PRACTICE PROBLEMS 2 SOLUTIONS

Problem 1
The Bergen Company and the Gutenberg Company are the only two firms that produce and sell a
particular kind of machinery. The demand curve for their product is

P = 580 – 3Q

where P is the price (in dollars) of the product, and Q is the total amount demanded. The total
cost function of the Bergen Company is

TCB = 410QB

where TCB is its total cost (in dollars) and QB is its output. The total cost function of the
Gutenberg Company is

TCG = 460QG

where TCG is its total cost (in dollars) and QG is its output.

a. Is these two firms collude and they want to maximize their combined profit, how much will
the Bergen Company produce?

Bergen’s marginal cost is always less than Gutenberg’s marginal cost. There Bergen would
produce all the combination’s output. Setting Bergen’s marginal cost equal to the marginal
revenue derived from the demand function yields
410 = 580 - 6Q (1)
QB = 170/6 and QG = 0

b. How much will the Gutenberg Company produce?

As discussed in part (a), Gutenberg’s marginal cost is always greater than Bergen’s. If
Gutenberg were to produce 1 unit and Bergen 1 unit less, it would reduce their combined
profits by the difference in their marginal costs. If Gutenberg were to produce 1 unit without
any reduction in Bergen’s output, it would reduce their combined profits by the same
amount.
c. Will the Gutenberg Company agree to such an arrangement? Why or not?

Without cooperation, it’s a Bertrand outcome, so only Bergen would produce and hence set
P equal to MC of the other firm. Solving this gives profit for Bergen to be 2000. With
cooperation, the total profit is $2408.33. So the difference is the maximum that Bergen would
be willing to pay.

Problem 2
The can industry is composed of two firms. Suppose that the demand curve for cans is

P = 100 – Q

where P is the price (in cents) of a can and Q is the quantity demanded (in millions per month) of
cans. Suppose the total cost function of each firm is

TC = 2 + 15q

where TC is total cost (in tens of thousands of dollars) per month and q is the quantity produced
(in millions) per month by the firm.

a. What are the price and output if managers set price equal to marginal cost?

If managers set price equal to marginal cost

For both firms, P = 100 - Q = 100 - qa - qb = MC = 15
qa = 85 – qb
By symmetry, qa = qb = 42.5
Which lead to Q = 85, P = 15 and a combined loss of 4.

b. What are the profit-maximizing price and output if the managers collude and act like a
monopolist?

If managers collude and act like a monopolist

Setting MR = MC
Solving, we get Q = 42.5 and P = 57.5
Hence, profit for the combined firm is 1804.25
Thus, managers make a higher combined profit on colluding. The profits are higher by
1804.25 - (-4) = 1808.25
c. Do the managers make a higher combined profit if they collude than if they set price equal to
marginal cost? If so, how much higher is the combined profit?

The managers make a higher combined profit if they collude than if they set price equal to
marginal cost.

Problem 3
Two firms, the Alliance Company and the Bangor Corporation, produce vision systems. The
demand curve for vision systems is

P = 200,000 – 6(Q1 + Q2)

where P is the price (in dollars) of a vision system, Q1 is the number of vision systems produced
and sold per month by Alliance, and Q2 is the number of vision systems produced and sold per
month by Bangor. Alliance’s total cost (in dollars) is

TC1 = 8,000Q1

Bangor’s total cost (in dollars) is

TC2 = 12,000Q2

a. If managers at these two firms set their own output levels to maximize profit, assuming that
managers at the other firm hold constant their output, what is the equilibrium price?

P = $73.888.34 (derived in part b).

b. What is the output of each firm?

Alliance and Bangor’s profits cab be written as

Π1 = [200000 - 6(Q1 - Q2)] Q1 - 8000Q1 = 192000Q1 - 6Q12 - 6Q1Q2
Π2 = [200000 - 6(Q1 - Q2)] Q2 - 8000Q2 = 188000Q2 - 6Q22 - 6Q1Q2

Profit-maximizing levels of output are determined by setting the first derivative of each firm’s
profit function equal to zero and solving for Q1 and Q2.
δΠ1 / δQ1 = 192000 - 12Q1 - 6Q2 = 0
δΠ2 / δQ2 = 188000 - 6Q1 - 12Q2 = 0

Solving these two equations, we get

 Q1 = 10888.89 and Q2 = 10222.22
P = 200000 - 6(10888.89 – 10222.22) = $73333.34

c. How much profit do managers at each firm earn?

At these prices and quantities, the profit will be

Π1 = 192000 Q1 - 6Q12 - 6 Q1Q2 = $711,407,550
Π2 = 188000 Q2 - 6Q22 - 6 Q1Q2 = $626,962,890

Problem 4
The West Chester Corporation believes that the demand curve for its product is

P = 28 – 0.14Q

where P is price (in dollars) and Q is output (in thousands of units). The firm’s board of
directors, after a lengthy meeting, concludes that the firm should attempt, at least for a while, to
increase its total revenue, even if this means lower profit.

a. Why might managers adopt such a policy?

b. What price should managers set if they want to maximize total revenue?

Maximize total revenue

Total Revenue (R) = 28Q – 0.14Q2
δR / δQ = 28 - 0.28Q = 0
Hence, P = 14, Q = 100

c. If the firm’s marginal cost equals $14, do managers produce a larger or smaller output than
they would to maximize profit? How much larger or smaller?

MC is 14
For maximizing profit,
MR = MC
28 – 0.28Q = 14
P = 14, Q = 50
Managers reduce output by 50 to maximize profits.