Question

The gasoline market in Davis features upstream monopoly refinery supply and down- stream monopoly retailing (gas stations). Demand is Q = 10 - p. The marginal cost of refining gasoline is 1, and the marginal cost of selling it at a gas station is 2. As- sume first that the industry is not vertically integrated, so the refiner sells gasoline to the retailer, and the retailer sets prices at the pump. Both are profit-maximizing monopolists.

(a) Derive the upstream demand curve. In other words, how much gasoline will the retailer want to sell as a function of the price that the refiner is charging it.

(b) What is the monopoly quantity the refiner will choose to sell in this market? What is the final price at the pump as a result?

(c) What is the producer surplus of the refiner and the retailer in this market, given your previous answers?

(d) Now assume that the monopoly retailer is allowed to buy the refinery, forming a single vertically integrated monopoly. What is the profit-maximizing monopoly quantity and price for the newly integrated firm?

(e) What is the consumer surplus at the vertically integrated monopoly quantity? Did it go up or down relative to the case with a separate refinery and retail company?

Answer 1