1. Suppose demand for a pure monopoly falls so that its profit-maximizing price is below
average variable cost. How much output should the firm supply? Hint: draw the graph.
2. How do you differentiate monopolistic completion from oligopoly market?
Part IV: Work Out
For the following question provide the required solution neatly and clearly.
1. A monopolist with the cost function C=1/2Q2 faces a demand curve Q=12-P
a. What will be its equilibrium price and quantity?
b. If for some reason the firm behaves as if it were in a perfectly competitive
industry, what will the equilibrium price and quantity be?
c. How much money will the firm require to forgo monopoly profits and behave
competitively instead?
1. If the profit-maximizing price is below average variable cost, it means that the firm is unable to cover its variable costs by selling at that price. In this case, the firm should shut down and produce zero output, as continuing to produce would lead to further losses.
By shutting down, the firm avoids incurring any variable costs, and its loss would be equal to its fixed costs.
2. Monopolistic competition is a market structure where there are many firms producing differentiated products. Each firm has some market power, meaning they can set their own prices. There is relatively easy entry and exit into the market.
In contrast, an oligopoly is a market structure where a few large firms dominate the market. There are significant barriers to entry, and the actions of one firm can have a large impact on the market as a whole. Firms in an oligopoly often engage in strategic behavior, such as price fixing or collusion.
In summary, the main differences are the number of firms in the market, the degree of product differentiation, and the ease of entry and exit.
Part IV: Work Out
1. a. To find the equilibrium price and quantity, we need to set the demand curve equal to the marginal cost curve.
Q = 12 - P (demand curve)
MC = dC/dQ = Q (marginal cost curve)
Setting Q = 12 - P = Q, we get P = 12/2 = 6.
Substituting P = 6 into the demand curve, we get Q = 12 - 6 = 6.
So, the equilibrium price is 6 and the equilibrium quantity is 6.
b. In a perfectly competitive industry, the equilibrium price and quantity are determined by the intersection of the demand and supply curves. The demand curve remains the same (Q = 12 - P), but the supply curve is given by the marginal cost curve (MC = Q).
Setting Q = 12 - P = Q, we get P = 12/2 = 6.
Substituting P = 6 into the supply curve (MC = Q), we get Q = 6.
So, the equilibrium price and quantity in a perfectly competitive industry are both 6.
c. To calculate the firm's monopoly profits, we need to find the difference between its total revenue and total cost at the monopoly equilibrium price and quantity.
Total revenue = P * Q = 6 * 6 = 36
Total cost = C = 1/2 * Q^2 = 1/2 * 6^2 = 18
Monopoly profits = Total revenue - Total cost = 36 - 18 = 18
Therefore, the firm would require $18 to forgo monopoly profits and behave competitively instead.