Question

1. Amanda Enterprises Inc. (AEI) is a profit-maximizing firm. It has a patent for a unique smartphone application called Pandagram. a. Assume that AEI is making an economic profit. Draw a correctly labeled graph and show the profit-maximizing price and quantity as Pm and Qm. b. Assume that the state government increases AEl's annual property taxes. i. What will happen to output and market price in part (a)? Explain ii. What will happen to AEl's profits? c. Now instead, assume that the state grants a per-unit subsidy to AEl for Pandagram. i. What will happen to output and market price in part (a)? Explain il. What will happen to AEl's profits?

Answer 1

1.a. When earning economic profits, AEI produces at MR=MC point. The price is Pm and quantity Qm. At Pm price, average cost is at Cm. The box Pm14Cm is the profit generated.

b.i) A annual property tax will increase the fixed cost of AEI. There will be no impact on marginal cost as variable costs are unchanged. So quantity and price will remain unchaned at MR=MC.

ii) Due to rise in fixed costs, average costs rise from AC to AC'. Average revenues being unchanged, Profits will decrease due to rise in costs. The new profit is denoted by the box - Pm13C'.

c.i) A per unit subsidy will decrease marginal cost as well as avergae costs. MC decreases to MC' and AC decreases to AC''. The new profit maximization condition is MR=MC'. Now more output is produced at Q'' at a lower price of P''.

The new profits is denoted by box - P''25C''. Visually we can see this box is larger and so profits have increased. However this is intuitive as well. Since MR is rising, this means the monopolist produces at elastic part of the demand curve. In that case a decrease in price raises total revenue (and so AR). While on the other hand there is a fall in total costs (and hence AC & MC) due to the per unit subsidy. So TR is rising, TC is falling. This clearly indicates an increase in profits.