A monopolist with a constant marginal cost of production of 10 maximizes its profit by choosing...

A monopolist with a constant marginal cost of production of 10 maximizes its profit by choosing to produce where the price elasticity of demand is –3. (Recall that MR = p(1 + 1/ε) where MR is marginal revenue, p is price and ε is the point price elasticity of demand.)

A. If price is decreased (from its profit maximizing level) by a small amount, revenue of the monopolist will increase.

B. If the monopolist’s fixed cost increases, its profit maximizing price also increases.

C. The price set by the monopolist is equal to 30.

D.Since marginal cost is constant, both profit-maximizing and revenue-maximizing quantities are equal.

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Solutions

Expert Solution

Option (A) is correct.

Using Lerner Index,

- 1 / Elasticity = (P - MC) / P

- 1 / -3 = (P - 10) / P

1/3 = (P - 10) / P

P = 3P - 30

2P = 30

P = 15

Since absolute value of elasticity is higher than 1, demand is elastic. With elastic demand, a decrease in price increases revenue.

However, revenue-maximizing and profit-maximizing price-output bundles are different, and change in fixed cost does not influence the profit-maximizing price-output bundle obtained using MR = MC.

Rahul Sunny answered 1 year ago

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