A risk-neutral monopoly must set output before it knows the market price.There is a 50 percent chance the firm's demand curve will be P = 20 − Q and a 50 percent chance it will be P = 40 − Q.The marginal cost of the firm is MC = Q.The profits are maximized in the expected sense when:

Question

Quizplus · Accepted Answer

In order to maximize profits in the expected sense for a risk-neutral monopoly, it should choose the quantity that equates its expected marginal revenue (EMR) to its marginal cost (MC). Since the demand curve is uncertain, we need to take the expected value of both demand curves.

EMR = (1/2)(20-Q) + (1/2)(40-Q) = 30-Q/2

Now, we set EMR equal to MC:

30-Q/2 = Q

Solving for Q, we get:

Q = 20

Substituting Q back into either demand curve, we get:

P = 20

Therefore, the monopoly should produce a quantity of 20 and set the price at 20, which maximizes expected profits. Hence, the correct answer is D, MC = E(MR).

A Risk-Neutral Monopoly Must Set Output Before It Knows the Market