Raphael works for a firm that is a monopolistic provider of cable TV services in a small town. At the present time, the firm charges $45 per month for basic cable service. The demand for cable TV in this town has been estimated to be
Q = 12,000 - 120P
where Q is the number of subscribers and P is the monthly price for basic cable. Thus, 6,600 residents currently purchase cable TV services from Raphael's firm. Cable TV is an industry with high fixed costs but low marginal cost - in fact, the best estimate of the firm's cost of providing cable services to one more household is close to zero (so, let's take MC to be zero for this firm). Is Raphael's firm charging the right monthly rate? How do you know? If they are not charging the right price, what rate should they be charging?
Suppose now that the government has decided to tax the cable TV industry (the government doesn't like the amount of sex and violence on cable). A law is enacted that requires cable providers to pay $1.50 to the government per subscriber (the money is to be used to pay for educational programs on public television). Raphael's boss doesn't know what to do - should he leave the monthly rate at $45? Should he raise the monthly rate by $1.50 to offset the tax? He asks Raphael for advice. What should he tell his boss to do? That is, what is the new profit- maximizing price? How much of the tax is paid for by the firm? Compare your answer to this problem with the answer to #1 of Problem set 4. Based on this comparison, who passes on more or a tax increase to their customers (through higher prices), monopolists or perfectly competitive firms and why?