MBA 505

Professor Allen
Spring 2015
Problem Set 4
1. Microsoft has a monopoly on operating systems for personal computers. (A court
opinion, not mine.) Suppose that the annual demand for operating systems is P =
200 2.5*Q, where P is expressed in dollars and Q is millions of operating systems.
The cost function for producing operating systems is C = 1000 + 10Q, where 10
represents the cost of producing and distributing CDs and packaging.
a) What price will Microsoft set for operating systems? How many operating
systems will it produce and sell? What will Microsofts profits be?
b) Suppose the market for operating systems were perfectly competitive. What
price would be charged? How many would be sold? Would the firms in this
industry be profitable?
c) You are a federal judge assigned to resolve the Microsoft issue. Given this
information on costs and demand, plus your answers to parts (a) and (b),
devise a scheme that would produce an outcome that would be most
satisfying to consumers, while still allowing Microsoft shareholders to make a
competitive rate of return.
2. DeBeers has a monopoly on the distribution of diamonds. Research has shown that
the demand for diamonds is P = 1250 5*Q, where P represents price per pound
and Q represents thousands of pounds. DeBeers costs can be represented by C =
2000 + 50*Q + 5Q2; MC is 50 + 10Q.
a) Calculate DeBeers price, output, and profits.
b) If the diamond distribution industry were perfectly competitive, what would
prices, output, and profits be?
c) Compare consumer surplus, producer surplus, and deadweight loss between
monopoly and competitive market structures.
3. Procip is a revolutionary new drug that eradicates all bacteria and viruses. The good
news about Procip is that it already has FDA approval. More good news about
Procip is that the marginal cost of producing each dose is $25 and that one dose is
all that is needed to kill all the bugs. Market research indicates that the elasticity of
Procip demand in the USA is 2.
a) What price should the owners of the Procip patent charge in the USA?
b) In India and Mexico, the elasticity of Procip demand is estimated to be 5.
Explain how this is likely to affect your pricing decisions in those countries.
Would you charge the same price in both?
c) The federal government offers you $30 a dose to meet the needs of persons
with low incomes who do not have health insurance. You would sell the drug
to the feds and they would distribute it free through local clinics (only under a
doctors prescription of course). How should you respond to this offer?

4. Text, chapter 9, problem 16: Suppose that a monopolistic seller of flux capacitors
faces the inverse demand curve P = 40 0.5Q, and that the monopolist can produce
flux capacitors at a constant marginal cost of $5.
a) How many units will an unregulated monopolist sell?
b) Suppose that the government imposes a price ceiling of $6. What does this
price ceiling do to the monopolists marginal revenue curve? Specifically,
what is the marginal revenue of the 10th unit? The 68th? How about the
69th?
c) How many units will a profit-maximizing monopolist sell when the price ceiling
is in place? At what price?
d) Compare the deadweight loss of unregulated monopoly to the deadweight
losses with the price ceiling. Does the price ceiling improve social welfare?
5. There are 10 households in Lake Wobegon, Minnesota, each with a demand for
electricity of Q = 50 - P. Lake Wobegon Electrics (LWE) cost of producing electricity is
TC = 500 + Q..
a) If the regulators of LWE want to make sure that there is no deadweight loss in
this market, what price will they force LWE to charge? What will output be in
that case? Calculate consumer surplus and LWEs profit with that price.
b) If regulators want to ensure that LWE doesnt lose money, what is the lowest
price they can impose? Calculate output, consumer surplus, and profit. Is
there any deadweight loss?
c) Kristina knows that deadweight loss is something that this small town can do
without. She suggests that each household be required to pay a fixed amount
just to receive any electricity at all, and then a per-unit charge for electricity.
Then LWE can break even while charging the price you calculated in part (a).
What fixed amount would each household have to pay for Kristinas plan to
work? Why can you be sure that no household will choose instead to refuse
the payment and go without electricity?
Source: Pindyck and Rubenfeld, Microeconomics, 7th ed.
6. Daynas Doorstops, Inc. (DD), is a monopolist in the doorstop industry. Its cost isC =
100 - 5Q + Q2, and demand is P = 55 - 2Q.
a) What price should DD set to maximize profit? What output does the firm
produce? How much profit and consumer surplus does DD generate? What
is the deadweight loss?
b) What would output be if DD acted like a perfect competitor and set MC = P?
What profit and consumer surplus would then be generated?

c) Suppose the government, concerned about the high price of doorstops, sets
a maximum price at $27. How does this affect price, quantity, consumer
surplus, and DDs profit? What is the resulting deadweight loss?
d) Now suppose the government sets the maximum price at $23. How does this
affect price, quantity, consumer surplus, DDs profit, and deadweight loss?
e) Finally, consider a maximum price of $12. What will this do to quantity,
consumer surplus, profit, and deadweight loss?
Source: Pindyck and Rubenfeld, Microeconomics, 7th ed.
7. Demand for business travel on flights between New York to Los Angeles is P = 2000
Q, whereas demand for leisure travel is P = 1000 2Q. Initial estimates indicate
that marginal cost for each passenger is 100. What price will airlines charge
business and leisure travelers if they know for sure whether each customer is a
business or a leisure traveler?
8. Your publishing house is about ready to release John Grishams newest novel just in
time for Holiday giving. You are in charge of pricing decisions. Explain why it is
important for you to know whether Grisham is being paid a lump sum of $5 million or
whether he gets royalty payments of 25 percent of gross sales before you decide
which price to charge. In which case will the book sell the most copies?
9. Text, chapter 10, problem 9: Owners of a movie theater have determined that the
elasticity of demand for movie tickets equals 2.0 for students and 1.5 for adults.
a) If the owners of the theater decide to segment the market, who should be
charged a higher price, students or adults? Use your knowledge of
microeconomic theory to explain why.
b) Use the Lerner index as described in the text to determine the ratio of prices.
In percentage terms, how big a price premium should be charged to the
group that pays the higher price?
10. Based on the experience of the companies your group members have worked for,
give one example of first, second, and third degree price discrimination. Then give
an example of a situation where a company would like to price discriminate but is
currently not choosing to do so (and try to explain why, if possible).