Chapter 12 – Pure Monopoly

PROBLEMS

1. Suppose a pure monopolist faces the following demand schedule and the same cost data
as the competitive producer discussed in problem 4 at the end of Chapter 10. Calculate
the missing TR and MR amounts, and determine the profit-maximizing price and profit-
maximizing output for this monopolist. What is the monopolist’s profit? Verify your
answer graphically and by comparing total revenue and total cost.

Price (P) Quantity Total Marginal ATC MC

Demanded Revenue Revenue
(Q) (TR) (MR)

$115 0 $0 NA - -

100 1 100 100 105 45

83 2 166 66 72.5 40

71 3 213 47 60 35

63 4 252 39 52.5 30

55 5 275 23 49 35

48 6 288 13 47.5 40

42 7 294 6 47.14 45

37 8 296 2 48.13 55

33 9 297 1 50 65

29 10 290 -7 52.5 75

Answer:

Price (P) Quantity Total Marginal

Demanded Revenue Revenue
(Q) (TR) (MR)

$115 0 $0 NA
 100 1 100 100

83 2 166 66

71 3 213 47

63 4 252 39

55 5 275 23

48 6 288 13

42 7 294 6

37 8 296 2

33 9 297 1

29 10 290 -7

Profit-maximizing price = $63; profit-maximizing quantity = 4 units; monopolist’s

profit = $42.

The graph should have the general shape of Figure 12.4.

Feedback:

To calculate Total Revenue, multiply price (P) by Quantity Demanded (Q): TR = P ×

Q

To calculate Marginal Revenue, find the change in total revenue for each unit
demanded: MR = Δ TR = TR (i + 1) – TR (i).

See table below.

 Price (P) Quantity Total Marginal
Demanded Revenue Revenue
(Q) (TR) (MR)

$115 0 $0 NA

100 1 100 100

83 2 166 66

71 3 213 47

63 4 252 39

55 5 275 23

48 6 288 13

42 7 294 6

37 8 296 2

33 9 297 1

29 10 290 -7

To find the profit maximizing quantity compare marginal revenue from the first table
above with the marginal cost from second table.

Price (P) Quantity Marginal Marginal

Demanded Revenue Cost
(Q) (MR) (MC)

$115 0 NA NA

100 1 $100 $45

83 2 66 40

71 3 47 35

63 4 39 30

55 5 23 35

48 6 13 40

42 7 6 45

37 8 2 55
 33 9 1 65

29 10 -7 75

Starting with the first unit MR = $100 > MC = $45, produce this unit. The same logic
applies to units 2, 3, and 4. However, for the fifth unit MR = $23 < MC = $35. Thus,
the firm does NOT produce this unit. (NOTE: We have modified the MR = MC rule
to MR > MC, which is more general. Produce all units where MR > MC.)

The profit maximizing quantity produced is 4 units.

The profit maximizing price is the price associated with the profit maximizing
quantity, 4 units. Thus, the profit maximizing price is $63.

The monopolist's profit equals total revenue minus total cost. Total revenue equals
$252 at 4 units of output. We still need total cost. From the 'cost data' table we see
that average total cost (ATC) equals $52.50. Since ATC equals total cost divided by
quantity we can determine total cost from the ATC cost data.

ATC = Total Cost / Quantity

or

Total Cost = Quantity × ATC = 4 × $52.50 = $210

Profit = $252 – $210 = $42

Another approach is to use the following relationship.

Profit = TR – TC

Divide through by Q
 Profit/Q = TR/Q -TC/Q

Since TR/Q = Average Revenue = P and TC/Q = ATC, we have:

Profit/Q = P – ATC

Rearranging,

Profit = Q (P – ATC) = 4($63 – $52.50) = 4 × $10.5 = $42.

Either approach above will work.

The graph should have the general shape of Figure 12.4.

2. Suppose that a price-discriminating monopolist has segregated its market into two groups
of buyers. The first group described by the demand and revenue data that you developed
for problem 1. The demand and revenue data for the second group of buyers is shown in
the following table. Assume that MC is $13 in both markets and MC = ATC at all output
levels. What price will the firm charge in each market? Based solely on these two prices,
which market has the higher price elasticity of demand? What will be this monopolist’s
total economic profit?

Answer: Price in market 1 = $48; price in market 2 = $33; the second market has
the higher price elasticity of demand; total economic profit = $330.

TR-TC

6*48 – 6*13=210

6*33 – 6*13 = 120

SUM of both = 330

Feedback: Let's start with the second market. Marginal cost is $13 for all output
levels. The marginal revenue from producing the 6 th unit is $13 (= $198 – $185), so
this is the last unit produced by the firm for this market.

Thus, the marginal revenue equals marginal cost rule results in 6 units being produced
in this market (MR = MC = $13 at 6 units in this market).

The price the firm charges in this market is $33, which is the price associated with the
6th unit.
The firm’s profit in this market can be found using the following relationship (see
problem 1 in this chapter for derivation).

Profit Market 2 = Q (P – ATC) = 6($33 – $13) = 6 × $20 = $120.

