1. Mp34u. Music Ventures sells a very popular mp3 player, the mp34u.
The firm
currently sells one million units for a price of $100 each. Marginal cost is estimated to
be constant at $40, whereas average cost (at the output level of one million units) is
$90. The firm estimates that its demand elasticity (at the current price level) is
approximately -2. Should the firm raise price, lower price, or leave price
unchanged? Provide calculations and explain. Hint: think about optimal pricing
MC
According to optimal price f ormula : p = 1+ 1e
40
p= 1
1+ −2
= 80$
and using all given numbers, the optimal price should is 80$ (but demand at this price will
change, quantity also).
The firm should lower the price.
2. Carbon tax. Consider an industry with demand q = 1– p and supply q=p. Suppose that
each unit of output implies one unit of CO2 added to the atmosphere and a marginal social
cost of e, where e is the total level of emissions.
(a) What is the level of CO2 emission at the market equilibrium?
(b) What is the socially optimal level of CO2 emissions?
(c) Determine the Pigou tax that achieves the social optimum.
a) D=S
1-p=p
2p=1
p*=0.5 q*=0.5
Level of CO2 emission at the market equilibrium is q=e=0.5
b)
The total marginal cost of producing a qth unit is given the sum of production marginal cost
and social marginal cost- curve S+c. The socially optimal output level is the point where
S+c crosses the demand curve.
In our case:
D: q=1-p S+c: q=p-e
Soc. optimal equilibrium: D=S+c
1-p=p-e
2p=1+e |:2
p*= 1+e
2 q*=1- 1+e
2 =
1−e
2
If we say that e=q, than
1−q 1
q*= 2 → 2q = 1 − q → 3q = 1 → q = 3
1+ 13 2
p*= 2 = 3
1 2
The quantity drops from 0.5 to 3 and the price increase to 3
c) Determine the Pigou tax that achieves the social optimum.
pigou tax = a tax on any markets that creates negative externalities. We have to impose an
output tax if the externality is negative -> a tax is levied on suppliers for each output unit.
S+t: q=p-t
1+e
t=p−q = 2 -q
If we say that e=q
1+q 1−q
t = 2 -q= 2
The social optimum is q = 1/3 .
Then
1− 13 1
t= 2 = 3
3. Multiple two-part tariffs. Consider the model of non-linear pricing introduced in Section
6. Suppose there are two types of consumers, in equal number: type 1 have demand 𝐷1(𝑝) =
1 – 𝑝, and type 2 have demand 𝐷2(𝑝) = 2 (1 − 𝑝). Marginal cost is zero.
Show that if the seller is precluded from using non-linear pricing, then the optimal price is = 21
. With such optimal price what profit (per costumer) seller gets?
Hint: think about the way we find optimal price, first.
Dall = 1 − p + 2(1 − p) = 3(1 − p)
Dall = 3(1 − p) q = 3(1 − p) p =− 13 q + 1
MC = 0
1
p (optimal) = 2
The seller must use linear pricing
d R(q) d q(− 13q+1) d − 13q 2 +1q − 23q +1
MR = dq = dq = dq = 1 = 1 − 23 q
MR=MC
1 − 23 q = 0
− 23 q =− 1| : (− 23 )
3
q= 2
p =− 13 q + 1 =− 1
3
3
* (2) + 1 =
1
2
With constant value 'zero' of marginal cost, the value of average cost is also
constant and is equal to zero. So profit=revenue
3 1
Π=R→Π=q×p= 2 × 2 = 0.75
