PROBLEM SET #8

Mankiw #1
A publisher faces the following demand schedule for the next novel from one of its popular
authors:

The author is paid $2 million to write the book, and the marginal cost of publishing the book
is a constant $10 per book.
a. Compute total revenue, total cost, and profit at each quantity. What quantity
would a profit-maximizing publisher choose? What price would it charge?

Total Marginal Variable

Total Cost Profit
Price Revenue Revenue Cost
Quantity Fixed Cost MC 𝐹𝐶 + 𝑉𝐶 𝑇𝑅 − 𝑇𝐶
$ 𝑃×𝑄 ∆𝑇𝑅 𝑄×𝑀𝐶
∆𝑄
$ $
$ $
100 0 0 --- $2,000,000 $10 0 2,000,000 -2,000,000
90 100,000 9,000,000 90 $2,000,000 $10 1,000,000 3,000,000 6,000,000
80 200,000 16,000,000 70 $2,000,000 $10 2,000,000 4,000,000 12,000,000
70 300,000 21,000,000 50 $2,000,000 $10 3,000,000 5,000,000 16,000,000
60 400,000 24,000,000 30 $2,000,000 $10 4,000,000 6,000,000 18,000,000
50 500,000 25,000,000 10 $2,000,000 $10 5,000,000 7,000,000 18,000,000
40 600,000 24,000,000 -10 $2,000,000 $10 6,000,000 8,000,000 16,000,000
30 700,000 21,000,000 -30 $2,000,000 $10 7,000,000 9,000,000 12,000,000
20 800,000 16,000,000 -50 $2,000,000 $10 8,000,000 10,000,000 6,000,000
10 900,000 9,000,000 -70 $2,000,000 $10 9,000,000 11,000,000 -2,000,000
0 1,000,000 0 -90 $2,000,000 $10 10,000,000 12,000,000 -12,000,000

Profit is maximum at the price of $60 or $50 both would lead to profits of
$18,000,000. To maximize profit, the publisher would choose to supply
400,000 or 500,000 novels.
b. Compute marginal revenue. (Recall that MR 5 ∆TR/∆Q.) How does marginal
revenue compare to the price? Explain.
Total Revenue Marginal Revenue
Price
Quantity 𝑃×𝑄 ∆𝑇𝑅
$ ∆𝑄
$
100 0 0 ---
90 100,000 9,000,000 90
80 200,000 16,000,000 70
70 300,000 21,000,000 50
60 400,000 24,000,000 30
50 500,000 25,000,000 10
40 600,000 24,000,000 -10
30 700,000 21,000,000 -30
20 800,000 16,000,000 -50
10 900,000 9,000,000 -70
0 1,000,000 0 -90

A monopolist’s marginal revenue is always less than price of the good

because a monopoly faces a downward-sloping demand curve. To increase
the amount of goods sold, they must lower the price.
Example:
When the price is at $60, they can sell 400,000 novels, and by reducing the
price to $50 it can sell 500,000 novels however, the revenue received on each
novel also gets reduced thus reducing the marginal revenue.

c. Graph the marginal-revenue, marginal-cost, and demand curves. At what

quantity do the marginal-revenue and marginal-cost curves cross? What does
this signify?

Marginal
Price Revenue
Quantity MC
$ ∆𝑇𝑅
∆𝑄
100 0 --- $10
90 100,000 90 $10
80 200,000 70 $10
70 300,000 50 $10
60 400,000 30 $10
50 500,000 10 $10
40 600,000 -10 $10
30 700,000 -30 $10
20 800,000 -50 $10
10 900,000 -70 $10
0 1,000,000 -90 $10
 MC is constant at $10; thus, it will be a horizontal line. The marginal-revenue
and marginal-cost curves intersect at $10 showing that the firm maximizes
profits on that region.

d. In your graph, shade in the deadweight loss. Explain in words what this means.

