Consider a monopolist that faces inverse demand p(q) = 120 q. The monopolist has

Question

Consider a monopolist that faces inverse demand p(q) = 120 q. The monopolist has the cost function C(q) = 40q.

(a)Solve for the monopoly price and quantity.

Suppose the government has decided to tax this monopolist and let 0 < < 1 be the tax rate they will impose. However, the government is still debating whether to impose this tax on the monopolist’s total revenue or on the monopolist’s profit.

(b)Which tax is more likely to cause the monopolist to reduce output? Explain why. Hint: You may find it useful to write out the monopolist’s profit function under either tax scenario.

Explanation / Answer

MR=120-2Q

MC=40

Thus monopoly will produce af a point where MR=MC

120-2Q=40. Then Q=40 and P=80

B) tax on revenue will likely be causing a decrease in output because tax on revenue will change the marginal revenue and thus change the output decision because MR=Mc is the equilibrium condition for producer.

But tax on profit will not affect the decision or quantity choice because MR and MC is not changed.

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