Problem Set 6
Market Interventions
1. In a perfectly competitive market, the market demand curve is 𝑄𝑑 = 200 − 5𝑃𝑑 , and
the market supply curve is 𝑄𝑠 = 35𝑃𝑠 .
a) Find the equilibrium market price and quantity demanded and supplied in the
absence of price controls.
b) Suppose a price ceiling of $2 per unit is imposed. What is the quantity
supplied with a price ceiling of this magnitude? What is the size of the
shortage created by the price ceiling?
c) Find the consumer surplus and producer surplus in the absence of a price
ceiling. What is the net economic benefit (i.e., total surplus) in the absence of
the price ceiling?
d) Find the consumer surplus and producer surplus under the price ceiling.
Assume that rationing of the scarce good is as efficient as possible. What is the
net economic benefit in this case? Does the price ceiling result in a deadweight
loss? If so, how much is it?
e) Find the consumer surplus and producer surplus under the price ceiling,
assuming that the rationing of the scarce good is as inefficient as possible.
What is the net economic benefit in this case? Does the price ceiling result in a
deadweight loss? If so, how much is it?
2. Suppose that in the domestic market for computer chips, demand is 𝑃𝑑 = 110 − 𝑄𝑑 ,
where 𝑄𝑑 is the number of units of chips demanded domestically when the price is 𝑃𝑑 .
The domestic supply is 𝑃𝑠 = 10 + 𝑄𝑠 , where 𝑄𝑠 is the number of units of chips
supplied domestically when domestic suppliers receive a price 𝑃𝑠 . Foreign suppliers
would be willing to supply any number of chips at a price of $30. The government is
contemplating three possible policies:
Policy I: The government decides to ban imports of chips.
Policy II: Foreign suppliers are allowed to import chips (with no tariff).
Policy III: The government allows imports, but imposes a tariff of $10 per unit.
Fill in the table below, giving numerical answers:
Policy I Policy II Policy III
How many units of chips would be consumed domestically?
How many units of chips would be produced domestically?
What is the size of domestic producer surplus?
What is the size of consumer surplus?
What is the size of government receipts?
3. Suppose that the demand in the market for corn is given by 𝑄𝑑 = 20,000 − 50𝑃 and
the supply is given by 𝑄𝑠 = 30𝑃. Suppose that the government would like to see the
price at $300 per unit and is prepared to artificially increase demand by initiating a
government purchase program. How much would the government need to spend to
achieve this? What is the total deadweight loss if the government is successful in its
objective?
Monopoly
4. The marginal cost of preparing a large latte in a specialty coffee house is $1. The
firm’s market research reveals that the elasticity of demand for its large lattes is
constant, with a value of about –1.3. If the firm wants to maximize profit from the
sale of large lattes, about what price should the firm charge?
5. A monopolist faces a demand curve given by 𝑃 = 100 − 𝑄 and its marginal cost is
given by 𝑀𝐶 = 20.
a) Calculate the profit maximizing monopoly quantity and compute the
monopolist’s total revenue at the optimal price.
b) Compute the deadweight loss due to monopoly.
Price Discrimination
6. Suppose a profit-maximizing monopolist producing Q units of output faces the
demand curve 𝑃 = 20 − 𝑄. Its total cost when producing 𝑄 units of output is 𝑇𝐶 =
24 + 𝑄 2 .
a) If price discrimination is impossible, how large will the profit be? How large
will the producer surplus be?
b) Suppose the firm can engage in perfect first-degree price discrimination. How
large will the profit be? How large is the producer surplus?
7. Let the inverse demand curve for a monopolist’s product be 𝑃 = 100 − 2𝑄 and the
marginal cost of production be constant at 𝑀𝐶 = 10. Find the optimal two-block
tariff for the firm.
8. Mathnet, a monopoly in the market for statistical software, has fixed cost of $20 and
marginal cost of $1. The market is characterized as having two different classes of
buyers, professionals and students, with the following demand:
Professionals: 𝑃 = 10 − 𝑄
Students: 𝑃 = 20 − 𝑄
Assume that there are no costs to identifying the two groups, and that the two groups
cannot resell the good to the other groups. What is the profit maximizing quantity to
sell to each group? What price should these quantities be sold for? What is the total
profit of the monopolist?