Professional Memo

MONOPOLY

Practice Problems

Answer Key

1. True, false or uncertain? Explain your answer.

a. A decrease in the firm’s fixed cost will change its profits, but will not influence the firm’s decision about how much good to produce.

True. A one-time change in the size of the fixed cost does not affect any part of the profit maximization condition (MR=MC). Therefore, the optimal output will remain the same.

On the other hand, Total Profit = TR – TC = P · Q – TC. An increase in fixed cost will increase total cost, so the profit will decrease.

b. When the fixed cost of a firm increases, the best thing the firm can do is to increase its price in order to compensate for the cost increase.

False. The change in the fixed cost doesn’t change our profit maximization point (we should keep producing and selling the same amount as before). So our price shouldn’t change as well, because otherwise we won’t be able to sell the same amount.

2. If a profit-maximizing firm finds that, at its current level of production, MR > MC, it will

a) earn greater profits than if MR = MC.

b) increase output.

c) decrease output.

d) shut down.

3. Suppose you have found out that the good your firm produces and sells has unit price elasticity of demand in a wide range of prices. Given that, can you increase your profits by changing the price of this good? If yes, explain carefully what that change should be. If not, explain why it is not possible.

Profit = TR - TC.

Since the price elasticity of demand is equal to one, total revenue will not change as a result of a change in price (and therefore quantity produced). However, we can decrease our total cost by producing less (and therefore charging higher price according to the law of demand).

So, if we increase our price, we can produce less. Our TR will stay the same, but TC will decrease. As a result, profit will increase.

4. Two tables below contain information about the total cost of the firm...