Firm Organization and Market Structure

&
Perfect Competition
Exercises
Profit Maximization
1. A firm has revenue given by R(q) = 200q - 5q2 and its cost function is C(q) = 50 +
20q. What is the profit-maximizing level of output? What profit does the firm
earn at this output level?
2. A firm has to pay a tax equal to 10% of its revenue. Give a condition that
determines the output level at which it maximizes its after-tax profit.
Owners’ versus Managers’ Objectives
3. Three firms have identical revenue and profit functions with the inverted-U
shape. Firm 1 is a private sector firm operated by an owner-manager who
wishes to maximize profit. Firm 2 is managed by an income-maximizing
manager whose pay is proportional to the firm’s revenue. Firm 3 is a
government-owned firm that has been instructed to maximize the amount of
employment, L, subject to the constraint that revenue must not be negative. To
increase q, L must increase.
a. Which of these firms produces the most, which the least, and which is in the middle? Show
the output level of each firm in a diagram.
b. Each of the three firms has a revenue function R(q) = 100q - 2q2 and a cost function C(q) =
100 + 20q. Determine how much output each firm chooses.
The Make or Buy Decision
4. Anthony sells cakes, tiramisu, and other desserts. He currently purchases
tiramisu from a pastry store for €4 each and sells them at his store for a price
that does not change with the number of tiramisu that he sells. Anthony is
considering vertically integrating by making his own tiramisu. If the fixed cost of
vertically integrating is €500 and he can produce tiramisu at €2 per serving, his
total cost of producing tiramisu, q, himself is C = 500 + 2q. How many tiramisu
does Anthony need to sell for vertical integration to be a profitable decision?
Competition in the Short Run
5. Should a firm shut down if its revenue is R = $1,800 per week,
a. its variable cost is VC = $1,200, and its sunk fixed cost is F = $800?
b. its variable cost is VC = $1,900, and its sunk fixed cost F = $200?
c. its variable cost is VC = $1,200, and its fixed cost is $800, of which $700 is avoidable if it shuts
down?

6. The cost function for Scrantan Cement is C(q) = 50 + 20q + 3q2 , where q is tons of cement
produced. Derive the firm’s marginal cost, average cost and average variable cost curves. What
q should the firm choose so as to maximize its profit if the market price is p? How much does it
produce if the competitive market price is p = 80?
Competition in the Short Run
7. Smell Good soap company’s cost function is C(q) = 40 + 10q + 2q2.
a) What quantity maximizes the firm’s profit if the market price is p? How
much does it produce if p = 50?
b) If the government imposes a specific tax of t = 8, what quantity maximizes
its after-tax profit? Does it operate or shut down?
Competition in the Long Run
8. After a series of powerful earthquakes devastated towns and villages across
central Italy in 2016, the Italian government promised to rebuild “everything,
100 percent”. Use side-by-side firm and market diagrams to show the effects
(number of firms, prices, output and profits) of such a shift in demand of one
such industry, such as construction materials, in both the short run and the
long run. Explain how your answer depends on whether the shift in demand is
expected to be temporary or permanent.
9. A typical firm in long-run equilibrium in an industry with identical firms has a
cost function given by C = 576 +q2. What is the equilibrium price?
Competition and Well-Being
10. If the inverse demand function for electric irons is p = 100 - 2Q, what is the
consumer surplus when the price is 60?
11. If the supply function is Q = -20 + 0.5p, what is the producer surplus if price is 60?
12. The government sets a minimum wage above the current equilibrium wage. What
effect does the minimum wage have on the market equilibrium? What are its
effects on consumer surplus, producer surplus, and total surplus? Who are the
consumers and who are the producers?
13. Suppose that the demand curve for wheat is Q = 100 - 2p and the supply curve is Q
= -20 + p. The government imposes a price ceiling of p = 30.
a. Describe how the equilibrium changes.
b. What effect does this price ceiling have on consumer surplus, producer surplus, and deadweight
loss?