HUL-212 (Microeconomics)

Problem Set - 6
March 2025

1. Suppose that a representative, perfectly competitive, firm in the market

has production function
√
F (K, L) = KL

The price of the firm’s product is equal to p, the price per unit of capital
is r, and the cost per unit of labour is w.

(a) Consider the short run case when capital is fixed at some level K̄.
i. What is the firm’s choice of labour as a function of r, w, K̄,
p?
ii. Taking parameters r, K̄, p as fixed, graph the firm’s labour
demand as a function of w.
iii. Now, taking w, K̄, r as fixed, graph the firm’s supply curve
as a function of p. How does the firm supply curve change
when w increases?
(b) Suppose that K̄ = 180,r = 4 and the demand for the firm’s prod-
uct is given by QD = 10 − p.
i. Solve for the equilibrium quantity and price in this market
as a function of w. How does the wage affect the equilibrium
price and quantity?
ii. Find the elasticity of labour demand with respect to the wage
in this market.
(c) Now consider the (perfectly competitive) long run, with the same
demand curve QD = 10 − p for the firm’s product and price of
capital is still r = 4, but the firm may freely adjust capital.
i. Now solve for the equilibrium price and quantity in the long
run as a function of wage. How does wage affect the equilib-
rium price and quantity?

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 ii. Find the elasticity of labour demand with respect to wage in
the long run.
(d) Compare the wage elasticity of labor demand in the short run and
long run. Explain why they are different.
2. Suppose a worker has preferences over consumption and leisure that
can be represented by the following utility function: U = ln(c) + ln(l)
There are 16 hours per day available for leisure (l) and work (L). The
hourly wage is w, and assume that the price of each unit of consumption
is $1. The only source of income for this worker is the wage.
(a) Write down the worker’s budget constraint in terms of c and L.
(b) Find the optimal consumption and work as a function of w.
(c) Now suppose there are 100 workers identical to the one we an-
alyzed. There√ are also 100 firms, each one with a production
function y = L. Suppose that the price of the firms’ output is
$1 per unit. Find the labour supply and labour demand curves,
and use them to find the equilibrium wage and labour.
(d) Suppose that the government sets a proportional tax on wages, so
for every $1 paid by the firm, the worker receives $(1 − τ ). Find
the new equilibrium of the labour market
i. Write down the new budget constraint for the worker and find
the optimal consumption and labour.
ii. Find the demand for labour by each firm as a function of w.
iii. Find the new equilibrium wage and labour of the labour mar-
ket.
3. A monopoly faces market demand Q = 30 − P and has a cost function
C(Q) = 12 Q2
(a) Find the profit maximizing price and quantity and the resulting
profit to the monopoly.
(b) What is the socially optimal price? Calculate the deadweight loss
(DWL) due to the monopolist behaviour of this firm. Calculate
consumer surplus (CS) and producer surplus (PS). Show CS, PS,
and DWL on the diagram.
(c) Assume that the government puts a price ceiling on the monopolist
at P = 18. How much output will the monopolist produce? What
will be the profit of the monopolist? Calculate CS, PS, and DWL.
Why is the deadweight loss different now?

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 (d) Assume that the government put a price ceiling on the monopo-
list in order to maximize the total (i.e. consumer plus producer)
surplus. What price ceiling should it choose? How much output
will the monopolist produce at this price ceiling? What will the
profit of the monopolist be? What is the DWL?

4. A monopolist sells in two states and practices price discrimination by

charging separate prices in each state. The monopolist produces at
constant marginal cost MC=10. Demand in market 1 is Q1 = 50 − p1 .
Market 2 demand is Q2 = 90−1.5p2 . What price will be charged in each
market? Suppose a third party enters the market, not as a producer
but as a reseller, capable of reselling by transporting the goods from
market to market at a cost of $4 per unit. How does this affect the
monopolist?

5. You have been asked to analyze the market for steel. From public
sources, you are able to find that last year’s price for steel was $20 per
ton. At this price, 100 million tons were sold on the world market.
From trade association data you are able to obtain estimates for the
own price elasticities of demand and supply on the world markets as
−0.25 for demand and 0.5 for supply. Assume that steel has linear
demand and supply curves throughout

(a) Solve for the equations of demand and supply in this market and
sketch the demand and supply curves.
(b) Suppose that you discover that the current price of steel is $15
per ton and the current level of worldwide sales of steel is 150
million tons. The most recent elasticity estimates from the trade
association this year are −0.125 for demand and 0.25 for supply.
Describe the change in the supply and demand curves over the
past year using your diagram from part (a). What sort of event(s)
might explain the change?

6. Suppose that in NYC the daily demand for taxi rides is Q = 2100 -
100P where P is the price in dollar. Suppose also that the daily cost
of operating each cab is a fixed $100 rental cost per vehicle, plus a
variable cost of q 2 /100, where q is the number of cab rides per cab per
day.

