Chapter 16: Problems 4, 6(a, c), 9
4. What are the incentives to innovate for a monopoly firm’s as compared with a firm in
a competitive market if patent protection is not available.
A monopolist without patent protection would still have strong incentives to innovate, in order to
maintain the monopoly position and profit levels of the firm. The competitive firm would be forced
to innovate in order to survive, since there is no cushion of monopoly profits to fall back on. By
staying ahead of competition, innovation is a way to earn above-normal profits until others catch up.
In the case of a monopolist with patent protection, the incentives to innovate are likely to be reduced.
The monopolist might carry out an extensive research and development program, but delay bringing
innovations to the market unless they are clearly and immediately profitable, or unless they are
needed to forestall new competition.
6. The industry demand function for bulk plastics is represented by the following equation:
Where Q represents millions of pounds of plastics
The total cost function for the industry, exclusive of a required return on invested capital, is
+ 500Q +10Q2
Where Q represents millions of pounds of plastic
(a) If this industry acts like a monopolist in the determination of price and output, compute the
profit –maximizing level of price and output
(b) What are total profits at this price and output level?
© Assume that this industry is composed of many (500) small firms, such that the demand
function facing any individual firm is
P=$620
Compute the profit-maximizing level of price and output under these conditions (the industry’s
total cost function remain unchanged)
The bulk plastic industry analysis:
a. P = 800  20 Q
TR = 800Q  20 Q2
TC = 300 + 500 Q + 10 Q2
MC = 500 + 20 Q
MR = 800  40 Q
MC = MR, implies: 500 + 20 Q = 800  40 Q, or 60 Q = 300, or Q* = 5
P* = 800  20(5) = 700.
b. Profit = TR – TC = P∙Q  [ 300 + 500 Q +10 Q2 ] at P = $700 and Q = 5.
 * = 5(700)  [300 + 500(5) + 10(5)2] = $450 (million)
c. MC = MR, as is the case in competition.
500 + 20Q = 620, or 120 = 20 Q, or Q* = 6 and P* = $620.
d. * = P∙Q - [300 + 500 Q +10 Q2] = 6(620)  [300 + 500(6) + 10(6)2] = $60 (million)
e. Rate of return (monopoly) = 450,000,000 / 2,000,000,000 = 22.5%, so under monopoly, profits
are "above normal."
Rate of return (competition) = 60,000,000 / 2,000,000,000 = 3%, so under competition, profits are
well "below normal."
f.
With below normal profits, some of the firms would be expected to leave the industry, thereby
reducing supply, increasing prices and profits until a "normal" profit level is achieved.
g. With an increase in costs to TC = 400 + 560Q + 10Q2
MC = 560 + 20Q. Assuming monopoly, MC = MR, so 560 + 20Q = 800  40Q, or 60 Q = 240.
Now Q* = 4 and P* = 720
 = 4(720)  [400 + 560(4) + 10(4)2] = $80 (million) (or a 4% rate of return)
h. If the standards are imposed only on Texas firms, these firms may be forced to close down or
move. If they close down, the reduced supply could be expected to result in increased prices (in
the short run) and possibly increased profits for the rest of the industry.
9. Branding Iron Products, a specialty steel fabricator, operates a plant in the town of West Star,
Texas. The town has grown rapidly because of recent discoveries of oil and gas in the area. Many
of the new residents have expressed concern at the amount of pollution (primary particulate
matter in the air and waste water in the town’s river) emitted by Brandon Iron. Three proposals
have been made to remedy the problem:
(a) Impose a tax on the amount of particulate matter and the amount of waste water emitted by the
firm.
(b) Prohibit pollution by the firm
( c) Offer tax incentives to the firm to clean up its production processes.
Evaluate each of these alternatives from the perspectives of economic efficiency, equity, and the
likely long-term impact on the firm.
Branding Iron Products pollutes the air and water.
a. The tax alternative is desirable in that it internalizes costs to the firm, causing it to adjust
its price, output, and production technology in order to maximize profits, while
considering the cost of the externalities it generates. The most difficult aspect of this
alternative is specifying the amount of pollution tax rate so that the firm will reduce its
pollution to a "satisfactory" level.
b. It is probably not desirable to absolutely prohibit pollution by the firm, since it is likely
that the cost of eliminating the last few percentage points of pollution will be very high.
Like the Coase Theorem, if Branding Iron has a property right to pollute, it could be paid to
reduce that pollution. Indeed, there is a presumption that Branding Iron was operating for
some time before the “new residents” start to complain.