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Chapter 8 - Competitive Market Solutions
Chapter 8 - Competitive Market Solutions
Chapter 8 - Competitive Market Solutions
Giacomo Rosso∗
March, 2024
1 Multiple Choices
1. A price taker is:
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1 MULTIPLE CHOICES
3. Because of the relationship between a perfectly competitive firm’s demand curve and its
marginal revenue curve, the profit maximization condition for the firm can be written as:
(a) P = MR.
(b) P = AVC.
(c) AR = MR.
(d) P = MC.
(e) P = AC.
Answer: D
(e) increased demand for the good the input is used for.
Answer: A
(c) its MC curve above the minimum point of the AVC curve.
(d) its MC curve above the minimum point of the ATC curve.
(a) the difference between profit at the profit-maximizing output and profit at the profit-
minimizing output.
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1 MULTIPLE CHOICES
(c) at the new profit maximizing output, price has increased more than marginal cost.
(d) at the new profit maximizing output, price has risen more than marginal revenue.
9. If current output is less than the profit-maximizing output, then the next unit produced
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2 EXERCISES
Answer: D
2 Exercises
1. Conigan Box Company produces cardboard boxes that are sold in bundles of 1000 boxes.
The market is highly competitive, with boxes currently selling for 100$ per thousand.
Conigan’s total curves are:
(a) Calculate Conigan’s profit maximizing quantity. Is the firm earning a profit?
(b) Analyze Conigan’s position in terms of the shut-down condition. Should Conigan
operate or shut down in the short-run?
Solution:
(a) Calculate Conigan’s profit maximizing quantity. Is the firm earning a profit?
Given the competitive nature of the industry, Conigan should equate P to MC.
P = MC
100 = 0.002Q
Q = 50, 000
TR = P ∗ Q
= 5, 000, 000$
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2 EXERCISES
= 5, 500, 000$
= −500, 000$
(b) Analyze Conigan’s position in terms of the shut-down condition. Should Conigan
operate or shut down in the short-run?
Reminder from theory:
- a competitive firm should shut down if price is below AVC (if it shuts down the
output is zero);
- the firm may produce in the short run if price is greater than average variable cost.
TV C
AV C =
Q
TV C = TC − TFC
= 2, 500, 00$
2, 500, 000
AV C = = 50$
50, 000
In both ways you obtain the average variable cost. And you have AVC = 50$; P =
100$. The firm should operate since P > AVC.
2. The market demand for a type of carpet known as KP-7 has been estimated as:
P = 40 − 0.25Q
where P is price ($/yard) and Q is rate of sales (hundreds of yards per month). The
market supply is expressed as:
P = 5 + 0.05Q
A typical firm in this market has a total cost function given as:
C = 100 − 20q + 2q 2
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2 EXERCISES
(c) Determine the rate of profit (or loss) earned by the typical firm.
Solution:
40 − 0.25Q = 5 + 0.05Q
0.30Q = 35
δC
MC = = −20 + 4q
δq
P = 10.825 = −20 + 4q = M C
(c) Determine the rate of profit (or loss) earned by the typical firm. The profit rate is
as follows:
T R(q) = T R(7.71) = P q = 10.825(7.71) = 83.46$
3. A competitive market is made up of 100 identical firms. Each firm has a short-run
marginal cost function as follows:
M C = 5 + 0.5q
where q represents units of output per unit of time. The firm’s average variable cost
curve intersects the marginal cost at a vertical distance of 10 above the horizontal axis.
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2 EXERCISES
Determine the market short-run supply curve. Calculate the price that would make 2,000
units forth-coming per time period in the market. Note the minimum price at which any
quantity would be placed on the market.
Solution:
The market supply curve is the horizontal summation of the individual firms’ MC curves
above the intersection with the respective average variable cost curves. We must express
the quantity in terms of MC or:
q = 2M C − 10
q1 = 2M C − 10
q2 = 2M C − 10
...
q100 = 2M C − 10
X
Q= q = 100 ∗ (2M C − 10) = 200M C − 1000
4. The long-run cost function for LeAnn’s telecommunication firm is: C(q) = 0.03q 2 + tq. A
local telecommunication tax of 0.01$ has been implemented for each unit LeAnn sells. If
LeAnn can sell all the units she produces at the market price of 0.70$, calculate LeAnn’s
optimal output before and after the tax. What effect did the tax have on LeAnn’s output
level? How did LeAnn’s profits change? Check for the shut down condition both before
and after the tax.
Solution:
The profit maximizing output level is where the market price equals marginal cost (pro-
viding the price exceeds the average variable cost). To determine the optimal output
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2 EXERCISES
level, we need to first equate marginal cost, when there is not tax, to the market price.
That is,
M C(q, t) = 0.06q + t
hence
q = 11.67
C(q)
AV C(q) = = AV C(11.67) = 0.03(11.67) = 0.35$
q
Since P > AV C(11.67), LeAnn will maximize profits at 11.67 units. LeAnn’s profits are:
hence
q = 11.5
C(q)
AV C(q) = = AV C(11.5) = 0.03(11.5) + 0.01 = 0.355$
q
25q 2
5. Spacely Sprockets’ short-run cost curve is: C(q, K) = K
+ 15K,where q is the number
of Sprockets produced and K is the number of robot hours Spacely hires. Currently,
Spacely hires 10 robot hours per period.
(a) If Spacely receives 250$ for every sprocket he produces, what is his profit maximizing
output level? Calculate Spacely’s profits and check for the shutdown condition.
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2 EXERCISES
(b) If Spacely hires 12 robot hours per period, how does Spacely’s optimal output and
profits change? Check for the shutdown condition
Solution:
(a) The profit maximizing output level is where the market price equals marginal cost
(providing the price exceeds the average variable cost). To determine the optimal
output level, we need to first equate marginal cost to the market price. That is,
q
M C(q, K) = 50
K
q
M C(q, 10) = 50 = P = 250
10
q = 50
25q 25(50)
AV C(50, 10) = = = 125$
K 10
Since P > AV C(50, 10), Spacely will maximize profits at 50 units. Spacely’s profits
are:
25(50)2
π = P q − C(q, 10) = 250(50) − + 15(10) = 6, 100$
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(b) With K = 12,
q
M C(q, 12) = 50 = P = 250
12
q = 60
25q 25(60)
AV C(60, 12) = = = 125$
K 12
Since P > AV C(60, 12), Spacely will maximize profits at 60 units. Spacely’s profits
are:
25(60)2
π = P q − C(q, 12) = 250(60) − + 15(12) = 7, 320$
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With the increasing of robots hour the output increases and the profit as well.
6. The squishy industry is competitive and the market price is 0.80$. Apu’s long-run cost
0.436 32 32
function is: C(q, r) = 3
r q ,where r is the price Apu pays to lease a squishy machine
and q is squishy output.
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2 EXERCISES
(a) What is Apu’s optimal output if the price Apu pays to lease a squishy machine is
1.10$? Check for the shut down condition.
(b) Suppose the lease price of squishy machines falls by 0.55$. What happens to Apu’s
optimal output if the market price for a squishy remains at 0.80$? Did profits
increase for Apu when the lease rate of squishy machines fell? Check for the shut
down condition.
Solution:
(a) The profit maximizing output level is where the market price equals marginal cost
(providing the price exceeds the average cost). To determine the optimal output
level, we need to first equate marginal cost to the market price. That is,
3 1
M C(q, r) = 0.218r 2 q 2
3 1
M C(q, 1.10) = 0.218(1.10) 2 q 2 = P = 0.8
q = 10.12
q = 80.94
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