(a) What is the long run total cost function of each cab?

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 (b) If the market is a constant cost-competitive one, what is the long-
run price of a cab ride? What is the number of rides each cab
supplies and the number of cabs operating?
(c) What is consumer surplus and producer surplus in the taxi cab
market?
(d) Does the market achieve the condition for efficiency that p=mc.
Explain.
(e) Suppose that a tax of $3 per ride is imposed. What is the new
market price? What is the number of rides per day and the number
of cabs?
(f) What is the deadweight cost of the tax per day?

7. First, we examine a monopolistic firm. The firm faces a market de-

scribed by the demand function p = A − By, where p is the price the
firm receives if it sells quantity y of output. The firm’s cost function is
given by C(y) = 12 y 2 .

(a) Find the profit-maximizing quantity of output and the correspond-

ing profit for this firm.
(b) Show that if the firm could sell more output at the (constant)
equilibrium price, it would do so. (To do this, take a derivative
of the firm’s payoff under the assumption that price is constant
rather than a function of output, and then evaluate this derivative
at the equilibrium price and quantity from part 7a.)
(c) Let p be the equilibrium price and y the equilibrium quantity so
that p = A − By. Now suppose the demand in the market shifts,
so that the new demand curve is p = A′ − B ′ y, with A′ > A
and B ′ > B, but with it still being the case that p = A′ − B ′ y
. Hence, if the firm does not change its quantity, its price will
also not change. Is the quantity of output y still optimal, given
this new demand curve? If not, will the firm decide to produce
more or less? Formulate your first-order condition from part 7a
in terms of the elasticity of demand, and use this to explain your
result in this part.

8. Suppose you must design a tax on the monopoly. Let the demand
function bep = A − By.

(a) First suppose you consider a sales tax of 10% on this market.
Suppose that the firm has to pay the tax, as is typically the case

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 with sales taxes. Hence, if the firm produces quantity y of output,
the price paid by consumers isp = A − By, but the price received
by the firm is 0.9p = 0.9(A − By), where the 0.9 appears because
the firm gets to keep only ninety per cent of the purchase price,
paying the remaining ten per cent to the government in taxes.
Find the profit-maximizing quantity of output for the firm, the
price paid by consumers, the price received by the firm, and the
firm’s profit. Explain how these answers compare to those of part
7a. In particular, do consumers pay more as a result of the tax?
Does the price received by the firm fall? Does the firm’s profit
fall?
(b) Instead of a sales tax, the government considers a profit’s tax.
Hence, if the firm chooses the quantity of output y and charges
price p = A − By, the government collects t[py − 21 y2] = t[(A −
By)y − 12 y 2 ] in tax revenue, leaving (1 − t)[py − 12 y 2 ] = (1 −
t)[(A−By)y − 21 y 2 ] as aftertax profit for the firm. Once again, find
the firm’s profit-maximizing quantity of output and the resulting
price. What effect does the profit’s tax have on the quantity of
output and price? What effect does it have on the firm’s profit?
In light of your answers, given that a fixed amount of revenue is to
be raised, which tax would consumers prefer a sales tax or profit’s
tax? Why?
(c) Now suppose the cost function is given by 12 x2 + F , where F is a
fixed cost. For example, F may be the cost of conducting environ-
mental impact studies or acquiring the licenses needed to produce.
What effect does F have on the firm’s optimal quantity of output,
price, and profits? Many communications firms are monopolies
because the government gives them exclusive rights to use certain
bands of airwave lengths. Sometimes, the government simply gives
the firms this exclusive right, while other times, it sells the right to
the highest bidder. The latter method has been criticized on the
grounds that it will drive up the firm’s costs and, hence, the prices
charged to consumers. What do you think of this argument?
9. A monopolist operates in two separate markets with demand functions:
Q1 = 200 − 2P1
Q2 = 150 − 3P2
The firm has a constant marginal cost of 20 in both markets and ini-
tially maximizes profit in each market independently by setting differ-
ent prices.

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 (a) Independent Profit Maximization:
i. Find the profit-maximizing price and quantity in each market
when the firm sets prices separately.
ii. Calculate the total profit under this strategy.
(b) Overall Profit Maximization:
i. Suppose the firm now decides to maximize total profit across
both markets rather than treating them separately. What
conditions must be satisfied for this new strategy?
ii. Determine the new profit-maximizing prices and quantities in
both markets. Compare the total profit under this strategy
with the previous one.
(c) Same price for both the markets:
i. Suppose the government mandates that monopolists cannot
charge different prices in different markets. How do the mar-
ket price, the quantity and the profit earned change for the
monopolist?

10. A monopolist operates in two markets, A and B, with marginal costs

M CA = 20 and M CB = 30, respectively. The elasticity of demands for
both the markets are ϵA = 1 and ϵB = 1.2. Write down the market
price ratio.