Dead weight loss or DWL is the loss incurred in the total surplus of the
economy when a company charges a price higher than the marginal cost. It is
 represented by the area of the triangle between the demand curve and the
marginal cost curve.
e. If the author were paid $3 million instead of $2 million to write the book, how
would this affect the publisher’s decision regarding what price to charge?
Explain.
If the author were paid $3 million instead of $2 million to write the book, the
publisher would not change the price because there would be no change in
MC or MR. Marginal cost can only be changed if there are also changes in the
variable cost component. Thus, as there are no marginal revenue and
marginal cost changes, the profit-maximizing output level remains the same
at 500,000 units. However, an increase in fixed costs will reduce the total
profit earned.

f. Suppose the publisher was not profit-maximizing but was concerned with
maximizing economic efficiency. What price would it charge for the book? How
much profit would it make at this price?
To maximize economic efficiency, the publisher should set the price at the
marginal cost of $10 per book; thus, at this price, the publisher will have
negative profits equal to the amount paid to the author.
Mankiw #2

A small town is served by many competing supermarkets, which have the same constant
marginal cost

a. Using a diagram of the market for groceries, show the consumer surplus, producer
surplus, and total surplus.

b. Now suppose that the independent supermarkets combine into one chain. Using a
new diagram, show the new consumer surplus, producer surplus, and total surplus.
Relative to the competitive market, what is the transfer from consumers to
producers? What is the deadweight loss?
Mankiw #8

Henry Potter owns the only well in town that produces clean drinking water. He faces the
following demand, marginal revenue, and marginal cost curves:

𝐷𝑒𝑚𝑎𝑛𝑑: 𝑃 = 70 − 𝑄
𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒: 𝑀𝑅 = 70 − 2𝑄
𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝐶𝑜𝑠𝑡: 𝑀𝐶 = 10 + 𝑄
a. Graph these three curves. Assuming that Mr. Potter maximizes profit, what quantity
does he produce? What price does he charge? Show these results on your graph.
Equilibrate marginal revenue and marginal cost to get the quantity (Q) and then
substitute Q in the demand equation to get the price (P). Marginal revenue and
marginal cost were equilibrated because producers, in this case the monopolist, will
always produce where marginal revenue equals marginal cost.

𝑀𝑅 = 𝑀𝐶 20 = 𝑄
70 − 2𝑄 = 10 + 𝑄
70 − 10 = 2𝑄 + 𝑄 𝑃 = 70 − 𝑄
60 3𝑄
3
= 3 𝑃 = 70 − 20
𝑃 = $50
b. Mayor George Bailey, concerned about water consumers, is considering a price
ceiling that is 10 percent below the monopoly price derived in part (a). What quantity
would be demanded at this new price? Would the profit-maximizing Mr. Potter
produce that amount? Explain.

𝑃2 = $50 𝑥 . 90

𝑃2 = $45

𝑃 = 70 − 𝑄
45 = 70 − 𝑄
𝑄 = 70 − 45
𝑄 = 25

𝑀𝑅 = 70 − 2𝑄
𝑀𝑅 = 70 − 2(25)
𝑀𝑅 = 70 − 50
𝑀𝑅 = 20
𝑀𝐶 = 10 + 𝑄
𝑀𝐶 = 10 + 25
𝑀𝐶 = 35
The price ceiling is at $45, the price 10 percent below the monopoly price.
Quantity demanded is 25 units at the price ceiling. At this output, marginal
cost is greater than marginal revenue and so, Mr. Potter would not produce at
this amount. The cost is higher than the projected revenue and
profit-maximizing Mr. Potter would suffer losses.

c. George’s Uncle Billy says that a price ceiling is a bad idea because price ceilings cause
shortages. Is he right in this case? What size shortage would the price ceiling
create? Explain.

