HUL 212

Problem Set 2
1. State whether the following statements are true or false. Provide an ex-
planation for your answer.
(a) A monopolist sells a product x in two different markets, A and B
at prices pA and pB respectively. If the elasticity of demand in mar-
ket A is lower than the elasticity of demand in market B,then pA >pB .

True. See Microeconomic Analysis pg. 249.

(b) A monopolist necessarily produces a higher quantity of output when
he price discriminates between two markets as compared to when he
charges the same price in the two markets.

False. Consider the case of linear demand functions: a monopolist

may produce the same quantity. See example of third degree price
discrimination discussed in tutorial.
(c) A monopolist will always operate on the inelastic section of the de-
mand curve.

False. On the inelastic portion of the demand curve, the MR will be

negative. A profit maximizing monopolist operates where MR=MC.
This is not possible when MR is negative. He can raise profits by
producing lesser and correspondingly charging higher prices.
(d) The elasticity of demand faced by each firm in a perfectly competi-
tive market is 0.

False. Elasticity of demand faced by a competitive firm is −∞.

2. A furniture store sets a price higher than P = M C and allows their sales
personnel to offer discounts to customers depending on their perceptions
of a customer’s willingness to pay. What type of price discrimination is
the store attempting to implement?

Ans. First degree price discrimination.

3. Suppose that the marginal cost of producing a commodity x increases
from 4 to 5. If the elasticity of demand is −1.25, what will be the increase
in the price charged for x by a profit maximizing monopolist?

Ans.Under profit maximization, P (1 + 1e ) = M C. Therefore, when

MC=4, the price,P=20. When MC increases to 5, P increases to 25.
4. Suppose that the inverse demand for Hal R. Varian’s Microeconomic Anal-
ysis in two markets, U SA and Europe is as follows:

1
 PU SA = 36 − 4QU SA ; PEU = 24 − 4QEU

The marginal cost of producing the book is 4. If the production of the

book is monopolized by a firm A, calculate the profits made by firm A if:

(a) Firm A does not price discriminate;

Ans. Let QU SA + QEU = QT , PU SA = PEU = P . QT = 15 − P2 .
M RT = 30 − 4QT . Using first order condition for profit maximiza-
tion, MR=MC implies Q∗T = 6.5; P ∗ = 17. Profit=TR-TC=17X6.5-
4X6.5=84.5.
(b) Firm A charges different prices in the two markets.
Ans.Using first order condition, M RU SA = M C = M REU . There-
fore, Q∗U SA = 4, P ∗U SA = 20; Q∗EU = 2.5, PEU
∗
= 14. Profit=20X4+14X2.5-
4(4+2.5)=89.