Olga Petranevskaya

Tutorial 8

Microeconomics I
Tasks from
Tutorial 7 2
Task 4 3
Firms in a perfectly competitive market are said to be
“price takers”—that is, once the market determines an
equilibrium price for the product, firms must accept this
price. If you sell a product in a perfectly competitive
market, but you are not happy with its price, would you
raise the price, even by a cent?

4
Task 5 5
The AAA Aquarium Co. sells aquariums for $20 each.
Fixed costs of production are $20. The total variable costs
are $20 for one aquarium, $25 for two units, $35 for the
three units, $50 for four units, and $80 for five units. In
the form of a table, calculate total revenue, marginal
revenue, total cost, and marginal cost for each output
level (one to five units).

6
The profit maximizing level of output is 4 aquariums,
with a profit of $10. Producing more or less than this
amount results in lower profits.

7
What is the profit-maximizing quantity of output? On one
diagram, sketch the total revenue and total cost curves.
On another diagram, sketch the marginal revenue and
marginal cost curves.

8
Task 6 9
A computer company produces affordable, easy-to-use
home computer systems and has fixed costs of $250. The
marginal cost of producing computers is $700 for the first
computer, $250 for the second, $300 for the third, $350
for the fourth, $400 for the fifth, $450 for the sixth, and
$500 for the seventh.
Create a table that shows the company’s output, total
cost, marginal cost, average cost, variable cost, and
average variable cost.

10
» At what price is the zero-profit point? At what price is
the shutdown point?
» If the company sells the computers for $500, is it
making a profit or a loss? How big is the profit or loss?
Sketch a graph with AC, MC, and AVC curves to
illustrate your answer and show the profit or loss.

11
» If the firm sells the computers for $300, is it
making a profit or a loss? How big is the profit or
loss? Sketch a graph with AC, MC, and AVC curves
to illustrate your answer and show the profit or
loss.

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Monopoly 13
The monopolist must take account of the
market demand curve:

The higher the price it sets, the fewer units of its

product it will sell;

the lower the price it sets, the more units it will

sell

14
The Monopolist’s Demand Curve Is the Market
Demand Curve 15
Q P TR TC PR
0 12 0 0 0
1 11 11,00 0,50 10,50
2 10 20,00 2,00 18,00
3 9 27,00 4,50 22,50
4 8 32,00 8,00 24,00
5 7 35,00 12,50 22,50
6 6 36,00 18,00 18,00
7 5 35,00 24,50 10,50
8 4 32,00 32,00 0
9 3 27,00 40,50 -13,50
10 2 20,00 50,00 -30,00
16
P
R
O
F
I
T
17
» If the firm produces a quantity at which MR >MC, the
firm cannot be maximizing its profit because it could
increase its output and its profit would go up.

» If the firm produces a quantity at which MR <MC, the

firm cannot be maximizing its profit because it could
decrease its output and its profit would go up.

» Thus, the only situation at which the monopolist

cannot improve its profit by increasing or decreasing
output is where marginal revenue equals marginal
cost.
» That is, if Q* denotes the profit-maximizing output, 18

then MR(Q*) =MC(Q*)

 Profit-maximization
condition for a monopolist

MR(Q) = MC(Q)

*is a general one, applying to both

monopolists and perfectly competitive 19

firms
 Marginal revenue is not equal to market price

Area III represents the additional revenue the monopolist gets from the additional
3 million ounces of output it sells when it lowers its price to $7: $7 * (5 - 2) million
$21 million. The extra 3 million ounces are called the marginal units. 20
 Marginal revenue is not equal to market price

Area I represents the revenue the monopolist sacrifices on the 2 million ounces it
could have sold at the higher price of $10: ($10 - $7) * 2 million = $6 million.
These 2 million ounces are called the inframarginal units. 21
 
Area III = price * change in quantity = PΔQ
Area I = - quantity * change in price = -Q ΔP

Thus, the change in the monopolist’s total

revenue is:
TR = area III - area I =PΔQ+ Q ΔP

22
 Average revenue and
Marginal Revenue
» If Q>0, then

» Marginal revenue is less than price (MR < P).

» Because average revenue is equal to price,
marginal revenue is less than average revenue
(MR < AR).
» Since the average revenue curve coincides with
the demand curve, the marginal revenue curve
must lie below the demand curve. 23
AR and MR

24
 Average revenue
AR=TR/Q
AR=(P*Q)/Q=P

Total revenue per unit of output (i.e., the ratio of total

revenue to quantity).

25
Task 1 26
Suppose that the equation of the market demand
curve is P=a-Bq

Problem What are the expressions for the average and

marginal revenues curves?

27
The Monopolist’s Profit- Maximization Condition 28
Task 2 29
The equation of the monopolist’s demand curve
previous graph is
P = 12 - Q,
and the equation of marginal cost is MC = Q,
where Q is expressed in millions of ounces.