Uncle Billy is right at this case because as what the previous computations
proved, marginal cost is greater than marginal revenue and thus, incurring
losses. There will be a shortage of 5 units since Mr. Potter would only produce
at an output where marginal revenue at least covers marginal cost, which is at
the output of 20 units. Therefore, Uncle Billy is right that price ceilings cause
shortages because consumers’ demand is greater than what the suppliers will
provide.
 d. George’s friend Clarence, who is even more concerned about consumers, suggests a
price ceiling 50 percent below the monopoly price. What quantity would be
demanded at this price? How much would Mr. Potter produce? In this case, is Uncle
Billy right? What size shortage would the price ceiling create?
𝑃3 = $50 𝑥 . 50

𝑃3 = $25

𝑃 = 70 − 𝑄
25 = 70 − 𝑄
𝑄 = 70 − 25
𝑄 = 45

𝑀𝑅 = 70 − 2𝑄
𝑀𝑅 = 70 − 2(45)
𝑀𝑅 = 70 − 90
𝑀𝑅 =− 20

𝑀𝐶 = 10 + 45
𝑀𝐶 = 10 + 45
𝑀𝐶 = 55

A price ceiling set below 50 percent of the monopoly price is equal to $25 and
would induce quantity demanded of 45 units. In this case, Uncle Billy is again
right because in the computed marginal revenue and cost at this quantity,
marginal cost is $55 while only earning a marginal revenue of $-20, which is
actually a loss. There will be a shortage of 25 units since again, Mr. Potter is
only willing to produce at the output (20 units) where marginal revenue at
least equals marginal cost.

Mankiw #10
Based on market research, a film production company in Ectenia obtains the following
information about the demand and production costs of its new DVD:
𝐷𝑒𝑚𝑎𝑛𝑑: 𝑃 = 1, 000 − 10𝑄
 2
𝑇𝑜𝑡𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒: 𝑇𝑅 = 1, 000𝑄 − 10𝑄
𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒: 𝑀𝑅 = 1, 000 − 20𝑄
𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝐶𝑜𝑠𝑡: 𝑀𝐶 = 100 + 10𝑄,
where Q indicates the number of copies sold and P is the price in Ectenian dollars.
a. Find the price and quantity that maximize the company’s profit.
𝑀𝑅 = 𝑀𝐶
1, 000 − 20𝑄 = 100 + 10𝑄
1, 000 − 100 = 20𝑄 + 10𝑄
900 30𝑄
30
= 30

30 = 𝑄
𝑃 = 1, 000 − 10𝑄
= 1, 000 − 10(30)
𝑃 = 700

Price Quantity
Maximize the company’s profit $700 30 DVDs

b. Find the price and quantity that would maximize social welfare.
𝑃 = 𝑀𝐶
1, 000 − 10𝑄 = 100 + 10𝑄
1, 000 − 100 = 10𝑄 + 10𝑄
900 20𝑄
20
= 20

45 = 𝑄
𝑃 = 1, 000 − 10𝑄
= 1, 000 − 10(45)
𝑃 = 550

Price Quantity
Maximize the social welfare $550 45 DVDs
c. Calculate the deadweight loss from monopoly.
*
𝑄 = 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑤ℎ𝑒𝑛 𝑚𝑎𝑥𝑖𝑚𝑖𝑧𝑒𝑑 𝑠𝑜𝑐𝑖𝑎𝑙 𝑤𝑒𝑙𝑓𝑎𝑟𝑒
𝑚
𝑄 = 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑤ℎ𝑒𝑛 𝑚𝑎𝑥𝑖𝑚𝑖𝑧𝑒𝑑 𝑝𝑟𝑜𝑓𝑖𝑡
 𝑚
𝑃 = 𝑝𝑟𝑖𝑐𝑒 𝑤ℎ𝑒𝑛 𝑚𝑎𝑥𝑖𝑚𝑖𝑧𝑒𝑑 𝑝𝑟𝑜𝑓𝑖𝑡
' 𝑚
𝑃 = 𝑀𝐶 𝑎𝑡 𝑄

' *
𝑀𝐶 = 𝑃 = 100 + 10𝑄 𝑄 = 45
𝑚
𝑄 = 30
= 100 + 10(30)
' 𝑚
𝑃 = 400 𝑃 =700

𝐷𝑊𝐿 =
1
2 (𝑄* − 𝑄𝑚)(𝑄𝑚 − 𝑃')
1
= 2
(45 − 30)(700 − 400)

1
= 2
(15)(300)

= 2250
d. Suppose, in addition to the costs above, the director of the film has to be paid.
The company is considering four options.
For each option, calculate the profit-maximizing price and quantity. Which, if any,
of these compensation schemes would alter the deadweight loss from monopoly?
Explain.
i. a flat fee of 2,000 Ectenian dollars.
If there was a flat fee of 2,000 Ectenian dollars, there will be an
increase of 2,000 in the total cost but there will be no affect to the MR
and MC.

