Question

Consider the perfectly competitive market for a good. There are 100 identical consumers who each have a demand for good X given by q = 10 – ½ P, where q is quantity demanded and P is the market price. Firms in this industry incur constant marginal costs and no fixed costs: MC = ATC = 10. What are the price of the good and the quantity sold in the competitive market equilibrium in the short run? Illustrate the market outcome in the diagram provided.

Explain consumer and producer surplus in words. What is the surplus accruing to consumers in the market equilibrium from part (a)? What is the producer surplus? Indicate both in the diagram in part a.

Suppose instead the market for good X with 100 identical consumers (as above) is governed by a monopoly. The monopolist incurs production costs of MC = ATC = 10 and wants to set a single price. The monopolist intends to maximize profits, but his friends suggest 2 other goals.

Friend 1 suggests maximizing sales (quantity sold), but without incurring economic losses.

Friend 2 instead suggests maximizing total revenue.

Given the demand curve you obtained in part (a), work out the price, quantity and profit in each of the 3 options, and briefly explain your reasoning in words. Illustrate the 3 options in the diagram provided below.

The monopolist realizes that price discrimination is possible in this market and knows that the demand curve for each of the 100 identical consumers is given by q = 10 – ½ P. If he considers using a two-part tariff, what are the profit-maximising fee and the price per unit? Illustrate the fee and price per unit in a diagram. Calculate the profit for the monopolist in this case.

Calculate and compare the deadweight loss in the case of a profit-maximizing monopolist who sets a single price with a price discriminating monopolist who charges a two-part tariff. Carefully explain the difference in words.

Answer 1