4. Assume a monopolist is operating in two markets. The inverse demand functions
ID: 1133900 • Letter: 4
Question
4. Assume a monopolist is operating in two markets. The inverse demand functions in the two markets are given by P-P1(Q1) and P2-P2(Q2 The good is produced in one factory, so the cost function is given by (a) We know that a monopolist produces where MR-MC to maximize profits when operating in one market. Provide a similar profit-maximizng condition relating the marginal revenues in the two markets, MR, and MR2 , and the marginal cost, in each market? the two markets MC (b) Does the monopolist produce on the elastic portion of the demand curve (c) Provide an expression that relates the prices and demand elasticities in (d) A competitor enters the first market (but not the second market), resulting in consumers in the first market becoming more responsive to changes in P1 . How does this affect the monopolist's profit-maximizing price in the first market? Does the competitor entry affect the monopolist's profit-maximizing price in the second market?Explanation / Answer
a) profit is maximised when price in each market is set according to MRi = MC.
That is MR1= MC and MR2= MC
b) Yes the monopolist produces on the elastic portion of demand curve so that when it decreases price and quantity demanded increases. This leads to increase in total revenue.
c) following is the expression for relationship between prices and elasticities.
P1/P2 = (1+1/e2)/(1+1/e1)
Where e1 and e2 are demand elasticities in market 1 and 2 respectively.
d) when a new firm enters the first market, it brings competition in the market which reduces monopolist's profit maximising price in first market. There is no effect on entry in second market as markets are well sepearated and there is no arbitrage.
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