A public utility produces output at constant marginal cost of 20 dollars, has fixed costs of 19800 and sells its
output in two separate markets. Demand for the utility's output in each market is:
p1 = 50 − (3/400) q1
p2 = 40 − (1/250) q2.
If this firm must set "first-best" (i.e. welfare-maximizing) prices in each market:
a. what price will it charge in market 1?
b. what price will it charge in market 2?
c. what profit will it earn?
d. what will be the sum of (long-run) consumer and producer surplus across both markets?
Suppose the government can not afford to pay the subsidy required to keep this firm in business. Instead, it tells the firm it must charge (Ramsey) prices to maximize the sum of consumer and producer surplus from operations in both its markets combined—but the firm may earn (no more than) normal (i.e. zero economic) profit. If this firm charges Ramsey prices in each market:
e. what price will it charge in market 1?
f. what price will it charge in market 2?
g. what profit will it earn?
h. what will be the sum of (long-run) consumer and producer surplus across both markets?
i. Comparing your answers to (d) and (h), how big is the deadweight loss the government must accept if it can not subsidize this firm?
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