ECON203 LAB 08

1. What is the difference between economic profit and accounting profit, and how does this difference matter for actual business decisions?

 Economic profit includes all costs, including the opportunity cost of all resources used by the firm, whether or not they involve outside payments. Accounting profit looks only those costs that entail cash outlays. The firm should consider economic profit only.

 4. A firms total revenue curve is given by.

Is this a perfectly competitive firm? Explain why or why not.

 Price = TR/Q, so this firm's demand curve is given by P = 3 0.02Q. Since its price is a decreasing function of its output, it cannot be a perfectly competitive firm.

 6. True or false: If marginal cost lies below average fixed cost, the firm should shut down in the short run. Explain.

 False. The firm should shut down if and only if its price is below AVC. MC can lie below AFC at the same time price lies above AVC (see diagram).

 8. True or false: In a constant-cost industry, a tax of a constant, fixed amount on each unit of output sold will not affect the amount of output sold by a perfectly competitive firm in the long run. Explain.

 The effect of such a tax is to produce a parallel upward movement in each firm's long-run average cost curve. The output level for which the minimum value of LAC occurs will thus be the same as before, which means that firms in long-run equilibrium will each have the same amount of output as before. Thus the statement is true. The long-run market equilibrium price will be equal to the minimum LAC + the amount of the per-unit tax, and buyers will pay 100% of the tax.

 10. True or false: Consumer surplus is the area between the demand curve and the price line. For a perfectly competitive firm the demand curve equals the price line. Thus, a perfectly competitive industry produces no consumer surplus.

 Consumer surplus in a competitive industry is the area between the price line and the market demand curve, not the individual firm's demand curve. Since the market demand curve is downward sloping, there will in general be positive consumer surplus. Indeed, compared to other market structures, perfect competition creates the maximum consumer surplus. Thus the statement is false.

 5. A perfectly competitive firm faces a price of 10 and is currently producing a level of output at which marginal cost is equal to 10 on a rising portion of its short-run marginal cost curve. Its long-run marginal cost is equal to 12. Its shortrun average variable cost is equal to 8. The minimum point on its long-run average cost curve is equal to 10. Is this firm earning an economic profit in the short run? Should it alter its output in the short run? In the long run, what should this firm do?

 Since P = SMC > AVC, we know that the firm should continue at its current level of output (call it Q0) in the short run. Is the firm making economic profits? Since LMC = 12 > min LAC = 10, we know that the firm is producing to the right of its long run costminimizing level, that LAC is rising, and therefore that 10 < LAC(Q0) < 12. Since SMC LMC, LAC(Q0) < SAC(Q0), and hence P = MC < SAC. Therefore the firm is incurring losses in the short run, and in the long run it should shift to a smaller size of plant (in fact, the size that minimizes LAC at Q*), as shown in the following diagram.

16. Suppose a representative firm in a perfectly competitive, constant-cost industry has a cost function TC=4Q^2+100Q+100. a. What is the long-run equilibrium price for this industry? b. If market demand is given by the function Q = 1000-P, where P denotes price, how many firms will operate in this long-run equilibrium? c. Suppose the government grants a lump-sum subsidy to each firm that manufactures the product. If this lump-sum subsidy equals 36, what would be the new long-run equilibrium price for the industry?

TC=4Q^2+100Q+100.
a. What is the long-run equilibrium price for this industry? a) LAC = TC/Q = 4Q + 100 + 100/Q. The minimum point on LAC is found either by graphing the LAC curve or by taking the first derivative and setting it equal to zero: dLAC/dQ = 4 100/Q^2 = 0, which yields Q = 5 units. In the long run, P = LAC = $140/unit.

TC=4Q^2+100Q+100.
b. If market demand is given by the function Q = 1000-P, where P denotes price, how many firms will operate in this long-run equilibrium? b) If demand is Q = 1000 P, then at P = 140, we get Q = 860 units. So in long run equilibrium, there will be 860/5 = 172 firms.

