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Practice Questions - Session 11-12
Practice Questions - Session 11-12
Rons Window Washing Service is a small business that operates in the perfectly competitive residential
window washing industry in Evanston, Illinois. The short-run total cost of production is STC(Q) = 40+ 10Q +
0.1Q2, where Q is the number of windows washed per day. The corresponding short-run marginal cost
function is SMC(Q) = 10 + 0.2Q. The prevailing market price is $20 per window.
a) How many windows should Ron wash to maximize profit?
b) What is Rons maximum daily profit?
d) What is Rons short-run supply curve, assuming that all of the $40 per day fixed costs are sunk?
e) What is Rons short-run supply curve, assuming that if he produces zero output, he can rent or sell his fixed
assets and therefore avoid all his fixed costs?
a)
b)
P MC
TR TC
Rons profit is given by
.
20(50) (40 10(50) 0.10(50) 2 )
210
d) If all fixed costs are sunk, then ANSC = AVC = (10Q + 0.1Q2)/Q = 10 + 0.1Q. So the first
step is to find the minimum of ANSC by setting ANSC = SMC, or 10 + 0.1Q = 10 + 0.2Q which
occurs when Q = 0. The minimum level of ANSC is thus 10. For prices below 10 the firm will
not produce and for prices above 10, its supply curve is found by setting P = SMC:
P 10 .2Q
Q 5 P 50
if P 10
if P 10
e)If all fixed costs are non-sunk, as in this case, then ANSC = ATC = (40/Q) + 10 + 0.1Q. The
40
10 .1Q 10 .2Q
Q
Q 20
minimum point of ANSC occurs where ANSC = SMC:
The minimum level of ANSC is thus 14. For prices below 14 the firm will not produce and for prices above
14, its supply curve is found by setting P = SMC as before.
0
5P 50
s( P)
if P 14
if P 14
9.11. Newsprint (the paper used for newspapers) is produced in a perfectly competitive market. Each identical
firm has a total variable cost TVC(Q) = 40Q + 0.5Q2, with an associated marginal cost curve SMC(Q) = 40 +
Q. A firms fixed cost is entirely nonsunk and equal to 50.
a) Calculate the price below which the firm will not produce any output in the short run.
b) Assume that there are 12 identical firms in this industry. Currently, the market demand for newsprint is
D(P) = 360 2P, where D(P) is the quantity consumed in the market when the price is P. What is the shortrun equilibrium price?
a) The firm will not produce any output when the price falls below the point where SMC = ANSC, i.e. the
50 / Q 40 0.5Q 40 Q
minimum of the ANSC curve. Therefore
This implies Q = 10. The corresponding price, below which the firms will not produce, is equal to MC(10) =
ANSC(10) = 50.
P 40 Q
QMarket
8P60, 14P,
when P 10
when P 10
So the equilibrium price must be less than 10, with only Type B firms producing (and Type A firms not
producing).
Setting market supply equal to market demand: 8P = 108 10P, so that P = 6.
We have found that in equilibrium, only Type B firms produce, and the equilibrium price is 6.
b)
Lets first assume the equilibrium price exceeds 10, so that all firms are producing. If this is true,
setting market supply equal to market demand: -60 + 14P = 228 10P, so that P = 12; the market supply we
have used is valid for P=12. At this equilibrium both types of firms will be producing.
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11.7. A monopolist operates with the following data on cost and demand. It has a total fixed cost of $1,400
and a total variable cost of Q2, where Q is the number of units of output it produces. The firms demand curve
is P = $120 - 2Q. The size of its sunk cost is $600. The firm expects the conditions of demand and cost to
continue in the foreseeable future.
a) What is the firms profit if it operates and it maximizes profit?
b) Should the firm continue to operate in the short run, or should it shut down? Explain.
a)
The monopolist chooses Q so that MR = MC: 120 4Q = 2Q => Q = 20.
P = 120 2(20) = 80.
Profit = PQ V F = 80(20) 202 1400 = - 200.
The firm has nonsunk fixed costs: FNonsunk = F - FSunk = 1400 600 = 800.
b)
Producer surplus = PQ V FNonsunk = 80(20) 202 800 = 400. So the firm should continue to operate in
the short run. If it operates, its profit is -200. But if it shuts down, its profit = - FSunk = -600. So it can lessen its
losses by 400 if it continues to operate (and this is why producer surplus is +400 annually.)
11.11. Assume that a monopolist sells a product with a total cost function TC = 1,200 + 0.5Q2 and a
corresponding marginal cost function MC = Q. The market demand curve is given by the equation P = 300 Q.
a) Find the profit-maximizing output and price for this monopolist. Is the monopolist profitable?
b) Calculate the price elasticity of demand at the monopolists profit-maximizing price. Also calculate the
marginal cost at the monopolists profit-maximizing output. Verify that the IEPR holds.
P 300 Q
a)
If demand is given by
MR 300 2Q
then
300 2Q Q
MR MC
Q 100
Q 100
At
price will be
TR 200(100) 20, 000
1
. Therefore, at the profit-maximizing price
200
100
Q , P 1
Q , P 2
The marginal cost at the profit-maximizing output is MC = Q = 100. The inverse elasticity pricing rule states
that at the profit-maximizing price
P MC
1
P
Q,P
In this case we have
200 100
1
200
2
1 1
2 2
b) If
MC 10
at plant 1, by the logic in part (a) Gillette will only use plant 2 if Q < 18. It will produce all
MR MC
output above Q = 18 in plant 1 at MC = 10. Assuming Q > 18, setting
implies
968 40Q 10
Q 23.95
(So again, this approach is valid. You can verify that setting MR = MC2 would again lead to Q > 18.) The
firm will allocate production so that Q2 = 18 and Q1 = 5.95. At Q = 23.95, price will be $4.89.