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Assignment #2 13W-Solution Econ 471 Ubc

1) The document discusses monopoly and oligopoly market structures in mining and power supply industries. It sets up Lagrangian maximization problems to solve for equilibrium prices and quantities under different market conditions. 2) For a monopoly mining firm, the Lagrangian analysis shows there is no scarcity rent since marginal revenue equals marginal cost at the competitive level of output in both periods. 3) For a power supply market, the analysis compares outcomes under perfect competition, cartelized large firms with competitive small firms, and full monopoly. Equilibrium prices and quantities are higher when market power increases.

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110 views4 pages

Assignment #2 13W-Solution Econ 471 Ubc

1) The document discusses monopoly and oligopoly market structures in mining and power supply industries. It sets up Lagrangian maximization problems to solve for equilibrium prices and quantities under different market conditions. 2) For a monopoly mining firm, the Lagrangian analysis shows there is no scarcity rent since marginal revenue equals marginal cost at the competitive level of output in both periods. 3) For a power supply market, the analysis compares outcomes under perfect competition, cartelized large firms with competitive small firms, and full monopoly. Equilibrium prices and quantities are higher when market power increases.

Uploaded by

LB
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Question 1

Consider a two-period mine (periods 0 and 1) industry that is owned by a monopoly


firm. Let interest rates, demand, extraction costs, and initial stock be give by: r = 5%,
P(Qt) = 100 – Qt/2, MC = $50/barrel, S0 = 150 barrel. (4+5+6 points)
(a) Set up the maximization problem and Lagrangian for this monopoly firm.

Maximize
P1Q1  50Q1
  P0 Q0  50Q0 
1.05
(100  0.5Q1 )Q1  50Q1
 [(100  0.5Q0 )Q0  50Q0 ] 
1.05
subject to Q0  Q1  150

Lagrangian:
50Q1  0.5Q1
2

L  50Q0  0.5Q0    (150  Q0  Q1 )


2

1.05

(b) Solve the above maximization problem using Lagrangian multiplier method.
Calculate the scarcity rent. Test if you get negative rent; if scarcity rent is
negative, then that means scarcity rent is zero. Use the correct method to solve
this maximization problem.

Differentiating,
L
 50  Q0    0  50  Q0   ......(1)
Q0
L 50  Q1 50  Q1
   0   ......(2)
Q1 1.05 1.05
L
 150  Q0  Q1  0  Q0  Q1  150 ......(3)


From (1) and (2):


50  Q1
50  Q0 
1.05
1.05Q0  Q1  2.5 ..........................(4)

Add (3) and (4) to get,


2.05Q0  152.5
Q0  74.39
Q1  150  74.39  75.61
Scarcity rent in period 0 = MR0 - MC0 = 50 - Q0 = 50 – 74.39 < 0. Similarly
discounted scarcity rent in period 1 < 0. This implies that there is no scarcity of
this resource given the monopoly market structure. When there is no scarcity,
the miner will maximize discounted value of the profits when MR - MC = 0 in
both the periods.

MR0 - MC0 = 50 - Q0 = 0 → Q0 = 50 and


(MR1 - MC1)/1.05 = (50 - Q1)/1.05 = 0 → Q1 = 50

You may also solve graphically:

50

47.62
MR1  MC1
MR0  MC0
1 r

Q0 50 50 Q1
150

Question #2
The market for power supply in Lower Mainland, BC consists of 4 large and 10 smaller
firms. The large firms each has a cost function as follows: CL = 0.5qL2. The small firms
each has a cost function as follows: CS = 5qs2. The market demand curve is: P = 1200 –
Q. (5+10+5points)
(a) Calculate the equilibrium price and quantity that would prevail if all firms act as
competitive price-taking firms?

i) Market Supply Curve:


Supply curve of one large firm: P = MC = qL
So total supply curve of 4 large firms is:
QL = 4qL = 4P
Similarly, total supply curve of 10 smaller firms is:
QS = 10qS =10 (P/10) = P.
The total market supply is given by:
Qs = QL + QS = 5P
ii) At the competitive equilibrium, Qs = Qd.
5P = 1200 – P
P = $200 and Q = 1000.

(b) What are the equilibrium price and total quantity when the 4 large firms act as a
cartel, and the remaining smaller firms take the price determined by the cartel as
given? Draw a diagram to illustrate your results.

Demand faced by 4 large (dominant) firms


QL = Qd – QS = 1200 – P – P = 1200 – 2P
or P = 600 – 0.5Q and MRL = 600 – Q.
To maximize profits, dominant firms set MR = MC
600 – Q = Q/4
5Q/4 = 600
QL = 480
Price determined by the dominant firms
P = 600 – 0.5 *480 = $360.
The smaller fringe firms take this price as given and produce QS = P = 360.
Thus the total production Q = QL + QS = 480 + 360 = 840
$
1200
MCS

MCL
600

360

DL D

MRL

360 480 840 1200


Q

(c) If all of these 14 firms merge together and act as a single firm, what would be the
resulting equilibrium price and quantity?

P = 1200 – Q; MR = 1200 – 2Q ;
Rewriting total supply curve (that is Q = 5P), MC = Q/5
The monopolist maximizes Profits at MR = MC
1200 – 2Q = Q/5
11Q/5 = 1200
Q = 545.45
Substituting the value of Q into demand function,
P = 1200 – 545.45 = $654.54

Question #3
Should the gasoline taxes in the United States or Canada be higher than the current
level? What are the possible objections to higher gasoline taxes? Can you think of a
policy that would address these potential objections to higher taxes? (Hint: Read Topic
7 and its supplement readings to answer this question. Your answer should be typed
(no hand written), not more than one page in 11-12 font size, and single spaced (15 pts)

Answers may vary and so NO answer is provided !

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