Problem Set 4

Name:

Problem Set 4 is due by 11:59 p.m. (ET) on Friday of Module/Week 8.

1.      Monopolies can sometimes find themselves in difficult financial situations that lead to losses. Suppose Mr. Burns’ power company has a monopoly for providing electricity in Springfield. His costs of upkeep are so high that he is consistently losing money.

a.)    Show this outcome in a completely labeled graph. Clearly identify all parts of your graph, including the best price and output for the firm as well as the losses.

A=P1     B=P2      C=P3      D=Demand     F=Where P1 falls on the demand curve.       G=Where B intersects the marginal and average total costs.     H= Indicates where C intersects the Marginal Revenue and the marginal cost.

If Mr. Burn is incuring losses, C would be an example of this since his price would be below the ATC. At P1, or A, we see him earning a profit since he is able to charge prices over his costs.

Now, answer the following:

b.)    What happens to the market output when Mr. Burns raises the price he charges?

The output remains relatively the same since he is the only producer of electricity in the town.  Therefore the demand will not change since everyone uses electricity.

c.)    Will this stop his losses? Why or why not?

In theory, a raise in prices (or above costs) should stop his losses because he offers a product that has an inelastic demand. Consumers are willing to pay the extra price in order to keep electricity.

1. Assume the following game is played one time only. Based on the information in the payoff matrix below, PNC Bank and Citizens Bank are considering an implicit collusive agreement on interest rates. Payoffs to the two firms are represented in terms of profits in thousands of dollars.

Citizens Bank

Collude: Raise Rates

Defect: Keep Rates Where They Are

PNC

Collude: Raise Rates

(900, 600)

(700, 800)

Defect: Keep Rates Where They Are

(1100, 300)

(800, 400)