(a) Serena sells her own patented perfume as a single priced, profit maximising monopoly. The perfume has a demand function of P = 60 - 2.5Q and marginal cost function of MC = 2.5Q, where P is the price and Q is the quantity. The fixed cost is $120 and the total variable cost is the area under the marginal cost curve.

Identify the optimal output, the price, the profit or loss, the consumer surplus and the producer surplus for Serena as a monopolist. Show the optimal output, the price as well as consumer and producer surplus graphically with a suitable diagram.

(15marks)

(b)

(i) Assume that fixed costs are sunk. Explain why a perfectly competitive firm will operate if it can cover its total variable cost in the short run.

(5 marks)

(ii) Explain why all competitive firms will break even in the long run.

(5 marks)