Price Quantity
Maximize the company’s profit $700 30 DVDs

There will be no change in deadweight loss.

ii. 50 percent of the profits.

This will only increase the total cost by 50 % but will not affect the MR
and MC.

Price Quantity
Maximize the company’s profit $700 30 DVDs

There will be no change in deadweight loss.

 iii. 150 Ectenian dollars per unit sold.
This will increase the unit per sold by 150 thus changing the total
revenue and marginal revenue.
price and quantity that maximize the company’s profit
𝑀𝐶 = 100 + 10𝑄
𝑀𝐶 = 250 + 10𝑄
𝑀𝑅 = 𝑀𝐶 25 = 𝑄
1, 000 − 20𝑄 = 250 + 10𝑄
1, 000 − 250 = 20𝑄 + 10𝑄
750 = 30𝑄 𝑃 = 1, 000 − 10𝑄
750 30𝑄
= = 1, 000 − 10(25)
30 30
𝑃 = 750

price and quantity that would maximize social welfare

𝑃 = 𝑀𝐶 37. 5 = 𝑄
1, 000 − 10𝑄 = 250 + 10𝑄
1, 000 − 250 = 10𝑄 + 10𝑄 𝑃 = 1, 000 − 10𝑄
750 20𝑄 = 1, 000 − 10(37. 5)
20
= 20
𝑃 = 625

Deadweight loss

' *
𝑀𝐶 = 𝑃 = 250 + 10𝑄 𝑄 = 37. 5
= 250 + 10(25) 𝑚
𝑄 = 25
' 𝑚
𝑃 = 500 𝑃 =750

𝐷𝑊𝐿 =
1
2 (𝑄* − 𝑄𝑚)(𝑄𝑚 − 𝑃')
1
= 2
(37. 5 − 25)(750 − 500)

1
= 2
(12. 5)(250)
 = 1562. 5
iv. 50 percent of the revenue.
Total revenue will become half of the old revenue thus changing the
marginal revenue.
2
𝑇𝑅 = 1, 000𝑄 − 10𝑄
1 2
𝑇𝑅 = 2
(1, 000𝑄 − 10𝑄 )

2
= 500 − 5𝑄
𝑀𝑅 = 500 − 10𝑄
price and quantity that maximize the company’s profit
𝑀𝑅 = 𝑀𝐶
500 − 10𝑄 = 100 + 10𝑄
500 − 100 = 10𝑄 + 10𝑄
400 = 20𝑄
400 20𝑄
20
= 20

20 = 𝑄
𝑃 = 1, 000 − 10𝑄
= 1, 000 − 10(20)
𝑃 = 800
price and quantity that would maximize social welfare
𝑃 = 𝑀𝐶
1, 000 − 10𝑄 = 100 + 10𝑄
1, 000 − 100 = 10𝑄 + 10𝑄
900 20𝑄
20
= 20

45 = 𝑄
𝑃 = 1, 000 − 10𝑄
= 1, 000 − 10(45)
𝑃 = 550
 Deadweight loss

' *
𝑀𝐶 = 𝑃 = 100 + 10𝑄 𝑄 = 45
= 100 + 10(20) 𝑚
𝑄 = 20
' 𝑚
𝑃 = 300 𝑃 = 800

𝐷𝑊𝐿 =
1
2 (𝑄* − 𝑄𝑚)(𝑄𝑚 − 𝑃')
1
= 2
(45 − 20)(800 − 300)

1
= 2
(25)(500)

= 6250
Original DWL = 1125

Option DDWL Change in DWL

a flat fee of 2,000 1125
No change
Ectenian dollars.
50 percent of the 1125
No change
profits.
150 Ectenian dollars
1562.5 Decrease
per unit sold.
50 percent of the
6250 Increase
revenue.
Parkin #5-8

Minnie’s Mineral Springs, a single-price monopoly, faces the market demand schedule:

5. a. Calculate Minnie’s total revenue schedule.

