Consider a small isolated town in which a brewery

17. Consider a small, isolated town in which a brewery faces the following inverse demand: P = 15 – 0.33 Q
The brewery can produce beer at a constant marginal and average total cost of $1 per bottle.
a. Calculate the profit-maximizing price and quantity, as well as producer and consumer surplus and the
deadweight loss from market power.
b. If it were possible to organize the townsfolk, how much would they be willing to pay the brewery to sell
beer at a price equal to its marginal cost?
c. What is the minimum payment the brewery would be willing to accept to sell beer at a price equal to
marginal cost?
d. Is there potentially a bargain that can be struck between the townsfolk and brewery? What would the
deadweight loss be if such a bargain were struck?
.
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Market Power and Monopoly Chapter 9 119
Solution
17.
Quantity
of drugs
Price
($/unit)
$15
8
1
21.21 45.45
C
B
A
MC = $1
MR
D
E
0
Q
MC
$8
:
:
Q
:
MC
):
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120 Part 3 Markets and Prices
Solution
18. Consider the firm depicted in the diagram below.
Quantity
Price
($/output)
LMC
LATC
0
MR D
$25
10
7
700 500 1,000
a. Is the firm a natural monopoly? How do you know?
b. Will this firm earn a profit if it is not subject to regulation? How do you know?
c. If the government requires the firm to charge no more than its marginal cost of production, how many
units will be sold? At what price? What is the problem with the government capping prices at marginal
cost?
d. Suppose the government allows firms to charge no more than their average total costs of production.
How many units will this firm sell? At what price? What is the problem with capping prices at average
total cost?
e. Evaluate the deadweight loss under each of the three pricing regimes above. Show each regime’s dead-
weight loss as an area on the graph.
18. a. A natural monopoly refers to a situation in which the firm’s long-run average total cost curve is always
downward-sloping (exhibits economies of scale) over the relevant levels of output. Such is clearly the
case in this diagram, in which LATC is falling over all levels of potential quantities demanded. (