The first market is found in problem 1 (Table reproduced below):

Price (P) Quantity Total Marginal

Demanded Revenue Revenue
(Q) (TR) (MR)

$115 0 $0 NA

100 1 100 100

83 2 166 66

71 3 213 47

63 4 252 39

55 5 275 23

48 6 288 13

42 7 294 6

37 8 296 2

33 9 297 1

29 10 290 -7

Again, marginal cost is $13 for all output levels.

The marginal revenue equals marginal cost rule results in 6 units being produced in
this market as well (MR = MC = $13 at 6 units in this market).
 The price the firm charges in this market is $48, which is the price associated with the
6th unit.

The firm’s profit in this market can be found using the following relationship (see
problem 1 in this chapter for derivation).

Profit Market 1 = Q (P – ATC) = 6($48 – $13) = 6 × $35 = $210.

The combined profit from both markets gives us total profit.

Total Profit = Profit Market 1 + Profit Market 2 = $120 + $210 = $330

Since the firm charges a lower price in the second market (a price of $48), this market
has the higher price elasticity of demand.

3. Assume that the most efficient production technology available for making vitamin pills
has the cost structure given in the following table. Note that output is measured as the
number of bottles of vitamins produced per day and that costs include a normal profit.

a. What is ATC per unit for each level of output listed in the table?

b. Is this a decreasing-cost industry? (Answer yes or no).

c. Suppose that the market price for a bottle of vitamins is $2.50 and that at that price the
total market quantity demanded is 75,000,000 bottles. How many firms will there be
in this industry?
d. Suppose that instead the market quantity demanded at a price of $2.50 is only 75,000.
How many firms do you expect there to be in this industry?

e. Review your answers to parts b, c, and d. Does the level of demand determine this
industry’s market structure?

Answers:

(a) ATC per bottle is $4 per bottle at 25,000 bottles, $3 per bottle at 50,000
bottles, $2.50 per bottle at 75,000 units, and $2.76 per bottle at 100,000 units.

(b) No.

(c) There will be 1000 firms in this industry.

(d) There will be one firm in this industry.

(e) Yes.

Feedback:

a. To find Average Total Cost (ATC) divide Total Cost by Output (Quantity).

ATC = Total Cost / Output

Output TC MC ATC

25,000 $100,000 $0.50 $4.00

50,000 150,000 1.00 $3.00

75,000 187,500 2.50 $2.50

100,00 275,500 3.00 $2.76

0

b. No, the ATC cost does NOT decline for all levels of output.
 c. Since $2.50 is minimum ATC, firms will produce at this level of output. Any firm
that deviated from this level would incur a higher ATC and would be unprofitable at
the market price of $2.50.

The total number of firms can be found by dividing the market quantity demanded by
output produced by a firm at the ATC of $2.50, which is 75,000.

Number of Firms = Market Quantity Demanded / Output Minimum ATC =

75,000,000/75,000 = 1,000.

d. The total number of firms under this assumption is:

Number of Firms = Market Quantity Demanded / Output Minimum ATC =

75,000/75,000 = 1.

e. Yes, high demand will result in a competitive industry while very low demand can
result in a monopoly industry.

4. A new production technology for making vitamins is invented by a college professor who
decides not to patent it. Thus, it is available for anybody to copy and put into use. The TC
per bottle for production up to 100,000 bottles per day is given in the following table.

a. What is ATC for each level of output listed in the table?

b. Suppose that for each 25,000-bottle per day increase in production above

100,000 bottles per day, TC increases by $5,000 (so that, for instance, 125,000 bottles
per day would generate total costs of $85,000 and 150,000 bottles per day would
generate total costs of $90,000). Is this a decreasing-cost industry?
c. Suppose that the price of a bottle of vitamins is $1.33. At that price, the total quantity
demanded by consumers is 75,000,000 bottles. How many firms will there be in this
industry?

d. Suppose that, instead, the market quantity demanded at a price of $1.33 is only
75,000. How many firms will there be in this industry?

e. Review your answers to parts b, c, and d. Does the level of demand determine this
industry’s market structure?

Answers:

a. ATC per bottle is $2.00 per bottle for 25,000 bottles, $1.40 per bottle for 50,000
bottles, $1 per bottle for 75,000 bottles, and $0.80 per bottle for 100,000 bottles.

b. Yes, this is a decreasing cost industry.

c. Only one firm since this is a natural monopoly situation.

d. Only one firm since this is a natural monopoly situation.

e. No, the level of demand does not determine this market’s structure.

f. No, the new technology of this problem shows economies of scale and this
industry is therefore a decreasing-cost industry.

Feedback:

a. To find Average Total Cost (ATC) divide Total Cost by Output (Quantity).

