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problem set 5 pricing and output decisions 1

Please answer all questions on sheet attached

1) Refer to the following graphical representation of a short-run situation faced by a perfectly competitive firm. (p. 340 #1)

  1. Is this a good market for this firm to be in in the long run? Explain.

b) Which of the following describes the firm’s situation in the short run?

The firm is breaking even

There is a loss

There is a profit

The short run profit/loss situation cannot be determined from this graph

c) Which of the following do you expect to happen in the long run?

New firms will enter; short-run profits will disappear

New firms will enter; short-run losses will disappear

Some existing firms will leave; short-run profits will disappear

Some existing firms will leave; short-run losses will disappear

2) The Automotive Supply Company has a small plant that produces speedometers exclusively. Its annual fixed costs are $30,000, and its variable costs are $10/unit. It can sell a speedometer for $25. (p.358 #1)

  1. How many speedometers must the company sell to break even?
  2. What is the break-even revenue?
  3. If the company sold 3,000 units last year, what was its profit?
  4. Next year’s fixed costs are expected to rise to $37,500. What will be the break-even quantity given the new fixed costs?
  5. If the company will sell the break-even quantity you identified in part “d” above, with the new fixed costs of $37,500, and if the company wants to maintain the same profit as last year, what will its new price need to be?

3) A manufacturer of electronics products has just developed a handheld computer. Following is the cost schedule for producing these computers on a monthly basis. Also included is a schedule of prices and quantities that the firm believes it will be able to sell (based on previous market research). (p.341, #5)

Quantity (thousands)

Price

Marginal Revenue

Average Variable Cost (AVC)

Average Total Cost (AC)

Marginal Cost (MC)

0

$1,650

1

1,570

$1,570

$1,281

$2,281

$1,281

2

1,490

1,410

1,134

1,634

987

3

1,410

1,250

1,009

1,342.33

759

4

1,330

1,090

906

1,156

597

5

1,250

930

825

1,025

501

6

1,170

770

766

932.67

471

7

1,090

610

729

871.86

507

8

1,010

450

714

839

609

9

930

290

721

832.11

777

10

850

130

750

850

1,011

a) What price should the firm charge if it wants to maximize its profits in the short run?

b) What arguments can be made for charging a price higher than this price? (i.e. What reason(s) might a firm have for doing this?) Explain.

c) What arguments can be made for charging a price lower than this price? (i.e. What reason(s) might a firm have for doing this?) Explain.

4) Suppose three firms face the same total market demand for their product. This demand is:

P

Q

$80

20,000

70

25,000

60

30,000

50

35,000

Suppose further that all three firms are selling their product for $60 and each has about one-third of the total market. One of the firms, in an attempt to gain market share at the expense of the others, drops its price to $50. The other two quickly follow suit.

  1. What impact would this move have on the profits of all three firms? Explain your reasoning.
  2. Would these firms have been better off in terms of profit if they all had raised the price to $70? Explain. (If the firms had all raised their prices to $70 instead of lowering price, what would be the amount of total revenue each firm would have received?)

5) A monopolistically competitive firm has the following short-run inverse demand, marginal revenue, and cost schedules for a particular product:

P = $45 – $0.2Q

MR = $45 – $0.4Q

TC = $500 + $5Q

MC = $5

  1. What quantity would maximize profits for this firm? (Hint: Recall that profit maximizing is where MR = MC)
  2. At what price should this firm sell its product in order to maximize profits or minimize losses?
  3. What would be the amount of the firm’s total revenue at the quantity and price identified in parts “a” and “b” above?
  4. What would be the amount of the firm’s profit (if positive number) or loss (if negative number) at the quantity and price identified in parts “a”, “b” and “c” above?
  5. Which of the following do you think would happen in this market in the long run?
  • New firms would enter.
  • Some existing firms would leave.
  • Nothing – no long run change is expected.

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