Qf
MR = 30 − 2 Qf
MR = MC gives the optimal level of output that maximizes its profit (or minimizes the loss)
Q∗f = 10 seats

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Pd∗ = 30 − Q∗f = $ 20
TR = Pd∗ Q∗d = 20 × 10 = $ 200
(iii) combined results
TR = TR d + TR f = 3000 + 200 = $3200
Total output = Q∗d + Q∗f = 50 + 10 = 60 seats
TC = 100 + 10 Q = 100 + 10 × 60 = 700
Profit π = TR − TC = 3200 − 700 = $2500

b. Single Pricing case (without price discrimination)

Qd = 110 − Pd and Qf = 30 − Pf
The combined demand at a given price can be given as
Q = Qd + Qf = (110 − P ) + (30 − P )
= (140 − 2P )
P = (70 − 0.5 Q)
MR = 70 − Q
MC = 10
Q∗ = 60
P ∗ = 70 − 0.5 Q∗ = 40
π∗ = TR∗ − TC∗ = 60 × 40 − (100 + 10 × 60) = $1700

Monopolistic competition
1. A firm operating in a monopolistically competitive market faces the
following function
P = 8000 − 4 q
LAC = 8000 − 7q + 0.002 q2
Find profit-maximizing price and output for the firm. What is the profit at this output?
b. Is the industry in equilibrium? Why or why not?
Answer
In monopolistic Competition, optimum output happens when LAC is minimum.
LAC = 8000 − 7q + 0.002 q2
∂LAC
= 0 → −7 + 0.004 q = 0
∂Q
q∗ = 1750

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P ∗ = (8000 − 4 q∗ ) = 8000 − 4 × 1750 = $1000
LAC = 8000 − 7 × 1750 + 0.002 × (1750)2 = 8000 − 12250 + 6125 = $1875
b. Is the industry in equilibrium? Why or Why not?
In case of monopolistic market, long run equilibrium happens when all firms getting normal
profit. The industry is not in equilibrium as P ∗ > LAC and there is supernormal profit.

2. A monopolistically competitive firm faces the following demand and cost

conditions.
P = 20000 − 15.6 q
TC = 400000 + 4640 q + 10 q2
Determine the price, output level and profit in short-run and also in long run
Answer:
MR = 20000 − 31.2 q
MC = 4640 + 20 q
Using the marginal principle and setting MR = MC
20000 − 31.2 q = 4640 + 20 q
q∗ = 300
P ∗ = 20000 − 15.6 q = 20000 − 15.6 × 300
= $15320
TC 400000
AC = = + 4640 + 10 q
q q
AC at output level q∗ = 300
400000
AC = + 4640 + 10 × 300
300
= 8973.3
π∗ = (P ∗ − 𝐴𝐶)q∗ = (15320 − 8973.3) × 300 =
= 19,04,000
Long run scenario
P = LAC
Thus, we have
dP dLAC
=
dq dq

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dP
= − 15.6 (1)
dq

400000
AC = + 4640 + 10 q
q
dAC 400000
= − + 10 (2)
dq q2

Equating (1) and (2)

400000
− + 10 = − 15.6
q2
q∗ = 125
P ∗ = 20000 − 15.6 q = 20000 − 15.6 × 125
= $15320
400000 400000
AC = + 4640 + 10 q = + 4640 + 10 × 125
q 125

= $9090
π=0

22
 Oligopoly
Industry demand is given by: 𝐏 = 𝟐𝟎𝟎 − 𝟒 𝐐.
Assume there are 2 firms in the industry 1 and 2. Costs are the same for both firms. The cost
curve for the individual firm is given by:
TC = 10 q + q2

Find price, output and profit given that it is a centralized cartel. Find prices and output for an
individual firm and profit given that it is a decentralized cartel.
Answer:
Centralised Cartel
P = 200 − 4 Q
MR = 200 − 8 Q
Q Q 2
TC = 10 q + q2 = 10 ( ) + ( ) = 5 Q + 0.25 Q2
2 2

MC = 5 + 0.5 Q
Setting MC = MR
200 − 8 Q = 5 + 0.5 Q
Q∗ = 23
P ∗ = 200 − 4 x 23 = $108
π∗ = TR − TC = 108 x 23 − (5 x 23 + 232 ) = $2237

Decentralized cartel
Divide the market by the number of firms (that is, set Q = q1 + q2 + … + qn for all n firms).
In this case there are two firms. Substitute Q = 2q in price equation will provide equation for
a firm.
P = 200 − 4 Q
P = 200 − 4 x (2q) = 200 − 8 q i
MR i = MR for an individual firm
= 200 − 16 q i
MCi = MR for an individual firm
= 10 + 2 q i
MR i = MCi leads to 200 − 16 q i = 10 + 2 q i
q i ∗ = 10.56
P ∗ = 200 − 8 q i ∗ = $115.56
πi = TR − TC

