Intermediate Microeconomics ECC2000 Discussion

[Reckoner]

Not sure about these 2:

4. Suppose a monopolist operated in an industry where the market demand is perfectly elastic (with inverse demand given by P= 30 and its cost function is TC=100+Q + Q2. Calculate the profit maximising P and Q. Would this be any different if the industry is competitive?

Fine with calculating P & Q, but not sure about the second part of the question.

Answer is no. Think about the Q that is set by a monopolist, and the Q set in a perfectly competitive market. In a monopoly, the quantity is set by MR=MC. Now, In a perfectly competitive market, each firm still sets their quantity to MR=MC (they wish to maximise profit. However, because they are price takers, they have to take the price as given, meaning that their marginal revenue is always equal to whatever the prevailing price is. So in a competitive market, P=MR=MC is what sets the quantity.

This is not always the case in a monopolistic market though. Because a monopolist can set the price, the price they charge is not necessarily equal to their marginal revenue for that good. This is typically shown with a downward sloping demand curve, and you draw the marginal revenue curve with a steeper downward slope (I'll assume you know why this is, if you don't just say and I can draw graphs and stuff to show you).

This means, TYPICALLY (i.e, downward sloping demand curve), the marginal revenue for a monopolist drops faster than that in a competitive market, as q increases. Hence, assuming the same cost curves, the monopolist will reach the profit maximising quantity at a lower q than the market (you probably remember this ... monopolists typically crank up the price and reduce quantity).

Although, this typical case doesn't apply in this question! What's different? The demand curve is flat, not downward sloping. So the marginal revenue for a monopolist is equal to P, and in turn equal to the demand curve. So the monopolists MR curve is now the same MR curve as for the competitive market. Hence, the MR=P=MC will be the profit maximising q for the monopolist, as well as for the competitive market. Hence, the same q and P.

If you're still confused I'll draw pictures if you wish.

Not sure about these 2:

5. a.   True, False or Uncertain - and why, The difference between price and marginal cost is the amount of profit per unit of output. A monopolist will always set Q and P to make the per unit profit as big as possible

Not the case. They will want to maximise total profit not per unit profit (not the same thing). Lets just say that each good costs $1 to produce. Why sell 1 good for $100 each ($99 per unit profit), when you can sell 10 for $50 each (per unit profit of only 49, but a much greater total profit). It doesn't matter if your per unit profit decreases...as long as selling that additional good makes you any profit at all, then you would do it. See the attached picture.

It'll only be true if you have constant and flat MC and demand curves, because the per unit profit will be the same for all quantities. But for upward sloping MC and/or downward sloping demand curve, then it won't hold. 

[Sam_95]

Here's the intuition behind what you're showing. From first year micro, you would have learned that when the price elasticity of demand for a product is inelastic, that an increase in price will increase revenue. And for quantities where demand is elastic an increase in price will decrease revenue.

So if we are at a point that is inelastic, increasing Q will increase our revenue. If we are at a point that is elastic, then decreasing Q will increase revenue. Hence we can increase revenue by changing the quantity at all points where we are elastic, or inelastic. So the maximum would occur where we are unit elastic (where the two cases meet). This is of course assuming that the point exists (ignoring possible corner solutions, constant elasticities and stuff).

For the maths, just find MR, then set it equal to 0. Then manipulate the expression for the elasticity of demand so that you can sub it in somewhere. See here.

Thanks reckoner, really well explained, appreciate it!

[Sam_95]

6.   Assume that the long run total cost function for each firm in an industry is LRTC=q3-4q2+8q and the market demand function is Q=2000-100p.  (Hint: this is the market demand for perfect competitive market, where MC crosses LRATC for each firm at the lowest level—and use only this information to calculate each firm’s output)  Calculate: 

a.   Each firm’s individual output  - (guessing double derivatives required to find minimum)
b.   Equilibrium market price and quantity
c.   Number of firms in the industry
d.   Profit per firm

[Reckoner]

6.   Assume that the long run total cost function for each firm in an industry is LRTC=q3-4q2+8q and the market demand function is Q=2000-100p.  (Hint: this is the market demand for perfect competitive market, where MC crosses LRATC for each firm at the lowest level—and use only this information to calculate each firm’s output)  Calculate: 

a.   Each firm’s individual output  - (guessing double derivatives required to find minimum)
b.   Equilibrium market price and quantity
c.   Number of firms in the industry
d.   Profit per firm

In the long run, each firm will produce at the minimum AVERAGE cost. This makes sense, as we want each unit of the total output (in the long run) to be produced as cheaply as possible, hence minimum average cost. It doesn't matter what quantity each firm produces, as more firms will appear to satisfy any excess demand, so long as we are producing at minimum average cost. So we don't find MC straight away. For a. find the LRATC per firm, and minimise that. You will have q=2, so we know each firms output.

For b, we have to find Q. This would be really easy if we knew the market price (just sub it into out demand function!) but we don't know p. That's fine. Because we now know that each firm produces 2 units. As we know the total cost function, we can find the MC function for each firm. And if only there was something we knew about perfectly competitive firms MC and the prevailing price...

C and D are pretty easy once you've done a and b. But before doing any calcs, what do you expect the answer to be for D? Keep in mind that we are at LR equilibrium in a perfectly competitive market.

Calcs are here, but have a go first before you look. 

[UBS]

Not sure about this one:

Q. The following contentions about the demand and supply for narcotic drugs are widely believed: (1) demand is highly inelastic - hooked users are practically forced to buy drugs, no matter how high the price; and (2) the supply side of the market is dominated by a cartel (small group of firms acting as one monopolist—in this case Colombian Drug Lords, meaning that you can treat this market as a monopoly market for this question).  Is there a contradiction between these two beliefs (recall monopolists always set prices and quantities in an elastic region or at most at unitary elasticity)?  Why/why not?

[Sam_95]

Yes, the claims are contradictory as a profit-maximizing monopoly or cartel will not want to price its product in the region of inelastic demand as inelastic demand implies that Marginal Revenue is negative.

[Sam_95]

What type of price discrimination is 'transfer pricing'? Whereby multinational firms often pay less in taxes than non-multinational firms by “manipulating” the books to make it look like the majority of their revenues come from countries with lower tax rates.

and are there rent seeking gains and losses? Who gains and loses from rent seeking?

[UBS]

I think that's 3rd degree price discrimination, but I'm not completely sure.

Not sure about the 2nd question myself, either.

[Sam_95]

Is there anyway to get answers to the questions at the back of each chapter? I've done all the problem set questions & sample exam question, but I still feel so ill prepared for the exam.

[sluu001]

Dont worry about econ exams. If youve done all the prescribed material, you should be fine. Nobody walks into a micro/macro exam feeling like they covered everything.

Fact is, the lecturers want you to just be able to use the theory taught and apply it to a fresh scenario presented. So econ professors love to throw out unique scenarios come exam time. (Something you cant rote learn for) my micro/macro exams were completely different from previous yrs.

Just understand the theory, (not just memorise it); and youll be fine.