Aps5 - t5 13 Solutions
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ECO-6655: Application Problem Set 5 – SOLUTIONS, T5-1 !r" !ominic #" $ina%eo Make sure you show ALL your work and explain where asked. Groups who do not provide explanations or simply provide final answers will not receive credit for that question. See the assignment handout for more information. Groups should answer the following questions: 1. &'( Point)* Indicate wheth er each of the follow ing statements is true or false and exp lain why . A. A monopolis tically competiti ve firm that is incu rring a loss shou ld immediately ceas e operations. #A LSE" In t+e )+ort rn, it )+ol% contine to operate a) lon a) t+e lo))e) earne% a) le)) t+an T#C" In t+e lon rn, +o.e/er, it ma0 nee% to con)i%er %roppin ot o t+e mar2et i t+e price %oe) not ri)e e3al to or abo/e a/erae co)t" B. A monopoly w ill always earn econ omic pro fit because it is ab le to set its prices at any level it desires. #ALSE" 4+ile monopolie) %o +a/e mar2et po.er, t+e0 are )till )bect to t+e la. o %eman%, )o t+e0 cant c+are )t an0 price bt to ma7imi8e proit m)t ba)e price) c+are% ba)e% on con)mer .illinne)) to pa0 " #rt+ermore, .+ile a monopol0 can earn proit) in t+e )+ort or lon rn, .+et+er proit) are earne% %epen%) on t+e %eman% or t+e pro%ct o/er time" !eman% can %ecrea)e, an% i t+i) occr), price) an% proit) .ill all" Oten in t+e loner rn, monopol0 proit) are ero%e% b0 competition or c+ane) in tec+nolo0, )o proit) are b0 no mean) arantee% e/en or a monopol0" C. In the long run, firms oper ating in p erfect competit ion and monopolistic competition will tend to earn normal profits. T9UE" Entr0 or e7it o irm) .ill t+eoreticall0 lea% to t+i) con%ition" T+e onl0 e7ception .ol% be in t+e ca)e .+ere a irm +el% )ome n)al a%/antae, or )i mple lc2" D. Assuming a linear demand curve, a firm tha t wants to maximi e its revenu e will charg e a lower price than a firm tha t wants to maxim ie its pro fits. T9UE" In or%er to ma7imi8e re/ene, i rm) .ill price t+eir pro% ct at t+e point .+ere $9 8ero" ;0 implication, t+i) m)t be a lo.er price t+an t+e point .+ere $9 $C" !. "hen a firm is able to s ets its price, its pr ice will always be less than #$. #ALSE" 4+en t+e %eman% cr/e i) %o.n.ar% )lopin, t+e price c+are% i) reater t+an marinal re/ene" T+i) i) beca)e in or%er to )ell more nit), t+e irm m)t lo.er it) price on all nit) )ol%, )o $9 all)" %. &'( Point)* &un City, Ariona, a retirement community that features full'service living arrangements, is considering two proposals to provide lawn'care to elderly residents. (irst, a national lawn'care firm has offer ed to purc hase the city)s law n'care e*ui pment at an attra ctive price in re turn for an exclusive franchise on residential service. A second proposal would allow several small companies to enter the business without any exclusive franchise agreemen t or competitive restric tions. +nder this plan, individua l companies woul d bid for the right t o provid e service in a given neighb orhood. he city would then allocate business to the lowest bidder. he city has conducted a survey of &un City residents to estimate the amount they would be willing to pay for various am ounts of lawn se rvice. he city has also est imated the total cos t of service per residen t. &ervice costs are expected to be the same whether or not an exclusive franchise is granted. 1
Transcript of Aps5 - t5 13 Solutions
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ECO-6655: Application Problem Set 5 – SOLUTIONS, T5-1 !r" !ominic #" $ina%eo
Make sure you show ALL your work and explain where asked. Groups who do not provide
explanations or simply provide final answers will not receive credit for that question. See the
assignment handout for more information.
Groups should answer the following questions:
1. &'( Point)* Indicate whether each of the following statements is true or false and explain why.
