Question

Suppose a monopoly can produce any level of output it wishes at a constant marginal (and average) cost of $5 per unit. Assume the monopoly sells its goods in two different markets separated by some distance. The demand curve in the two markets are given by:

FIRM1 : Q1 = 55 − P1 FIRM2 : Q2 = 70 − 2P2

(a) If the monopolist can maintain the separation between the two markets, what level of output should be produced in each market, and what price will prevail in each market? What are total profits in this situation?

(b) How would your answer change if it costs demanders only $5 to transport goods between the two markets? What would be the monopolist’s new profit level in this situation?

(c) How would your answer change if transportation costs were zero and then the firm was forced to follow a single-price policy?

(d) Suppose the firm could adopt a linear two-part tariff under which marginal prices must be equal in the two markets but lump-sum entry fees might vary. What pricing policy should the firm follow?

Answer 1