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Unformatted text preview: Toronto, Department of Economics (STG). ECO 204, S. Ajaz Hussain. Do not distribute. Solution
Question 17.1 True or false: a firm with ample capacity and market power charging optimal 1st degree price
discrimination prices will produce the same total output as if it were charging the “perfectly competitive” uniform price?
Do NOT solve any profit maximization problems and use graphs to illustrate your answer.
Answer
True. Suppose the firm has a linear demand curve and constant returns (we’ll get the same conclusion even if the firm
has decreasing returns). If the firm is charging the optimal 1st degree price discrimination prices then recalling that under
1st degree price discrimination pricing the demand curve is also the
curve we see that the total output is where
or where the demand curve intersects the
curve. If the firm is charging the optimal uniform price as if it
is perfectly competitive then it will produce where
or where the demand curve intersects the
curve. 1st Degree Price Discrimination Uniform Pricing () Demand = () ()
Demand () In both cases the firm produces the same total output (but charges different prices altogether). 7
ECO 204 Chapter 17 & 18: Practice Problems & Solutions for Firms with Market Power: Business Apps and Price Discrimination in ECO 204 (this version 20122013) University of Toronto, Department of Economics (STG). ECO 204, S. Ajaz Hussain. Do not distribute. Question 17.2 A company with market power has constant returns and the following general Profit Maximization
Problem.
() () ⏟ (a) Setup, solve, and derive the conditions for the various KuhnTucker cases, given that the company can charge a
uniform price or 1st degree price discrimination prices. You must express all first order conditions and the conditions for
the KuhnTucker various cases in terms of marginal revenue and marginal cost only. State all assumptions and show all
calculations.
Answer
A company with market power solves the following Profit Maximization Problem (PMP):
() () Observe how price is a function of output. Recall that all inequality constraints must be expressed in the form ( )
Therefore: . () () () ()
Having expressed all constraints in terms of ( ) , form the Lagrangian:
[ () () [ (...
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This document was uploaded on 01/19/2014.
 Fall '14

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