Price Quantity demanded Total revenue

(dollars per bottle) (bottles per hour) (dollars)
10 0 0
8 1 8
6 2 12
4 3 12
2 4 8
0 5 0

b. Calculate its marginal revenue schedule.

Price Quantity demanded Total revenue Marginal revenue

(dollars per
(bottles per hour) (dollars) (dollars per bottle)
bottle)
10 0 0
8 1 8 8
6 2 12 4
4 3 12 0
2 4 8 -4
0 5 0 -8
6. a. Draw a graph of the market demand curve and Minnie’s marginal revenue curve.

b. Why is Minnie’s marginal revenue less than the price?

Minnie’s marginal revenue is less than the price at the output range of 3 to 5 which
denotes that demand is inelastic. Since demand is inelastic at this output range, a fall
in the price brings a decrease in total revenue. The revenue gain from the increase in
quantity sold is outweighed by the revenue loss from the lower price and marginal
revenue becomes less than the price.

7. a. At what price is Minnie’s total revenue maximized?

Based on the graph, Minnie’s total revenue is maximized at the output of 2.5 bottles,
which is at the price of $5. At this price, Minnie’s total revenue (2.5 x $5) is $12.50.

b. Over what range of prices is the demand for water from Minnie’s Mineral Springs
elastic?

The demand for Minnie’s Mineral Springs water is elastic between $5 per bottle and
$10 per bottle.

8. Why will Minnie not produce a quantity at which the market demand for water is
inelastic?

At quantities where market demand for water is inelastic, it is not preferred to

produce because a fall in the price decreases total revenue. Marginal revenue is
 negative when demand is inelastic because the revenue gain from the increase in
quantity sold is outweighed by the revenue loss from the lower price.

Parkin #9

Minnie’s Mineral Springs faces the market demand schedule in Problem 5 and has the
following total cost schedule:

a. Calculate Minnie’s profit-maximizing output and price.

b. Calculate the economic profit.

Quantity Total Marginal Total Marginal

Price Profit
demanded revenue revenue cost cost
(dollars per (dollars per
(bottles per hour) (dollars) (dollars per bottle) (dollars) (dollars)
bottle) bottle)

10 0 0 1 -1

8 1 8 8 3 2 5
6 2 12 4 7 4 5
4 3 12 0 13 6 -1
2 4 8 -4 21 8 -13
0 5 0 -8 21 0 -21

The table shows information on Minnie’s economic profit and her profit-maximizing output
and price. In order to get the profit, total cost is subtracted from the total revenue. Here,
profit is maximized at the output of 1 and 2 bottles at the prices of $8 and $6 respectively.
Parkin #15
La Bella Pizza can produce a pizza for a marginal cost of $2. Its standard price is $15 a pizza.
It offers a second pizza for $5. It also distributes coupons that give a $5 rebate on a
standard-priced pizza.
How can La Bella Pizza make a larger economic profit with this range of prices than it
could if it sold every pizza for $15? Use a graph to illustrate your answer.

La Belle Pizza is price discriminating that increases the firm’s profit. (1) It offers a
second pizza they buy for $5. This price discrimination moves downward along a
consumer’s demand curve and increases the quantity the consumer purchases. (2) It
also distributes coupons that give a $5 rebate that lowers the price of a stand-priced
pizza. La Bella has customers with varying levels of desire to pay, and the coupon
allows the firm to increase sales by targeting coupon users with lower willingness to
pay for pizza. On both counts, La Belle is expanding its sales, and the new sales
enhance La Belle's profit because the marginal revenues from these additional sales
surpass the marginal cost of $2. The firm would maximize its profit at the level of
output where its MC curve cuts the MR curve.