money and monopolistic price setting

Question 1

equation for maximizing real profits of the firm.

Question 2

maximizing prodits yields the following optimal relative price level.
explain the equation

Answer 2

• monopolistic firms charge a relative price with a markup over real marginal cost, or “unit labor costs”. These are the real cost of producing one more unit of output which is given by Wt/(PtAtt).
• when marginal costs rise, firms want to increase their relative price
• with the elasticity of substitution being >1, the markup is >1. The higher the elasticity, the lower the markup.

Question 3

What can we deduce from these two equations about monetary neutrality in this model

Answer 3

• there is monetary neutrality also in this model with endogenenous price setting: the money supply only affects the price level, not aggregate activity, which is determined by the real equilibrium of the economy.

Question 4

you are a social planner. show that the equilibrium is inefficient.

Answer 4