2) Consider the problem of the upstream and downstream monopolist (pg 510 in Varian). Suppose the upstream monopolist faces a constant marginal cost of MCupstream = 1. Suppose the upstream monopolist sells factor inputs to the downstream monopolist at the price w. The downstream monopolist faces the inverse demand p(y) = 5 y so that their marginal revenue is MR downstream = 5 - 2y. In addition the downstream monopolist produces output with the production function y = f(x) = x, where x are inputs pur- chased from the upstream monopolist at a price w. Suppose the marginal cost to the downstream monopolist is just w. (Hint: marginal revenue for the upstream monopolist will be MRupstream = 5 - 4x) a) Solve for x, y, w and p. b) Suppose that the downstream monopolist purchased the firm of the up- stream monopolist. What would be the new values of y and p be? c) How are the answers different? -

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