Question

Cutting Edge Pharmaceuticals Pty Ltd (a monopoly firm) has the following demand (average revenue) function: AR = 100 – Q

The marginal cost of production is given as constant and equal to $10.

a) What is the equation for the MR function? In showing this equation for the MR function explain the relationship between average revenue and marginal revenue. Determine the profit maximizing level of output of the firm (1 mark)

b) What is the equilibrium monopoly price set by the firm and what will be the monopoly profit earned? (1 mark)

c) Illustrate the market demand and marginal cost, average cost of this firm as well as, profit maximizing price quantity and profit level on a diagram (1 mark)

Answer 1

a) Firstly, demand function is AR = 100 - Q. Now MR has the same intercept as demand function with twice the slope. So MR = 100 - 2Q. The relationship between AR and MR indicates that AR is always greater than or equal to MR. In case of pure competition, AR coincides with MR but in impure competition, AR is always greater than MR. Now MC = 10 so we have MR = MC or 100 - 2Q = 10. This gives profit maximizing level of output at Q = 90/2 = 45 units

b) Price = 100 - 45 = $55 per unit. Profit = (P - AC)*Q = (100 - 55)*45 = $2025

c) Diagram is shown below