Imagine that you write and produce a hit pop album which you offer for sale on t
ID: 1113120 • Letter: I
Question
Imagine that you write and produce a hit pop album which you offer for sale on the internet. The following is the demand curve you are facing. [Note: you are a monopolist, you are the only person who can sell this good.] P S 23 4 56 789 10 12 750 700 650 600 550 500 450 400 350 300 250 200 1. a. First, assume that you offer the album as an mp3 download so that the marginal cost of producing one more unit is zero for all units. If this is the case, what price will maximize your profit? What will that profit be? b. What is the elasticity of demand at this price? (Calculate this by moving from this price to a price 1 dollar higher.) c. How will your answer to part a change if producing the album in the first place cost you S1000 d. What is the efficient quantity in this case? (If you don't know what efficient means, you better look up "Pareto efficient" and figure it out right now!) 2. a. Now imagine that, instead of a digital download, you are making vinyl records and each record (the physical record, not the album) costs $4 to manufacture. What price will you want to charge now? What will your profit be?Explanation / Answer
a) Because there is no cost of production, profit maximization is same as revenue maximization. Find TR by multiplying price and quantity. You will find that such a quantity is 400 units and price is $8 per unit. You earn a maximum profit of $3200
b) A dollar higher price is $9 and quantity is now 350. Find the mid point elasticity using mid point formula
Ed = (Q2 – Q1) / [(Q2 + Q1)/2] / (P2 – P1) / [(P2 + P1)/2]
Elasticity is -1.13
c) When fixed cost of $1000 is placed, profit is reduced by 1000 at all combinations but the profit maximzing combination remains unchanged at P = 8 and Q = 400
d) It is the quantity at which price is equal to marginal cost. Here MC is 0. But price is never zero.If we believe that demand pattern remains unchanged, then demand at P = 0 will be 800. This would be efficient quantity
Question 2
When MC = 4, we see that profit is maximum when 300 units are produced at a price of $10. Profits are $800 due to a fixed cost of $1000 of producing the album
Price Quantity Total revenue 1 750 750 2 700 1400 3 650 1950 4 600 2400 5 550 2750 6 500 3000 7 450 3150 8 400 3200 9 350 3150 10 300 3000 11 250 2750 12 200 2400