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TR 𝑖 = $115.56 x 10.56 = 1220
TC𝑖 = 10 q + q2 = 10 × 10.56 + 10.562 = 217
πi = $1003
Industry profit 𝜋 = 2 πi = $ 2006
2. Industry demand is given by: 𝐏 = 𝟏𝟓𝟎 − 𝟑 𝐐. Assume there are 2 firms in the
industry A and B. Costs are the same for both firms. The cost curve for the
individual firm is given by:
𝐓𝐂 = 𝟓 𝐪 + 𝟐 𝐪𝟐

Answer:
Let qi = output of individual firm qi = 1,2
Price function faced by individual firm: P = 150 − 6 q i .
MR i = 150 − 6 q i
𝑄
MCi = 5 + 4 q i = 5 + 4 ( ) = 5 + 2 Q
2
Setting MR i = MCi for solving q∗ 150 − 6Q = 5 + 2 Q
Q∗ = 18.125 (industry)
Sub q* = 18.125 into demand to solve P ∗
P ∗ = 150 − 3 Q∗ = $95.63
𝑀𝐶 = 5 + 2 Q = 41.25
π = (P − MC)𝑄 = (95.63 − 41.25) × 18.125 = 985
3. Consider a market for which inverse demand function is
P = 100 − 4 Q
Suppose there are four firms in this market all of which have a constant marginal cost
MC =$20
How which of these profit-maximizing firms forming a cartel would produce? Where they
agree to produce the same output. Explain the incentive for cheating.
Answer:
P = 200 − 4 Q ($)
TR = 200 Q − 4 Q2
MR = 200 − 8 Q
M C = 20
setting MR = MC

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Q∗ = 20
P ∗ = 100 − 2 Q∗ = 60
Since there are four firms, the output for each firm q∗i = 5
Profit of each firm πi∗ = (P ∗ − MC)q∗i = (60 − 20) × 5 = $200
Total industry profit = 4 × 200 = $800
(ii) there is a great incentive to cheat as (P ∗ − MC) = 40.
Let the first firm cheat and produce one more unit i.e. q1 = 6 units. The total output would be
Q = 6 + (5 + 5 + 5) = 21
P = 100 − 2 Q = 100 − 2 × 21 = $58
π1 = (P − MC) q1 = (58 − 20) × 6 = $228
The profit earned through cheating π1 = $228 is more than the previous and it acts as an
incentive to cheat.
Profit for the other three firms:
π2 = (P − MC) q 2 = (58 − 20) × 5 = $190
Thus, industry profit = π1 + 3 π2 = 228 + 3 × 190 = $798 < 800
Thus, the breakage of a cartel lowers the profit for the industry as a whole,
(iii) Assuming that all the four firms cheat and produce 6 units i.e. q i = 6 units,
Q = 6 x 4 = 24
P = 100 − 2 Q = 100 − 2 × 24 = $52
πi = (P − MC) q i = (52 − 20) × 6 = $192
Thus, by cheating, all the firms earn lower profit πi = $192 and industry profit 𝜋 =
$192 x 4 = $768
Suppose that the market demand function for a two-firm equal market-sharing
cartel is, 𝐐 = 𝟏𝟐𝟎 − 𝟏𝟎 𝐏 and that the total cost function of each duopolist is, TC =
0.1 Q2 . Determine the best level of output of each duopolist, the price at which each
will sell the commodity and the total profits of each. (ii) Determine the price, output
and profit considering a cartel.
Answer:
The half share of the market is faced by each duopoly firm:
Q
Thus, demand curve faced by Individual q i = = 60 − 5 P
2

Or P = 12 − 0.2 q i
TR = total revenue = P q i = (12 − 0.2 q i ) q i = 12 q i − 0.2 q i 2

25
 ∂TR
MR = Marginal revenue for a duopoly firm = = 12 − 0.4 q i
∂Q

TC (Q) = 0.1 q i 2
∂TC
MC = = 0.2 q i
∂Q
MR = MC gives the optimal level of output a duopoly firm produces that maximizes its profit
(or minimizes the loss)
12 − 0.4 q = 0.2 q
q i ∗ = 20
Q = 2 × q i ∗ = 40
P ∗ = 12 − 0.1 Q = 12 − 0.1 × 40
= $8
Thus, each duopoly firm produces 20 units and sells at price $8
TR = P ∗ q∗ = 8 × 40 = 320
TC (Q∗ ) = 0.1 𝑄 2 = 160
Optimal profit π∗ = 320 − 160 = $160
(ii) Assuming a cartel
The cartel operates as a monopolist firm.
TC = 0.1 Q2
MC = 0.2 Q
Q = 120 − 10 P ⟹ P = 12 − 0.1 Q
MR = 12 − 0.2 Q
Setting MC = MR.
12 − 0.2 Q = 0.2 Q
Q∗ = 30
P ∗ = 12 − 0.1 Q∗ = 9
π = TR − TC = 30 x 9 − 0.1 x 302 = $180
The cartel produces less and earns more profit.

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Cournot model Oligopoly model in which firms produce a homogeneous good, each firm
treats the output of its competitors as fixed, and all firms decide simultaneously how much to
produce.

27