ProbSet1Ans - AEM 331 Suggested Answers to Problem Set#1 1...

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AEM 331 Suggested Answers to Problem Set #1 1. a. The Harvard person would say that the market structure is established, and the monopolist would use her market power. Profit is: P*Q – C(Q) = (74 – 3Q)*Q – 2*Q = 74*Q – 3*Q^2 – 2*Q. Setting the derivative equal to zero (in the case of the monopolist, this is setting marginal revenue equal to marginal cost), we have 74 – 6Q = 2. So: Q = 12, P = 38 Plotting this on a graph, we can solve for CS and PS geometrically: CS = (36*12)/2 = 216, PS = 36*12 = 432, W = 648 b. The Chicago person would say that the threat of entry would keep the monopolist from raising the price. Since anyone can enter and charge P = 2, the monopolist has to charge P = 2 to avoid being undercut. Therefore: P = 2, Q = 24, CS = (24*72)/2 = 864, PS = 0, W = 864 Note that the idea of a market with only one supplier having a perfectly competitive equilibrium is known as contestability. 2. a. Setting price equal marginal cost (148 – 4Q = 12), we get: Q = 34, P = 12, consumer surplus = (136*34)/2 = 2312, Producer surplus = 0, total welfare = 2244.
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