MGEC: Session 4

Practice Problems Answer Key

Practice Problem 1

The Lone Star Transportation Company hauls coal and manufactured goods. The demand curve for its
services by the coal producers is PC = 495 - 5QC where PC is the price (in dollars) per ton-mile of coal
hauled and QC is the number of ton-mile of coal hauled (in thousands). The demand curve for its
services by the producers of manufactured goods is PM = 750 - 10QM where PM is the price (in dollars)
per ton-mile of manufactured goods hauled and QM is the number of ton-mile of manufactured goods
hauled (in thousands). The firm's total cost function is TC = 410 + 8(QC + QM) where TC is total cost (in
thousands of dollars).

a) What price should managers charge to haul coal?

Given,
Demand curve by coal producers: PC = 495 - 5QC
Demand curve by producers of manufactured goods: PM = 750 - 10QM
Firm’s Total cost function: TC = 410 + 8(QC + QM)

The firm’s profit (𝜋) = (Revenue from coal producers + Revenue from producers of
manufactured goods) – Total Costs, or
𝜋 = (𝑃𝑐 𝑄𝑐 + 𝑃𝑚 𝑄𝑚 ) − 𝑇𝐶

𝜋 = 𝑄𝑐 (495 − 5𝑄𝑐 ) + 𝑄𝑚 (750 − 10𝑄𝑚 ) − (410 + 8(QC + QM))

𝜋 = −410 + 487𝑄𝑐 − 5𝑄𝑐 2 + 742𝑄𝑚 − 10𝑄𝑚2

To maximize profits with respect to QC and QM we need to find first derivatives of the above
equation with respect to QC and QM and set them equal to 0:
𝜕𝜋
= 487 − 10𝑄𝑐
𝜕𝑄𝑐

0 = 487 − 10𝑄𝑐

Solving for QC , QC = 48.7, and similarly

𝜕𝜋
= 742 − 20𝑄𝑚
𝜕𝑄𝑚

0 = 742 − 20𝑄𝑚
Solving for Qm , Qm = 37.1
 Now we can find the Prices (PC and PM) by substituting QC and QM in the respective demand
functions.
PC = 495 - 5Qc, plugging QC = 48.7, in the equation, PC = 251.5

PM = 750 - 10Qm plugging Qm = 37.1, in the equation, Pm = 379

Hence, the firm should charge $251.5 per ton-mile of coal hauled.

b) What price should managers charge to haul manufactured goods?

Please refer to the solution to part a.

The firm should charge $379 per ton-mile of manufactured goods hauled.

c) If a regulatory agency were to require managers to charge the same price to haul both coal
and manufactured goods, would this reduce the firm's profit? If so, by how much?

Profits of the firm with discriminatory pricing can be found by plugging the following values;
PC = 251.5, QC = 48.7, PM = 379 and Qm = 37.1, in the equation:
𝜋 = −410 + 487𝑄𝑐 − 5𝑄𝑐 2 + 742𝑄𝑚 − 10𝑄𝑚2

𝜋 = $25212.55

If the firm were to charge the same price to haul both coal and manufactured goods, then
PC = P M
Letting this common price be P, the demand functions can be re-written as;
𝑃
𝑄𝑐 = 99 −
5
𝑃
𝑄𝑚 = 75 −
10
Since Q = QC + QM
3𝑃
𝑄 = 174 −
10
10𝑄
𝑃 = 580 −
3

Profit = TR - TC

𝜋 = 𝑃. 𝑄 − 𝑇𝐶
10𝑄
𝜋 = (580 − ) 𝑄 − (410 + 8𝑄)
3

To maximize profits with respect to Q we need to find first derivative of the above equation with
respect to Q and set it equal to 0:
 𝜕𝜋 20
= 572 − 𝑄
𝜕𝑄 3

20
0 = 572 − 𝑄
3

Solving for Q , Q = 85.8

Now we can find the Price (P) by substituting Q = 85.8 in the demand function;
10𝑄
𝑃 = 580 −
3
𝑃 = 294
Also, we can find the profit by plugging this value (Q = 85.8) in the profit equation:
10𝑄
𝜋 = (580 − ) 𝑄 − (410 + 8𝑄)
3
𝜋 = $ 24128.8
Clearly, by giving up discriminatory pricing, the firm’s profit has reduced.
The profit has reduced by $1083.7 (25212.55-24128.8).
Practice Problem 2

The Burr Corporation's total cost function (where TC is the total cost in Rupees and Q is quantity) is TC
= 20 + 2Q + 2Q2

a) If the firm is perfectly competitive and the price of its product is Rs. 24, what is its optimal
output rate?
At a given price, optimal output for perfectly competitive firm will be the one where marginal
cost equals price.
Given, Price = Rs. 24 and marginal cost can be found as follows
𝑇𝐶 = 20 + 2𝑄 + 2𝑄 2

𝑑𝑇𝐶
𝑀𝐶 =
𝑑𝑄

𝑀𝐶 = 2 + 4𝑄

To find optimal output, Equate P = MC

24 = 2 + 4𝑄

𝑄 = 5.5

b) At this output rate, what is its profit?

𝑃𝑟𝑜𝑓𝑖𝑡 = 𝑇𝑜𝑡𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 – 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡
𝜋 = P. Q − TC
𝜋 = (24 × 5.5) − (20 + 2Q + 2𝑄 2 )

𝜋 = 𝑅𝑠. 40.5

At output level of Q = 5.5, the firm makes a profit Rs. 40.5

Practice Problem 3

The White Company is a member of the lamp industry, which is perfectly competitive. The price of a
lamp is $50. The firm's total cost function is TC = 1000 + 20Q + 5Q 2 where TC is total cost (in dollars)
and Q is hourly output.

a) What output maximizes profit?

At a given price, optimal output for perfectly competitive firm will be the one where marginal
cost equals price.
Given, Price = $ 50 and marginal cost can be found as follows
𝑇𝐶 = 1000 + 20𝑄 + 5𝑄 2
𝑑𝑇𝐶
𝑀𝐶 =
𝑑𝑄

𝑀𝐶 = 20 + 10𝑄

To find optimal output, Equate P = MC

50 = 20 + 10𝑄

𝑄 = 3
b) What is the firm's economic profit at this output?
𝑃𝑟𝑜𝑓𝑖𝑡 = 𝑇𝑜𝑡𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 – 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡
𝜋 = 𝑃. 𝑄 − 𝑇𝐶
𝜋 = (50 × 3) − (1000 + 20𝑄 + 5𝑄 2 )
𝜋 = −955

At output level of Q = 3, the firm faces a loss of $955.

c) What is the firm's average cost at this output?

Given firm’s Total Cost Function:
𝑇𝐶 = 1000 + 20𝑄 + 5𝑄 2

𝑇𝐶
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑜𝑠𝑡 (𝐴𝐶) =
𝑄

1000 + 20𝑄 + 5𝑄 2
𝐴𝐶 =
𝑄

At output of Q = 3, AC = $368.33

d) If other firms in the lamp industry have the same cost function as this firm, is the industry in
equilibrium? Why or why not?
A perfectly competitive firm is in equilibrium when it makes no economic profits (or losses). In
this case, at given price of $50, all firms are incurring losses (as other firms in the lamp industry
have the same cost function as this firm) Hence, the industry is not in equilibrium.