Question

1)How do the following events affect a monopoly firm’s price and output? How will it affect the firm’s profits? Illustrate your answers graphically.

a. an increase in labor costs in the market in which the firm operates

b. a reduction in the price of gasoline

c. the firm’s Chief Executive Officer persuades the Board to increase his or her annual salary

d. demand for the firm’s product falls

e. demand for the firm’s product rises

f. the price of a substitute for the firm’s product rises

Answer 1

A monopoly produces where its rising marginal cost intersects with falling MR. The price is then determined by the demand line through vertically travelling along the quantity line.

a. an increase in labor costs in the market in which the firm operates

This shifts the MC and ATC curves up because labor is a variable factor. The quantity is reduced to Q1 and the price is increased to P1. Profits would fall and shown by a smaller blue region

b. a reduction in the price of gasoline

Gasoline is a fuel so when its price is reduced, firm will face a reduction in cost. MC and ATC both will fall. Price would fall and quantity is increased. Profits are increased

c. the firm’s Chief Executive Officer persuades the Board to increase his or her annual salary

Again this will raise average total cost because salary of a CEO is annual and is fixed. But marginal cost is not increased. Profits fall but quantity and price are unchanged.

d. demand for the firm’s product falls

This shifts the demand down and so price level and quantity both are reduced. Profits fall.

e. demand for the firm’s product rises

Since costs remain same, demand shifts to the right along with marginal revenue. This increases the price charged, quantity sold and the profits

f. the price of a substitute for the firm’s product rises

In case the price of substitutes rises its quantity demanded falls and so demand for firm's product will decrease. This decreases the price charged, quantity sold and the profits