# Problem Set Seven Solutions

Chapter 9 1. Two car manufacturers, Saab and Volvo, have fixed costs of $1 billion and constant marginal costs of $10,000 per car. If Saab produces 50,000 cars per year and Volvo produces 200,000, calculate the average fixed cost and average total cost for each company. On the basis of these costs, which company’s market share should grow in relative terms? Answer: Average total cost is average fixed cost plus marginal cost: ATC = FC/Q + MC. Volvo’s average fixed cost $1 billion/200,000 = 5,000 is much less than Saab’s average fixed cost $1 billion/50,000 = 20,000 due to producing more cars. Volvo’s average production cost $15,000 is lower than Saab’s of $30,000 by the difference in average fixed costs. Volvo’s market share should grow relative to Saab’s.

6. What is the socially desirable price for a natural monopoly to charge? Why will a natural monopoly that attempts to charge the socially optimal price invariably suffer an economic loss? Answer: The socially desirable price to charge is the one at which the marginal benefit to consumers equals the marginal cost of production. However, natural monopolies usually have very large fixed costs and relatively low marginal costs. The high fixed costs mean that average cost is greater than marginal cost, so that charging a price equal to marginal cost implies economic losses.

8. Suppose that Aggieland Cinema is a local monopoly whose demand curve for regular adult tickets on Saturday night is P = 12 - 2Q, where P is the price of a ticket in dollars and Q is the number of tickets sold in hundreds. The demand for student tickets on Sunday afternoon is P = 8 - 3Q, and for regular adult tickets on Sunday afternoon, P = 10 - 4Q. On both Saturday night and Sunday afternoon, the marginal cost of an additional patron, student or not, is $2. a. What is the marginal revenue curve in each of the three markets? Answer: The marginal revenue curves are MR = 12 - 4Q adult Saturday night, MR = 8 -...

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