Introduction to Economic
6.1 a) Consider a monopoly facing the following demand and MC curves: Demand: P = 12 – 0.002 Q
MC: MC = 3 + 0.001 Q
(i) Calculate the profit maximizing output of this monopoly.
Ans: The output level of monopoly to maximize profit is MR=MC. As, P=a-bQ, the MR curve will be MR=a-2bQ,
So, 12-2(0.002Q) = 3+0.001Q
12-0.004Q = 3+0.001Q
9 = 0.005Q
Q = 1800
Monopoly Price = 12-0.002(1800)
(ii) Calculate the socially efficient output level.
Ans: Socially efficient level : Market demand=P=MC
12-0.002Q = 3+0.001Q
9 = 0.003Q
Q = 3000
Social Market Price = 12-0.002(3000)
(iii) Suppose the government wants to adopt a price ceiling to induce this monopoly to produce at the socially efficient output level. Explain what the level of price ceiling should be. (Note: When the demand curve is P = a – b Q, the MR curve will be MR = a – 2 b Q.)
Ans: An effective price ceiling should be less than the monopoly market price which is $8.4 As we mentioned before, when the monopoly produces 3000 units, which is the socially efficient output level, the social market price is 12-0.002(3000) = $6. Therefore, if the government wants to adopt a price ceiling to induce this monopoly to produce at the socially efficient output level, the level of price ceiling should be set at $6.
6.1 b) Suppose a monopoly produces and sells a product which incurs external costs during the production process. Discuss whether it is possible for this firm to reach allocative efficiency in the absence of government intervention.
This diagram shows the pricing and output level of a monopoly. The allocative efficient output level and price is that when MC=D=P , which is Qe and Pe. However, a monopoly will set the output level at the point MC=MR=P , which is Q* and P*. Allocative efficiency could not be reached and the deadweight less exists in this situation.
If a monopoly produces and sells a product which incurs external costs during the production process, the MC curve will shift upward and become MC’. In this case, it is possible for this firm to reach allocative efficiency if the point that new MC’=D=P*. The output level will be Qd* which equals to the original monopoly output level and is allocative efficiency. In conclusion, it is possible for this firm to reach allocative efficiency in the absence of government intervention. But if the MC curve shift above or below to the MC’, it will be under-produced or over-produced.
c ) “Rivalry” and “Excludability” are the two features of consumption of products and services. Explain the meaning of these two terms.
Ans: Rivalry means that if one person consumes a product, it will decreases the quantity available for others. Excludability means that it is possible to prevent a person from enjoying the benefits of a good. If a good is rivalry and also excludability, that means this product is private good like food and a car. If a good is excludability but non-rivalry, that means this product is collective goods like Cable TV. If a good is rivalry but non-excludability, that means this product is commons good like fish in the ocean. If a good is rivalry but non-excludability, that means this product is Pure public goods like knowledge and a street light.
b ) Explain whether each of the following services has the characteristics of “rival among the consumers when consuming the services” and “excludable by the producer of the services”? Give your assumptions to justify the answers if necessary.
(i) Outdoor musical performance.
(ii) Weather forecast.
In case (i), we assume that it has enough equipment or venues for all people to enjoy the show. Under this circumstance, this performance is non-rival since the quantity...
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