McCullough has a monopoly on rental dwellings in the local community.

McCullough has a monopoly on rental dwellings in the local community. The demand for rental dwellings is QD = 70,000 – 50P  P = 1,400 – 0.02 QD. The resulting marginal revenue function is MR(Q) = 1,400 – 0.04 QD.

McCullough’s marginal cost of providing rental dwellings is MC(Q) = 0.01Q + 20. Suppose that to ease the burden on renters, the local community has instituted a price ceiling of $480. Does consumer surplus increase due to this price ceiling? Does social welfare increase as a result of the price ceiling?

ANSWER

Before the price ceiling is imposed, McCullough was charging a price of $832 per unit. Since McCullough has market power, we know that social welfare is less than it would be fore a competitive market. A competitive market sets price equal to marginal cost. At $480, demand is 46,000. Marginal cost at 46,000 is exactly $480. This means that the profit maximizing solution for McCullough is to provide 46,000 units at the price ceiling of $480 per unit. Since the price equals marginal cost, the market enjoys the competitive market price. In this case, we know that societal welfare exceeds welfare in a monopoly market.