MICROECONOMICS

Practice Problem Set #3

1. Suppose that Saregama India Limited, the music company, has the copyright to the latest pop album of the band
Euphoria. The market demand curve for the album is Q = 800 - 100p, where Q represents quantity demanded in
thousands and p represents the price in dollars. Production requires a fixed cost of $100,000 and a constant marginal
cost of $2 per unit.

a. What price and sales shall maximize profits for Saregama?

b. What is the maximum profit?
c. Calculate the Lerner Index at the profit-maximizing scale of production.
d. Suppose that the fixed cost rises to $200,000. How would this affect the profit-maximizing price?

2. In M G Road, Bengaluru, the movie market is monopolistically competitive. The demand function for daily
attendance and the long-run average cost function at the INOX are, respectively, P = 9 – 0.4Q and
AC = 10 – 0.06Q + 0.0001Q2

a. Calculate the price that INOX will charge for admission to movies in the long-run. What will be the number of patrons
per day at that price?
b. What is the value of LAC that the firm will incur? How much profit will the firm earn?

3. The research department of Kingston, a producer of pen drives, has estimated that the demand function facing
the firm for price increases and price declines from the prevailing price are, respectively,

Q = 210 – 30P and Q’ = 90 – 10P

The marginal and average total cost functions of the firm were also estimated to be

MC = 3.5 + (Q/30) and ATC = 3.5 + (Q/60)

a. Determine the best level of output of the firm, the price at which the firm sells the its output, as well as the
profit per unit and in total.
b. Within what range can the MC curve of the firm shift without inducing it to change its price and output?

4. The jetcraft industry is dominated by two major competitors: Airbus (A) and Boeing (B). Both companies have
similar technology allowing each firm to produce a jet at a cost of $20 million. Accordingly, their cost functions are
given by
TC(qA) = 20qA
TC(qB) = 20qB
To simplify our analysis, we assume no fixed costs. The inverse demand for jets by major airlines is estimated to be
P(q) = 200 – q

(a) Find the profit function for Boeing πB(qB), given that the production of Airbus amounts to q A = 100 jets. In a graph,
with qB on the horizontal axis, and π on the vertical one, plot the profit function.

(b) Is the production qB = 100 jets Boeing’s best response to qA = 100? Why, or why not? Find the optimal level of
production, given Airbus produces q A = 100, qA = 50, and qA = 0. Mark the three points in space (q A, qB).

(c) Find the best response function for Boeing, R B(qA), and for Airbus RA(qB), and plot it in the graph in space (q A, qB).

(d) Find the market price of an aircraft, the level of individual and aggregate production in a Cournot-Nash equilibrium.
Also find the level of profit of each individual firm. Show the equilibrium in your graph from part (c).
(e) What is the deadweight loss associated with oligopolistic trading by the two firms?

(f) Suppose the two firms A and B form a cartel. What is the aggregate level of production, and profit per firm, given
collusion? Does collusion benefit the two producers?

(g) Find the deadweight loss, given collusion, and compare it to the one from (e). Which loss is greater? Why?

5. Suppose that an industry comprising two firms produces a homogeneous product. Consider the following demand
and individual firm’s cost function:
P = 200 – 2(Q1 + Q2)
TC1 = 4Q1
TC2 = 4Q2
a. Calculate each firm’s reaction function.
b. Calculate the equilibrium price, profit-maximizing output levels, and profits for each firm. Assume that each
duopolist maximizes its profit and that each firm’s output decision is invariant with respect to the output decision of
its rival.

6. Suppose that an industry comprising two firms producing a homogeneous product. Suppose that the demand
functions for two profit-maximizing firms in a duopolistic industry are
Q1 = 50 – 0.5P1 + 0.25P2
Q2 = 50 – 0.5P2 + 0.25P1
Suppose, further, that the firms total cost functions are
TC1 = 4Q1
TC2 = 4Q2
where P1 and P2 represent the prices charged by each firm producing Q1 and Q2 units of output.

a. What is the inverse demand equation for this product?

b. What are the equilibrium price, profit-maximizing output levels, and profits for each firm?

7. The demand equation for two profit- maximizing firms in a duopolistic industry is
P = 200 – 2(Q1 + Q2)
and the firm’s total cost functions are
TC1 = 4Q1
TC2 = 4Q2
where Q1 and Q2 represent the output levels of firm 1 and firm 2, respectively.

a. Assume that firm 2 is a Stackelberg leader and firm 1 is a Stackelberg follower. What are the equilibrium price,
profit-maximizing output levels, and profits for each firm?

b. Suppose that the two firms in the industry decide to jointly determine output levels for the purpose of maximizing
industry profit. Determine the profit-maximizing levels of output, the equilibrium price, and total industry profit.
8. Funworld has estimated the following demand equation for the average summer visitor to its theme park
Q = 27 – 3P
where Q represents the number or rides by each guest and P the price per ride in rupees. The total cost of providing a
ride is characterized by the equation
TC = 1 + Q
Funworld is a profit maximizer considering two different pricing schemes: charging on a per-ride basis or charging a
one-time admission fee and allowing park visitors to ride as often as they like.

a. How much should the park charge on a per-ride basis, and what is the total profit to Funworld per customer?

b. Suppose that Funworld decides to charge a one-time admission fee to extract the consumer surplus of the average
park guest. What is the estimated average profit per park guest? How much should Funworld charge as a one-time
admission fee? What is the amount of consumer surplus of the average park guest?

9. You are the manager of a firm that manufactures front and rear windshields for the automobile industry. Due to
economies of scale in the industry, entry by new firms is not profitable. Toyota has asked your company and your
only rival to simultaneously submit a price quote for supplying 100,000 front and rear windshields for its new
Highlander. If both you and your rival submit a low price, each firm supplies 50,000 front and rear windshields and
earns a zero profit. If one firm quotes a low price and the other a high price, the low-price firm supplies 100,000 front
and rear windshields and earns a profit of $9 million and the high-price firm supplies no windshields and loses $1
million. If both firms quote a high price, each firm supplies 50,000 front and rear windshields and earns $7 million
profit.

(i) Determine your optimal pricing strategy if you and your rival believe that the new Highlander is a “special edition”
that will be sold only for one year.
(ii) Would your answer differ if you and your rival were required to resubmit price quotes year after year and if, in any
given year, there was a 50 percent chance that Toyota would discontinue the Highlander? Explain.

10. Suppose that Indigo Airlines has a monopoly on the route between Delhi and Goa. During the winter (November -
February), the monthly demand on this route is given by P = a1 - bQ. During the summer (March - June), the monthly
demand is given by P = a2 - bQ, where a2 > a1. Assuming that Indigo’s marginal cost function is the same in both the
summer and the winter, and assuming that the marginal cost function is independent of the quantity Q of passengers
served, will Indigo charge a higher price in the summer or in the winter?