ECON0051 Economics of Regulation
Sample Exam Question No. 3
AY2023/24
Question on Topic ‘’Ramsey Pricingí (related to lecture Week 7 and PS3) Suppose monopolist produces two services, 1 and 2. Further suppose the firm's total cost (in British Pounds) of supplying q1 units of service 1 and q2 units of service 2 is:
c (q1 ; q2 ) = 1800 + 20 (q1 + q2 ) .
Suppose the demand functions for the two services are, respectively:
q1 = 100 - p1
q2 = 120 - 2p2
(a) If the regulator of the monopolist set the price of each service equal to marginal cost, what prices would prevail? And what profit-level would these prices generate for the monopolist?
Then suppose the regulator raises the marginal cost price of each service by the same proportion x until the firm's total revenue is equal to total cost. Compute these increased prices and the corresponding quantities sold.
(b) Suppose now that the regulator, who is fully informed of the monopo- list's demand functions, proposes a Ramsey pricing scheme. Describe briefly what Ramsey prices are and then compute the Ramsey prices and the cor-responding quantities (assuming the firm breaks even)? Justify your answer by checking second-order conditions. Compare the welfare loss (relative to marginal cost pricing) of the Ramsey prices with that of the proportionally raised marginal cost prices from part (a). Interpret your findings!