Question

Suppose a monopoly firm has a dmenad curve estimated as P= 5 – .01Q where p is price and Q is quantity. Suppose that MC= $1. If a new firm with the same MC was to enter a new product based on the monopolist's residual demand, what would the new firm's penetration price be?

a. $200.00

b. $2.00

c. $100.00

Answer 1

Solution :

P= 5 - 0.01Q

MC = $1

Existing monopolist will produce at a point MR = MC to maximise his profit

Totla revenue = TR = PQ

TR = ( 5- 0.01Q)*Q

Thus at MR = MC,

5- 0.02Q = 1

4 =0.02Q

Q = 200

P= 5- 0.01Q

At Q= 200, P = 5-0.01(200)

P= 5-2 = $3

Thus since the current monopolist is charging a price of $3, the new firm with his new product with same MC will charge a penetration price of $2( has to be less than $ 3) based on residual demand (demand not met by monopolist) and penetration price is the low price charged by new firm in order to eliminate the competition and create a monopoly of its own.