Economics 172

Fall 2007

Due Wednesday November 7

Chapter 11

Questions 1, 6, 14

1. The answer is similar to figure 11.4 in the text except that in this homework, the quantity changes but not the price.

6. If the market demand curve hits the ATC curve along the downward sloping part of the ATC curve, then the firm can have a U shaped ATC curve but still be a natural monopoly. See the application on page 372 of the text.

14. The market demand Dt is the sum of the individual demands for Wellbutrin (Dw) and Zyban (Dz), which are the same drugs. That means there is a marginal revenue curve (MRt) from that Dt curve. The MR curve hits the MC curve and monopolist GlaxoWellcome then prices on its total demand curve. That total quantity Qt is broken up into the two components, Qw and Qz. The firm charges the same price Po for the two drugs. If it did not, a physician prescribing the higher priced drug would simply write a scrip for the lower price drug.

1. A monopoly is producing at an output level where average total cost of production is minimized and equals $50 per unit. If marginal revenue at that level of production equals $60, show that the monopoly cannot be producing at the profit maximizing output level.

If it is minimizing its average cost of production, then it is at the minimum point of the ATC curve. We know the MC curve crosses the minimum point of the ATC curve, so MC must also equal $50. But marginal revenue is $60, so MR>MC. It should expand production.

2. Suppose that you are the economic czar of the US world. You can dictate what gets produced, but not what prices are charged. You’re not that powerful. You have the option of having an AIDS vaccine produced by a monopoly or of not having the vaccine produced at all. Under which option would society be better off. Why?

If there is no vaccine produced, there is no producer or consumer surplus. If it is produced by a monopoly, there is at least some consumer and producer surplus, so there is more welfare than 0. More people will live than without the vaccine. The point is that a product produced by a monopoly is better than no product at all.

3. At its profit maximizing output level, the price of Abercrombie jeans is twice as high as marginal cost. What is the elasticity of demand?

Hint: Solve MR = P(1+(1/e)) for e the elasticity of demand and remember that MC = MR.

We know that P = 2MR Therefore MR = 2MR (1+(1/e))

The rest is just algebra:

MR/2MR = 1+ 1/e

-(1/2) = 1/e

e= -2