Problem What are the profit-maximizing

quantity and price for the monopolist?

30
Price elasticity of
demand 31
In monopoly market A, demand is relatively more
price elastic, than it is in market B, where demand
is relatively less price elastic

By setting too high a price, a monopolist will lose 32

customers to other products.

 MR and price elasticity

»   MR=
MR=
EQ,P=
MR=

33
MR and price elasticity

34
 MR and price elasticity
Region of Demand Marginal Revenue and Total Revenue and Price
Curve EQ,P
Elastic (-∞<EQ,P<-1) MR > 0 The monopolist can in-
[because 1 + (1/EQ,P)> 0] crease total revenue by
decreasing price (and
thereby increasing quantity)
by a small amount

Unitary elastic (EQ,P=-1) MR = 0 The monopolist’s total

[because 1 + (1/EQ,P)=0] revenue will not change
when price (or quantity)
is changed by a small
amount.

Inelastic (1<EQ,P<0) MR < 0 The monopolist can in-

[because 1 + (1/EQ,P)<0] crease total revenue by
increasing price (and
thereby decreasing quantity) 35
by a small amount.
 MC and price elasticity

»   MR=

MC(Q*)=
Q*, P* - profit maximization

36
Task 7 37
Classify the following as a government-enforced barrier to
entry, a barrier to entry that is not government-enforced, or
a situation that does not involve a barrier to entry.

A patented invention

38
Classify the following as a government-enforced barrier to
entry, a barrier to entry that is not government-enforced, or
a situation that does not involve a barrier to entry.

A popular but easily copied restaurant recipe

39
Classify the following as a government-enforced barrier to
entry, a barrier to entry that is not government-enforced, or
a situation that does not involve a barrier to entry.

A well-established reputation for slashing prices in

response to new entry

40
Classify the following as a government-enforced barrier to
entry, a barrier to entry that is not government-enforced, or a
situation that does not involve a barrier to entry.

A well-respected brand name that has been carefully built up

over many years

41
Task 7

42
Currently, Texas Tea Oil Co. is the only local supplier of home
heating oil in Frigid, Alaska. This winter residents were
shocked that the price of a gallon of heating oil had doubled
and believed that they were the victims of market power.
Explain which of the following pieces of evidence support or
contradict that conclusion.

a. There is a national shortage of heating oil, and Texas Tea

could procure only a limited amount.
Currently, Texas Tea Oil Co. is the only local supplier of
home heating oil in Frigid, Alaska. This winter residents
were shocked that the price of a gallon of heating oil had
doubled and believed that they were the victims of market
power. Explain which of the following pieces of evidence
support or contradict that conclusion.

b. Last year, Texas Tea and several other competing local oil
- supply firms merged into a single firm.
Currently, Texas Tea Oil Co. is the only local supplier of
home heating oil in Frigid, Alaska. This winter residents
were shocked that the price of a gallon of heating oil had
doubled and believed that they were the victims of market
power. Explain which of the following pieces of evidence
support or contradict that conclusion.

c. The cost to Texas Tea of purchasing heating oil from

refineries has gone up significantly.
Currently, Texas Tea Oil Co. is the only local supplier of home
heating oil in Frigid, Alaska. This winter residents were shocked
that the price of a gallon of heating oil had doubled and
believed that they were the victims of market power. Explain
which of the following pieces of evidence support or contradict
that conclusion.

d. Recently, some nonlocal firms have begun to offer heating oil

to Texas Tea’s regular customers at a price much lower than
Texas Tea’s.
Currently, Texas Tea Oil Co. is the only local supplier of home
heating oil in Frigid, Alaska. This winter residents were
shocked that the price of a gallon of heating oil had doubled
and believed that they were the victims of market power.
Explain which of the following pieces of evidence support or
contradict that conclusion.

e. Texas Tea has acquired an exclusive government license to

draw oil from the only heating oil pipeline in the state.
Task 8

48
You are thinking of setting up a coffee shop. The market
structure for coffee shops is monopolistic competition.
There are three Starbucks shops and two other coffee
shops very much like Starbucks in your town already. In
order for you to have some degree of market power, you
may want to differentiate your coffee shop. Thinking
about the three different ways in which products can be
differentiated, explain how you would decide whether you
should copy Starbucks or whether you should sell coffee in
a completely different way.
Task 9

Introduction to economics
50
Each of the following firms possesses market power. Explain
its source.
˃ Merck, the producer of the patented cholesterol-
lowering drug Zetia
Each of the following firms possesses market power.
Explain its source.
˃ WaterWorks, a provider of piped water
Each of the following firms possesses market power.
Explain its source.
˃ Chiquita, a supplier of bananas and owner of most
banana plantations
Each of the following firms possesses market power.
Explain its source.
˃ The Walt Disney Company, the creators of Mickey
Mouse