Question

Suppose a market is characterized by inverse demand P = 15,000-5Q. The marginal revenue curve associated with this market is MR=15,000-10Q. Marginal cost is constant at MC=40.

A) Solve for the equilibrium price and quantity if the market is characterized by perfect competition.

B) Solve for the equilibrium price and quantity if the market is characterized by a monopoly. C) Explain why total surplus is maximized under perfect competition (absent government intervention, externalities, etc.), but it is not maximized under monopoly.

D) Suppose the government could pay the monopolist (in B)) to supply at the perfectly competitive equilibrium level (in A)). Determine the maximum amount the government would be willing to pay the monopolist to provide at the perfectly competitive equilibrium.

Answer 1

A)

Setting P = MC,

15,000 - 5Q = 40

5Q = 14,960

Q = 2,992

P = 40

B)

Setting MR = MC,

15,000 - 10Q = 40

10Q = 14,960

Q = 1,496

P = 15,000 - 5 x 1,496 = 7,520

C)

Under perfect competition, price is set at MC, which ensures that the sum of consumer surplus and producer surplus is maximized. Under monopoly, price is higher than MC, which gives rise to deadweight loss, causing inefficient.

D)

Maximum amount government will pay (Subsidy) = Difference in price = 7,520 - 40 = 7,480