Question

Suppose you are working as a consultant for a firm that is a monopoly and is worried about its policies in the short run. What would you recommend in terms of quantity changes (raise, cut, shut down or stay put) and price changes (raise, cut, stay put) in each of the following situations a through c:

a. [5 points] P = $299 MC = $349 AVC = $249

b. [5 points] MR = $150 MC = $100 AVC = $140

c. [5 points] P = $288 MC = $288 AVC = $287

[Note: P = price; MR = marginal revenue; AVC = average variable cost; MC = marginal cost]

Answer 1

A. Reduce quantity and increase price because profit is maximised when MR=MC and price is charged on the demand curve. Which means price is greater than marginal revenue

b. Firm should produce more which will decrease the price. Because MC have to rise and MR will decrease on further production. Thus it should increase production/quantity unless MR=MC.

c. Should reduce quantity which will increase price because MR is less than 288 and MC=288

Thus firm should reduce quantity and increase price in order to maximise profit