Question 1: Suppose you are a monopolist of a parking garage that rents parking spots out by
the hour. You have 100 spots available to rent. Inverse demand for parking spots is given by
p(q) = 64 − 4q. While you could always sell the parking garage to commercial developers, on any
given day the marginal cost of renting out a stall is zero.
What is your profit function?
What is the first order condition corresponding to your profit maximizing problem?
What are your profits and what is consumer surplus?
You notice someone sitting in their vehicle and staring blankly out the window. Concerned,
you ask the person whether he is alright. He responds that he is fine, that he had to run
into a store for 5 minutes, but intends to make use of the remaining 55 minute because he
paid for the full hour. Comment.
Question 2: You own and operate a cupcake store that is adjacent to a muffin shop; all that separates the two businesses is a wall. Your cost function is C(q) = 36 − 2q + q2, where q represents
the number of cupcakes produced and the 36 represents what the salary you pay your head baker.
The muffin shop next door has cost function C(q) = 36 − 4q + q2 where q represents the number
of muffins produced and which also employs a head baker at a wage of 36.
(a) Which of the cupcake or muffin shop have economies of scale? If so, up to what level of
(b) Suppose you purchased the muffin shop next door which would allow you to fire one of
the head bakers. Is this an example of you exploiting economies of scale or economies of
Question 3: Suppose you are a monopolist airline on a given route. You know that you have two
types of customers: tourists who are price sensitive and business travelers who are not. While
you can usually tell them apart in person, when they book tickets online you find it impossible
to differentiate them. All you know is that tourists tend to plan vacations weeks if not months
in advance, while business travelers only know when their next meeting will be within a week’s
notice. An economist suggests that you adopt the following pricing scheme: when the flight is
more than a week away, set a price equal to the tourists’ willingness to pay and when the flight is
within a week’s time, set a price equal to the business people’s willingness to pay.
(a) What are the three prerequisites necessary for a successful third degree price discrimination scheme?
(b) How does this pricing scheme effectively prevent business people from “pretending” to be
tourists to obtain lower prices?
(c) Does this scheme seem to satisfy the three prerequisites in (a)? Explain.
Question 4: As we will see later in the course, The Economist has alleged that U.S. airlines are
colluding because even though marginal costs of airlines (i.e. fuel prices) have decreased, ticket
prices haven’t fallen.
Suppose all U.S. airlines were in fact monopolized (i.e. owned by a single firm) and that the
marginal costs of that airline fell. What rule of monopoly pricing that we have developed predicts
that even when a monopolist’s marginal costs fall, output increases and prices decrease?
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