Assume Home’s demand curve for gadgets is D = 1250-P/2, which you can invert to get P = $2500 – 2D. Assume there is one Foreign firm that has a monopoly on gadget production, and its marginal cost of production is a constant $400.
a) If the foreign firm sold gadgets at a price equal to marginal cost, how many gadgets would Home import?
b) Suppose the foreign firm maximized its profits, and because demand is linear we know that MR = $2500 – 4D. Solve for the profit-maximizing quantity and price? If the monopoly had to pay a fee of $200,000 to its government, how much profit would it have remaining if there were no other fixed costs? How much would the monopoly change Home’s consumer surplus, relative to (a) above?
c) Suppose the Home government imposed a tariff of $50 on each imported gadgets, effectively increasing marginal cost from $400 to $450. Solve for the new profit-maximizing quantity and price. How much would the foreign monopoly profits change, relative to your answer in (b)? How much would the tariff change Home’s consumer surplus, relative to (b)? How much revenue would Home’s government earn? Is Home better off or worse off with the tariff?