Question

4. A monopolist faces a linear demand for its product and has a flat marginal and average cost of production. An innovation lowers the cost of production by $1 per unit. Use the graph to show the profit-maximizing monopolist’s choice and the changes due to the innovations. a. How much will the price change as the result of the innovation? b. How much will profit per unit change as the result of the innovation? c. Summarize: who benefits from the innovation? Explain in 2-3 sentences.

Answer 1

a.

Price decreases by (P – P1). (Answer)

b.

Profit per unit at E equilibrium = (TR – TC) / Q

                                    = {(P × Q) – (C × Q)} / Q

                                    = (PQ – CQ) / Q

                                       = P – C

Profit per unit at E1 equilibrium = (TR1 – TC1) / Q

                                    = {(P1 × Q1) – ((C – 1) × Q1)} / Q

                                    = {P1Q1 – CQ1 + Q1} / Q

                                    = P1 – C

Profit per unit change = (P – C) – (P1 – C)

                                    = P – C – P1 + C

                                    = P – P1 (Answer)   

c.

Consumers benefit from this innovation, since it brings down price from P to P1. This thing increases consumer surplus, since equilibrium quantity increases from Q to Q1. Total surplus (which is the aggregate of consumer surplus and producer surplus) increases as well since there is the price advantage in profit.