Question

1. Show marginal cost, average cost, demand and marginal revenue for a monopolist earning zero economic profit. Be very clear about profit maximizing output.

2. Show what happens to a monopolist's profits when the price of the fixed input, i.e., the rental rate, increases.

Answer 1

Question:

DD is the demand curve.

MR is the marginal revenue curve

AC is the average cost curve

MC is the Marginal cost curve

Part A: At zero economic profit, monopoly firm selling price is equal to average cost at E

MC cuts AC at its minimum

Profit maximizing output is Q*

Part B: When the price of fixed input increases, the average cost increases from AC to AC' giving negative profit or loss to the producer which results that producer will leave the market in long run.

Producer should charge P1* price, bu can charge only P* price which results in loss, because no one is going to demand Q* output level at P1* price.