A. A monopolistically competitive firm that is incurring a loss should immediately cease operations.#ALSE" In t+e )+ort rn, it )+ol% contine to operate a) lon a) t+e lo))e) earne% a) le)) t+anT#C" In t+e lon rn, +o.e/er, it ma0 nee% to con)i%er %roppin ot o t+e mar2et i t+e price%oe) not ri)e e3al to or abo/e a/erae co)t"
B. A monopoly will always earn economic profit because it is able to set its prices at any level itdesires.#ALSE" 4+ile monopolie) %o +a/e mar2et po.er, t+e0 are )till )bect to t+e la. o %eman%, )ot+e0 cant c+are )t an0 price bt to ma7imi8e proit m)t ba)e price) c+are% ba)e% on
con)mer .illinne)) to pa0" #rt+ermore, .+ile a monopol0 can earn proit) in t+e )+ort or lonrn, .+et+er proit) are earne% %epen%) on t+e %eman% or t+e pro%ct o/er time" !eman% can%ecrea)e, an% i t+i) occr), price) an% proit) .ill all" Oten in t+e loner rn, monopol0 proit)are ero%e% b0 competition or c+ane) in tec+nolo0, )o proit) are b0 no mean) arantee% e/enor a monopol0"
C. In the long run, firms operating in perfect competition and monopolistic competition will tend toearn normal profits.
T9UE" Entr0 or e7it o irm) .ill t+eoreticall0 lea% to t+i) con%ition" T+e onl0 e7ception .ol% be in t+e ca)e .+ere a irm +el% )ome n)al a%/antae, or )imple lc2"
D. Assuming a linear demand curve, a firm that wants to maximie its revenue will charge a lower
price than a firm that wants to maximie its profits.T9UE" In or%er to ma7imi8e re/ene, irm) .ill price t+eir pro%ct at t+e point .+ere $9 8ero" ;0 implication, t+i) m)t be a lo.er price t+an t+e point .+ere $9 $C"
!. "hen a firm is able to sets its price, its price will always be less than #$.#ALSE" 4+en t+e %eman% cr/e i) %o.n.ar% )lopin, t+e price c+are% i) reater t+an marinalre/ene" T+i) i) beca)e in or%er to )ell more nit), t+e irm m)t lo.er it) price on all nit) )ol%,)o $9 all)"
%. &'( Point)* &un City, Ariona, a retirement community that features full'service living arrangements,
is considering two proposals to provide lawn'care to elderly residents. (irst, a national lawn'care firm has offered to purchase the city)s lawn'care e*uipment at an attractive price in return for an
exclusive franchise on residential service. A second proposal would allow several small companies toenter the business without any exclusive franchise agreement or competitive restrictions. +nder this
plan, individual companies would bid for the right to provide service in a given neighborhood. hecity would then allocate business to the lowest bidder.
he city has conducted a survey of &un City residents to estimate the amount they would be willing to
pay for various amounts of lawn service. he city has also estimated the total cost of service perresident. &ervice costs are expected to be the same whether or not an exclusive franchise is granted.
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ECO-6655: Application Problem Set 5 – SOLUTIONS, T5-1 !r" !ominic #" $ina%eo
SL!"#$:
A. +se the indicated price and total cost data to complete the following table.-red font answers/
%ours of
Lawn&are per
Month
'rice per%our
"( M( "& A"& M& 'rofit
( <''"5( ("(( ---- < ("(( ---- ----
1 <'1"=5 '1"=5 <'1"=5 '1"(( '1"(( '1"(( ("=5
' <'1"(( >'"(( <'("'5 >("5( '("'5 1?"5( 1"5(
<'("'5 6("=5 <1@"=5 5@"5( 1?"5( 1@"(( '"'5
> <1?"5( =@"(( <1="'5 =5"=5 1@"?> 1="'5 '"'5
5 <1@"=5 ?"=5 <15"=5 ?'"'5 1@">5 16"5( 1"5(
6 <1@"(( 1(@"(( <1>"'5 1(="'5 1="@@ 15"(( ("=5
= <1="'5 1'("=5 <1'"=5 1'("=5 1="'5 1"5( ("((
@ <16"5( 1'"(( <11"'5 1'"(( 16"5( 11"'5 ("((
? <15"=5 1>1"=5 <?"=5 15("(( 16"6= 1@"(( -@"'5
B. Determine price and the level of service if competitive bidding results in a perfectlycompetitive price0output combination.In a perectl0 competiti/e in%)tr0, t+e lon rn price an% otpt le/el occr) .+ere P minimm ATC, .+ic+ in t+i) ca)e i) @ +or) o la.n care per mont+" Proit in t+i) ca)ei) 8ero )ince P ATC"
C. Determine price and the level of service if the city grants a monopoly franchise.A monopol0 .ill ma7imi8e proit) b0 )ettin $9 $C" Bere, $9 $C <5"=5 at >+or) o la.n care per mont+ an% P <1?"5( per +or" Note: Alt+o+ $C tec+nicall0+a)nt reac+e% it) minimm 0et, t+e monopol0 +a) t+e abilit0 to )et price) +i+er t+an irm)in competiti/e mar2et) an% can earn a proit rear%le))" T+e0 re)trict otpt an% increa)e price) a) a re)lt" Proit &<1?"5( - <1@"?>* D > <'"'5"
. &'( Point)* 2aradox Dental, 3td., en4oys a local monopoly in the provision of oral examination services in us5egee, Alabama. otal and marginal revenue relations for the standard procedure are6
$ 7%89: ' 79 .991:%
#$ d$0d: 7%89 ' 79 .99%: #arginal - average variable/ costs for the process are stable at 7189 per unit. (ixed costs are ero.
