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Practice Set 2 Solutions

The document discusses the calculation of marginal cost and profit maximization in different market structures, including monopolistic competition and cartel behavior. It provides equations for marginal cost, total cost, and average cost, leading to the determination of optimal output and pricing strategies. The analysis concludes with the implications of price changes on firm shutdown decisions and economic profits in the short run.

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sanket bhatlawande
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5 views3 pages

Practice Set 2 Solutions

The document discusses the calculation of marginal cost and profit maximization in different market structures, including monopolistic competition and cartel behavior. It provides equations for marginal cost, total cost, and average cost, leading to the determination of optimal output and pricing strategies. The analysis concludes with the implications of price changes on firm shutdown decisions and economic profits in the short run.

Uploaded by

sanket bhatlawande
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Question 1(a)

Taking the derivative of the total cost equation with respect to Q gives the marginal cost
equation

MC = dTC/dQ = 2 + 0.02Q

Profit is maximised by equating price and marginal cost. Thus, the profit maximising output is
given by the solution to

10 = 2 + 0.02Q

Which is 400 pizzas per month.

Economic profit is total revenue minus total cost or

TR-TC = 10(400) – [1000+2(400) +0.01(400^2] = 600

Thus, in the short run, economic profit will be Rs. 600 per month.

1) (b)

Marginal cost is the derivative of total cost with respect to quantity. Thus,

MC = dTVC/dQ = 150 -20Q +Q^2

The shutdown point is where price equals minimum average variable cost. But profit
maximization requires that price also equal marginal cost. Thus, by setting MC=AVC, the
result is

150 – 40Q +3Q^2 = 150 – 20Q +Q^2

Rearranging the terms gives

2Q^2 – 20Q = 0

Which can be written as

2Q(Q-10) = 0

Solving this equation gives Q=0 or Q=10. Substituting Q=10 into the marginal cost equation
gives

P=MC = 150- 40(10) +3(100) = 50

A similar substitution for Q = 0 yields P= 150. The relevant solution is the nonzero output.
Thus, if the price falls below 50 per unit, the firm should shut down.
Question 2)
In monopolistic competition in the long run, price will be driven down to average cost. The
average cost equation is computed by dividing total cost by quantity. Thus, the optimal
quantity is the solution to P = AC, or

P = 309.75 – Q = 400 – 20Q + Q^2 = AC

Rearranging terms yields the quadratic equation

Q^2 – 19Q +90.25 = 0


Which has the single solution, Q=9.5. Substituting this quantity into the demand equation
gives P=309.75 – 9.5 = 300.25. Because price equals average cost, economic profit is zero.

In monopolistic competition, marginal revenue must equal marginal cost at the optimal
output. For the demand and total cost equations of this problem,
MR = 309.75 – 2Q and MC = 400 -4Q +3Q^2.

Substituting Q= 9.5 into these two equations gives MR = MC = 290.75. Hence, this condition
also is fulfilled.

4) Solution

If the cartel has succeeded in maximising profit at the $5.65 price with the given world demand curve,
then all three of the given Marginal cost functions will be equal to MR at that price (MCi = MCs = MCu
= MR). The marginal revenue function for the given demand curve will have the same dollar axis
intercept as the demand curve and twice the negative slope so it is MR = 8.30-0.001QT. To, determine
QT substitute the price of $5.65 into the demand curve equation to obtain 0.0005QT = 2.65 and QT =
5300. Substituting QT = 5300 into the MR function yields MR = 8.30 – 5.30, so that MR = 3. Setting
each of the three MCs equal to 3 will yield the following:

Irun: MCi = 0.25 + 0.00125Qi = 3

0.00125Qi = 2.75; Qi = 2200

Sheran: MCs = 0.60 + 0.002Qs = 3

0.002Qs = 2.40; Qs = 1200

Uwaq: MCu = 0.15 + 0.0015Qu = 3

0.0015Qu = 2.85; Qu =1900


5 Question)

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