III. Monopoly 1. The manager of a monopoly firm obtained the following estimate
ID: 1200422 • Letter: I
Question
III. Monopoly
1. The manager of a monopoly firm obtained the following estimate of the demand for its product.
Q = 1000 - 100P + 0.2M - 500PR
where M and PR are, respectively, consumer income and the price of a related good. The forecasted values for M
and PR are M = $30,000 and PR = $5.
a. What is the forecasted demand function? (SHOW WORK)
b. What is the inverse demand function? (SHOW WORK)
c. What is the marginal revenue function? (SHOW WORK)
The estimated average variable cost is
AVC = 40 - 0.08Q + 0.0001Q2
d. To maximize profit the firm should produce ______ units of output.
e. To maximize profit the firm should set a price of ______.
f. Check to see if the firm should produce in the short run rather than shut down.
g. Total fixed cost is $5,000. The firm makes a profit (loss) of _____.
Explanation / Answer
(1)
(a) Forecast demand function: Q = 1000 - 100P + 0.2M - 500PR
Q = 1000 - 100P + (0.2 x 30,000) - (500 x 5) = 1000 - 100P + 6,000 - 2,500
Q = 4,500 - 100P
(b) Inverse demand:
100P = 4,500 - Q
P = (4,500 - Q) / 100
P = 45 - 0.01Q
(c) Total revenue, TR = P x Q = 45Q - 0.01Q2
Marginal revenue, MR = dTR / dQ = 45 - 0.02Q
(d) AVC = 40 - 0.08Q + 0.0001Q2
Total variable cost, TVC = AVC x Q = 40Q - 0.08Q2 + 0.0001Q3
Marginal cost, MC = dTVC / dQ = 40 - 0.16Q + 0.0003Q2
Firm will maximize profit by equating MR with MC:
40 - 0.16Q + 0.0003Q2 = 45 - 0.02Q
0.0003Q2 - 0.14Q - 5 = 0
Solving this quadratic (using online solver),
Q = 500 (and Q = - 33.33 which is inadmissible)
(e) When Q = 500,
P = 45 - (0.01 x Q) = 45 - (0.01 x 500) = 45 - 5 = 40
NOTE: First 5 sub-questions are answered.