Question

3. There are two individuals looking to rent apartments in a neighborhood-consumer It is willing to pay $5.000 a monthly rent and consumer L is only willing to pay $3.000 monthly rent The valuation of the rental for each consumer is given below. Value of Group Apartment to Consumer 2000 55.000 The marginal cost of providing an apartment for rent is $1,000 for each apartment, MC = $1,000 Suppose there is a perfectly competitive rental market in this neighborhood Page 2 of 4 a) What will the monthly rent be? b) Who will rent at this price? c) What is the consumer surplus? Producer Surplus? Total Surplus? What if instead there is a single landlord who owns all apartment buildings in this neighborhood so it is a monopoly market a) Fill in the appropriate values for demand, revenue and profits for each price in the table below: Price Number of cars Total Revenue Profit sold, O TR $2,000 $5,000 b) What is the monopoly quantity? c) What is the monopoly price? d) Calculate the consumer surplus, producer surplus and total surplus e) Compare the efficiency of the markets across the two forms of competition and explain in the context of this example, why perfect competition provides allocative efficiency, while monopoly does not

Answer 1

1/A).

Let’s assume that the market is competitive and there are two types of consumers “consumer H” having valuation “$5,000” and “consumer L” having valuation “$3,000”. Now, under the competitive market the price should be equal to “MC”. So, here the monthly rent is “P = $1,000”.

1/B).

There are two types of consumers “consumer H” having valuation “$5,000” and “consumer L” having valuation “$3,000”, both the valuation is more than “$1,000”, => both types of consumer will rent at this price.

1/C).

Here the “consumer surplus” is the value to buyers after participating in the market, => CS = (5,000 -1,000)+(3,000-1,000) = $6,000. Now, the “producer surplus” is the value to sells after participating in the market, => PS =$0, because “P=MC”.

So, the “Total Surplus” is the sum of “CS” and “PS”, => TS = $6,000 + $0 = $6,000.

2/A).

Consider the following table below.

Q Price $2,000 $5,000 TR Profit $4,000 ($4,000 - $2,000) = $2,000 $5,000 ($5,000 - $1,000) = $4,000 1

Here if “P=$2,000 < $3,000” implied both the types of buyer will able to purchase the apartment, => “Q=2”, => TR = $2000*2 = $4000”. Now, if “P=$5,000 > $3,000” implied only “consumer H” will be able to purchase the apartment, => “Q=1”, => TR = $5,000*1 = $5,000”.

B, C).

Here if the monopolist charge “P=$3,000” implied both the types of buyer will able to purchase the apartment, => “Q=2”, => TR = $3000*2 = $6000”. So, the level of profit is “($6,000 - $1,000*2) = $4,000.

Now, if the monopolist charge “P=$5,000 > $3,000” implied only “consumer H” will be able to purchase the apartment, => “Q=1”, => TR = $5,000*1 = $5,000”. So, the level of profit is “($5,000 - $1,000) = $4,000”.

So, here in both the cases the level of profit is same implied monopolist will charge “P=3000” and both the types of consumer will purchase the apartment.