A. As a monopoly, calculate 2aradox Dental)s output, price, and profits at the profit'
maximiing activity level. B. "hat price and profit levels would prevail based on the assumption that new entry into the
local mar5et results in competitive mar5et pricing;
SOLUTION:
A" Set $9 $C to in% t+e proit-ma7imi8in acti/it0 le/el:$9 $C, or <'5( - <("((' <15(("((' 1((, or 5(,(((P T9 &<'5( - <("((1'* <'5( - <("((1 <'5( - <("((1&5(,(((* <'((
'
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ECO-6655: Application Problem Set 5 – SOLUTIONS, T5-1 !r" !ominic #" $ina%eo
π T9 - TC <'((&5(,(((* - <15(&5(,(((* <',5((,(((
;" In a perectl0 competiti/e in%)tr0, P $9 $C in e3ilibrim" T+), ater t+e emerenceo competiti/e mar2et pricin, P $C <15( .ol% re)lt" ;eca)e $C AC, P $C
implie) t+at π ("
>" &1( Point)* In t+e ollo.in li)t i) a nmber o .ell-2no.n companie) an% t+e pro%ct t+at t+e0 )ell"4+ic+ o t+e or t0pe) o mar2et) &perect competition, monopol0, monopoli)tic competition,oliopol0* be)t c+aracteri8e) t+e mar2et) in .+ic+ t+e0 competeF E7plain .+0" Bint: Go ma0 .i)+ to%i)tini)+ bet.een national an% localreional mar2et) or )ome irm)" &re% ont )oltion)*
a" #cDonald<s ' hamburgers: Oliopol0 in t+e national &or .orl%.i%e* a)t oo% mar2et, btmonopoli)tic competition in t+e local or per+ap) reional mar2et)"
b" !xxon'#obil ' gasoline6 Oliopol0 in t+e national &or .orl%.i%e* oil reiner0 mar2etHmonopoli)tic competition in t+e local retail mar2et &nei+bor+oo% a)oline )tation)*"
c" Dell ' personal computers: $onopoli)tic competition" T+e top i/e compter manactrer)&!ell, Compa3, I$;A, BP, an% ate.a0* +a/e le)) t+an 5(J o t+e PC mar2et int +e US, a).ell a) in t+e .orl% mar2et"
%" =ein ' 5etchup6 Oliopol0 &almo)t a %opol0i 0o t+in2 abot Bein8 an% !el $ontee))entiall0 %ominatin t+e 2etc+p mar2et*"
e" 2roctor > ?amble ' disposable diapers6 Oliopol0 &main competitor to Proctor) Pamper) i)Kimberl0-Clar2) Bie)*" Bo.e/er, pri/ate label %i)po)able %iaper) are increa)in t+eirmar2et )+are)"
" &tarbuc5s ' gourmet coffee6 $onopoli)tic competition" Starbc2) ma0 be alone a) a nationalc+ain, bt in local mar2et) t+ere are nmero) ormet coee+o)e)"
" Domino<s ' pia6 Oliopol0 in national pi88a c+ain)" $onopoli)tic competition at t+e localle/el"
+" Intel ' computer chips for 2C<s6 Oliopol0, bt beca)e o Intel) %ominance in t+i) mar2et, itcol% be calle% a nearM monopol0"
8. &( Point)* Bow "ow Baaar -B"B/ is a growing firm specialiing in gourmet dog food and suppliesin (lorida resort communities. B"B)s demand and cost information are as follows6
2 @899 ' :
#$ @899 ' %:C 189,999 @99: #C 7@99
where : is output, 2 is price in dollars, #$ is marginal revenue, C is total cost and #C is marginalcost. All costs include a normal return of 1% on capital investment.
