A bakery is a monopolist in a certain village. For simplicity suppose the bakery
ID: 1109572 • Letter: A
Question
A bakery is a monopolist in a certain village. For simplicity suppose the bakery has only one product. A croissant. Further suppose there are only two customers. Angel and Belen. The bakery knows that Angel is willing to pay 1 euro for the croissant and Belen is willing to pay 30 cents. Production cost are 10 cents. (a) Suppose Angel calls the bakery and wants to order a croissant for the next morning. Which price would the profit maximizing bakery tell him? Later that night Belen calls and also wants to order. Which price is the bakery charging her? (b) The mayor of the village finds it unfair that Angel and Belen are charged different prices. She decides to change the law such that the price has to be the same to everybody. Given this restriction, which price would the bakery charge? Who benefits from this regulation? Who suffers? Is the total surplus higher or lower after the change of the law? (c) Can you come up with an alternative regulation that ensures the same price to Angel and Belen but leads to higher total welfare than the situation in (b). Compare your solution to (a). A bakery is a monopolist in a certain village. For simplicity suppose the bakery has only one product. A croissant. Further suppose there are only two customers. Angel and Belen. The bakery knows that Angel is willing to pay 1 euro for the croissant and Belen is willing to pay 30 cents. Production cost are 10 cents. (a) Suppose Angel calls the bakery and wants to order a croissant for the next morning. Which price would the profit maximizing bakery tell him? Later that night Belen calls and also wants to order. Which price is the bakery charging her? (b) The mayor of the village finds it unfair that Angel and Belen are charged different prices. She decides to change the law such that the price has to be the same to everybody. Given this restriction, which price would the bakery charge? Who benefits from this regulation? Who suffers? Is the total surplus higher or lower after the change of the law? (c) Can you come up with an alternative regulation that ensures the same price to Angel and Belen but leads to higher total welfare than the situation in (b). Compare your solution to (a). A bakery is a monopolist in a certain village. For simplicity suppose the bakery has only one product. A croissant. Further suppose there are only two customers. Angel and Belen. The bakery knows that Angel is willing to pay 1 euro for the croissant and Belen is willing to pay 30 cents. Production cost are 10 cents. (a) Suppose Angel calls the bakery and wants to order a croissant for the next morning. Which price would the profit maximizing bakery tell him? Later that night Belen calls and also wants to order. Which price is the bakery charging her? (b) The mayor of the village finds it unfair that Angel and Belen are charged different prices. She decides to change the law such that the price has to be the same to everybody. Given this restriction, which price would the bakery charge? Who benefits from this regulation? Who suffers? Is the total surplus higher or lower after the change of the law? (c) Can you come up with an alternative regulation that ensures the same price to Angel and Belen but leads to higher total welfare than the situation in (b). Compare your solution to (a).Explanation / Answer
A monopoly is the market structure where there is only one seller selling the products and the products don't have any close substitutes. In the case given above the bakery is a monopoly and selling croissant which doesn't have any close substitutes.
a) As the bakery know that Angel is ready to give 1 Euro for the product, the profit maximising bakery will sell her the croissant at the maximum price which he can get from Angel. That is 1 Euro and earn a profit of 90 cents over and above his production cost.
The bakery knows that Belen is not going to pay 1 Euro for a croissant but only 30 cents so he will charge her only 30 cents and earn the profit of 20 cents in the process.
b) After the mayor of the village has changed the law the bakery will charge same 30 cents for both the customers (He cant charge more than that because in that case, he will lose Belen as a customer).
Angel will benefit largely from the regulation as she has to pay only 30 cents instead of 1 euro for the croissant. The main person suffering from the regulation will be the Bakery, as his profit has reduced significantly.
After the change in the law, the total surplus is same but transferred from producer's surplus enjoyed by Bakery to consumer's surplus enjoyed by Angel.
c) There are two things which can be done in the given situation which can lead to a higher surplus.
In comparison to the solution (a) introducing more shops and competition in the village will provide the people with a substitute where they can buy the croissant at a much lower price. This will reduce the monopoly power of bakery and force him to serve the consumer at a lower price.
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