Question

A dairy farmer is a monopolist in the milk industry and is currently selling milk at the profit maximizing price. As a result of a terrible storm, the dairy farmer sees an increase in cost of feed for the cows. At the same time, the dairy farm receives an insurance check which effectively lowers the fixed costs of the farm. What effect will this cost change have on the optimal price of milk the farmer sets?

which answer of the below?

The change in costs does not impact the profit maximizing price and quantity sold for the dairy farmer.

The increase in variable costs will decrease the optimal price that should be set by the farmer.

The increase in variable costs will increase the optimal price that should be set by the farmer.

The impact on price cannot be determined due to some costs increasing, and other costs decreasing.

Answer 1

As given in the question, the variable cost has increased. This means that the cost per additional unit or the marginal cost would also have risen.

Also we know that the marginal revenue is equal to the marginal cost in case of profit maximising level, so here the marginal cost would be more than the marginal revenue. This would mean that the farmer would need to increase the price of the milk, in order to get the optimal marginal revenue which would be equal to the marginal cost and hence the profit maximising level. Hence the farmer would need to increase the optimal price because of the increased variable cost.

Hence answer would be option C)