A. Determine the profit'maximiing price and output levels, and the profit earned.
Set $9 $C to %etermine t+e proit-ma7imi8in otpt le/el:>5(( - ' >((, or ' >1((, )o '(5( nit)
P >5(( - >5(( - '(5( <'>5(
Proit T9 - TC PD - TC &>5((-* - &15(,((( >((*
>5(( - ' - 15(,((( - >((
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ECO-6655: Application Problem Set 5 – SOLUTIONS, T5-1 !r" !ominic #" $ina%eo
>1(( - ' - 15(,((( >1((&'(5(* - &'(5(*' - 15(,(((
@,>(5,((( - >,'(',5(( - 15(,((( <>,(5',5((
B. Based on your results in 2art A and assuming the firm operates in a monopolistically competitiveindustry, explain what will happen to this industry in the long run; No, t+e irm i) not in lon-rn
e3ilibrim )ince it i) earnin )b)tantial economic proit) at pre)ent" T+e)e proit) .ill attractne. irm) to t+e lan%)capin in%)tr0, .+ic+ .ill attract b)ine)) a.a0 rom ;4; an% )+it;4;) %eman% cr/e let.ar% o/er time &i"e", t+eir mar2et )+are .ill all*" T+i) entr0 .illcontine ntil ;4;) economic proit) are eliminate%"
C. Determine the output level, price, and profits that will occur in long'run e*uilibrium. Assume a
high'price, low'output scenario assuming a parallel shift of the firm<s demand curve. Be sure toexplain what you are doing and why. =int6 he slope of the AC curve is '7189,9990:%.
Step 1: In t+i) problem, t+e oriinal %eman% cr/e .ritten in term) o P >5(( - , )o .e nee%to re.rite t+e oriinal %eman% cr/e in term) o , or >5(( - P" T+i) mean) t+e )lope o t+e%eman% cr/e i) -1 an% t+e oriinal intercept i) >5((" #rt+ermore, t+e problem )peciie) a
parallel )+it o t+e %eman% cr/e, )o t+e ne. %eman% cr/e intercept c+ane) bt t+e )loperemain) t+e )ame" 4e %o not nee% to %etermine t+e intercept at t+i) point beca)e .e are onl0intere)te% in t+e )lope o t+e %eman% cr/e to )ol/e t+i) problem"
Step ': #in% t+e point o tanenc0 bet.een t+e ATC cr/e an% t+e %eman% cr/e" T+i) occr).+ere t+e )lope o t+e ATC cr/e & -<15(,((('* e3al) t+e )lope o t+e ne. %eman% cr/e:
)lope o co)t cr/e ne. %eman% cr/e )lope-<15(,(((' -1
' 15(,((( )3are root o 15(,((( @="'?@ nit)"
Step : In lon-rn e3ilibrim, P AC:P AC TC &15(,((( >((* 15(,((( >(( 15(,(((@="'?@ >(( @="'?@ >(( <=@="'?@
Step >: In t+e lon rn, proit) are 8ero" To pro/e t+i):Proit T9 - TC P - 15(,((( - >((
&=@="'?@*D@="'?@ - 15(,((( - >((&@="'?@* (>,?1?" - 15(,((( - 15>,?1?" 8ero
ote6 If you got a small positive number it li5ely is due to rounding error.
D. Calculate B"B)s new long'run e*uilibrium demand curve.
In or%er to et t+e ne. %eman% cr/e, .ell nee% to %etermine t+e intercept" 4e 2no. t+at one pointon t+e %eman% cr/e alrea%0 i) P @=" an% @=", an% .e al)o 2no. t+at %eman% cr/e) are o t+e orm a - bP, an% .e alrea%0 %etermine% t+at b -1 rom part ;"
Sb)tittin t+e)e /ale): @=" a - =@=", t+en a 11=>"6" T+ereore, 11=>"6 - P i) ;4;)ne. %eman% cr/e"
>
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ECO-6655: Application Problem Set 5 – SOLUTIONS, T5-1 !r" !ominic #" $ina%eo
Alternati/el0, t+e in/er)e %eman% cr/e .ritten in term) o P 11=>"6 - " Notice t+at t+e interceptterm +a) %ecrea)e% )b)tantiall0 rom t+e oriinal one &P >5(( - *, in%icatin a mar2e% let.ar%)+it o t+e cr/e %e to mar2et entr0"
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