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A natural monopolist facing demand curve p = 18 2q with average costs AC = 12 0.5q sells output...

Question:

A natural monopolist facing demand curve p = 18 2q with average costs AC = 12 0.5q sells output using a two-part tariff. How much profit will this firm earn?

Monopoly

Monopoly is one of the various forms of a market structure. In this market form, there is one seller and many buyers. A monopolist sells the good which has no close substitute due to which it is the price maker. A monopolist does price discrimination to earn maximum profits.

Answer and Explanation: 1

Given:

The demand and average cost function is:

{eq}\begin{align*} p &= 18 - 2q\\ AC &= 12 - 0.5q \end{align*} {/eq}

The total cost and the marginal cost functions are:

{eq}\begin{align*} TC &= AC \times q\\ &= \left( {12 - 0.5q} \right) \times q\\ &= 12q - 0.5{q^2}\\ MC &= \dfrac{{dTC}}{{dq}}\\ &= 12 - q \end{align*} {/eq}

In a two-part tariff system, one part is the fixed fee and the other part is the quantity times the per unit price of the good charged.

The fixed fee is set as equal to the consumer surplus gained if the market would have been under perfect competition.

To calculate the equilibrium price and quantity under perfect competition, put p=MC:

{eq}\begin{align*} p &= MC\\ 18 - 2q &= 12 - q\\ q &= 6\\ p &= 6 \end{align*} {/eq}

So, the consumer surplus when p is equal to $6 and q is equal to 6 units is:

{eq}\begin{align*} CS &= 0.5\left( {18 - p} \right)\left( {q - 0} \right)\\ &= 0.5\left( {18 - 6} \right)\left( {6 - 0} \right)\\ &= 36 \end{align*} {/eq}

Therefore, the fixed fee charged is $36.

The total revenue (TR) function for the monopolist under two part tariff is:

{eq}TR = 36 + pq {/eq}

Let the profit earned be represented by x.

{eq}\begin{align*} x &= TR - TC\\ &= 36 + pq - \left( {12q - 0.5{q^2}} \right)\\ &= 36 + 36 - 72 + 18\\ &= 18 \end{align*} {/eq}

So, the monopolist will earn a profit of $18.


Learn more about this topic:

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What is a Monopoly in Economics? - Definition & Impact on Consumers

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Chapter 7 / Lesson 2
35K

Understand the meaning of a monopoly in economics and what it does. Also, know the characteristics of a monopoly and the different types of monopolies.


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