ATC = Total Cost / Output

Output TC ATC

25,000 $50,000 $2.00

50,000 70,000 $1.40

75,000 75,000 $1.00

100,000 80,000 $.0.80

b. The last two rows provide the additional cost and output information (you could
continue to add rows for additional output).
 Output TC ATC

25,000 $50,000 $2.00

50,000 70,000 $1.40

75,000 75,000 $1.00

100,000 80,000 $.0.80

125,000 $85,000 $0.68

150,000 $90,000 $0.60

From this additional information we can conclude this is a decreasing cost industry
because ATC falls as output increases at all levels.

c. Since this is a decreasing cost industry there will only be one firm.

d. Again, since this is a decreasing cost industry there will only be one firm.

e. No. Since this is a decreasing cost industry there will only be one firm regardless of
demand.

5. Suppose you have been tasked with regulating a single monopoly firm that sells 50-pound
bags of concrete. The firm has fixed costs of $10 million per year and a variable cost of
$1 per bag no matter how many bags are produced. LO7

a. If this firm kept on increasing its output level, would ATC per bag ever increase? Is
this a decreasing-cost industry?

b. If you wished to regulate this monopoly by charging the socially optimal price, what
price would you charge? At that price, what would be the size of the firm’s profit or
loss? Would the firm want to exit the industry?

MC= var TC / Var Q = var FC + VC / VAR q = 0+ 1/1 = 1 = AVC

ATC = AFC + AVC = AFC decreases + 1 = 10 + 1 = 11

9+1 = 10 / 1$=MC =AVC => indifferent point

c. You find out that if you set the price at $2 per bag, consumers will demand 10 million
bags. How big will the firm’s profit or loss be at that price?

d. If consumers instead demanded 20 million bags at a price of $2 per bag, how big
would the firm’s profit or loss be?

TR = 2*20 000 000 = 40 000 000

TC = 10 000 000 + (AVC*Q = 1 *20 000 000 ) = 30 000 000

e. Suppose that demand is perfectly inelastic at 20 million bags, so that consumers

demand 20 million bags no matter what the price is. What price should you charge if
you want the firm to earn only fair rate of return? Assume as always that TC
includes a normal profit.

TR = TC

P* 20 000 000 = 10 000 000 + 1*20 000 000

P= 30 000 000/ 20 000 000 = $1.5

Answers:

a. ATC will never increase. This is a decreasing cost industry.

b. Charge $1 per bag. At that price, the firm would lose its $10 million fixed
costs. This firm would be losing money and will want to exit the industry.

c. The firm will break even (no profit or loss).

d. The firm will make an economic profit of $10 million.

e. You should charge $1.50 per bag if you want this firm to earn a fair rate of
return.

Feedback:

a. ATC will never increase. This is a decreasing cost industry. The intuition is that FC
get distributed over more and more units so that ATC will fall asymptotically towards
the $1 per bag marginal cost.
b. Charge $1 per bag since the MC of all bags is $1 per bag. At that price, the firm
would lose its $10 million fixed costs (since the price is just enough to cover variable
costs). This firm would be losing money and will want to exit the industry.

c. The firm's revenue equals $20,000,000 [= $2 (price) × 10,000,000 (quantity)].

The firm's Fixed Cost equals $10,000,000 (given above).

The firm's Total Variable Cost equals $10,000,000 [= $1 (variable cost of producing
each bag) × 10,000,000 (quantity)].

The firm's Total Cost equals the sum of Total Fixed Cost and Total Variable Cost,
$20,000,000 [=$10,000,000 (Total Fixed Cost) + $10,000,000 (Total Variable Cost)].

The firm's profit equals $0 [= $20,000,000 (revenue) - $20,000,000 (total cost)]. The
firm breaks even.

d. The firm's revenue equals $40,000,000 [= $2 (price) × 20,000,000 (quantity)].

The firm's Fixed Cost equals $10,000,000 (given above).

The firm's Total Variable Cost equals $20,000,000 [= $1 (variable cost of producing
each bag) × 20,000,000 (quantity)].

The firm's Total Cost equals the sum of Total Fixed Cost and Total Variable Cost,
$30,000,000 [=$10, ,000 (Total Fixed Cost) + $20,000,000 (Total Variable Cost)).

The firm's profit equals $10,000,000 (= $40,000,000 (revenue) - $30,000,000 (total

cost)].

e. The fair rate of return is where economic profit is zero (Total Cost above includes
normal profit).

The first step is to find Total Cost.

The firm's Fixed Cost equals $10,000,000 (given above).

The firm's Total Variable Cost equals $20,000,000 [= $1 (variable cost of producing
each bag) × 20,000,000 (quantity)].

The firm's Total Cost equals the sum of Total Fixed Cost and Total Variable Cost,
$30,000,000 [= $10,000,000 (Total Fixed Cost) + $20,000,000 (Total Variable Cost)].
The second step is to find revenue (here the price is not known).

Revenue = Price (unknown) × 20,000,000.

The final step is to use the definition of profit to solve for the unknown price.

Profit = Revenue – Total Cost = Price × 20,000,000 – $30,000,000

We can also set profit to zero (fair rate of return requirement):

Price × 20,000,000 – $30,000,000 = 0

or

Price × 20,000,000 = $30,000,000 which gives us,

Price = $30,000,000 / 20,000,000 = $1.50.

Thus, the firm should charge $1.50 per bag to earn a fair rate of return.