Q = 1000-P

c. Suppose the government grants a lump-sum subsidy to each firm that manufactures the product. If this lump-sum subsidy equals 36, what would be the new long-run equilibrium price for the industry? c) Now LAC = (TC 36)/Q = 4Q + 100 + 64/Q. Again, the minimum point on LAC is found either by graphing the LAC curve or by taking the first derivative and setting it equal to zero. dLAC/dQ = 4 64/Q2 = 0, which yields Q = 4 units. In the long run, P = LAC = $132/unit. At this price, Q = 868 units, and the number of firms rises to 868/4 = 217.

 Question 8: Page 348 in Old Text and Page 388 in New Text, Problem 20. N/A

 Question 9: Some argue that the case for innovation in competitive markets is a negative one, because entrepreneurs innovate only to keep from making losses (the truck airfoil case in your text). What positive incentive is there for a strong R&D department in a competitive industry?

 If a firm can be the leader in technology, it can reap short-term profits for as long as it takes for industry-wide adjustment to occur. Of course, if it can patent and/or otherwise restrict access to the technology, then its share of industry production could increase, and the structure of the industry could even change.

Question 10:
4. Why does a profit-maximizing monopolist never produce on an inelastic portion of the demand curve? Would a revenue-maximizing monopolist ever produce on the inelastic portion of the demand curve?

Question 10: answer

On the inelastic portion of the demand curve, raising price will always increase revenue and (since output will be lower) it also lowers costs. Therefore the firm should always move up the demand curve to where it is not inelastic if profit maximization is a goal.

Question 11:
2. A monopolist has a demand curve given by P=100-Q and a total cost curve given by TC=16+Q^2. The associated marginal cost curve is MC=2Q. Find the monopolists profitmaximizing quantity and price. How much economic profit will the monopolist earn?

Question 11: answer

MC = 2Q = MR = 100 - 2Q; 100 - 2Q = 2Q, so Q* = 25, P* = $75/unit. TR = $1875; TC = $641 thus profit = TR - TC = $1234

Question 12:
8. The demand by senior citizens for showings at a local movie house has a constant price elasticity equal to -4. The demand curve for all other patrons has a constant price elasticity equal to -2. If the marginal cost per patron is $1 per showing, how much should the theater charge members of each group?

Extracting More Surplus 1: Price Discrimination

Third degree price discrimination

Charge different price in each market segment Result: charge high price to market segment with low price-elasticity of demand & charge low price to segment with high price-elasticity of demand

Example: Two market segments Two prices

Objective: max P1 (q1 )q1 P2 (q2 )q2 C (q1 q2 )

q1 ,q2

Two first-order conditions: P1 '(q1 )q1 P1 (q1 ) C '(q1 q2 ) 0 P2 '(q2 )q2 P2 (q2 ) C '(q1 q2 ) 0 In other words: MR1 (q1 ) MC (q1 q2 ) and MR2 (q2 ) MC (q1 q2 )

Extracting More Surplus 1:Price Discrimination

FIGURE 12-13 The ProfitMaximizing Monopolist Who Sells in Two Markets (third degree price discrimination)

 Ed =
An expression that relates MR to the elasticity of demand: MR = P(1 - 1/Ed) If demand is inelastic, Ed < 1 and MR < 0. As profit maximization requires that MR = MC and MC is always positive, we see that a monopolist must always price in the elastic portion of the demand curve.MR > 0 if and only if Ed > 1.

 MR = P(1 1/|h|) = MC, which implies that P = MC/(1 1/|h|) Senior citizens: PS* = 1.20/(1 1/4) = $1.60. Adults: PA* = 1.20/(1 1/2) = $2.40.

Question 13: N/A

Question 14:
Use the graph below of the monopolized market for fluorescent skyhooks to explore answers to questions ae. Answer with letters except where indicated.

 a) What is the consumer surplus if the monopolist is a singleprice profitmaximizer? b) The difference between the amount of consumer surplus in the competitive industry, and the consumer surplus in an industry with a single monopolist is __________ c) The singleprice monopolist has total costs that are lower than the competitive firms by this much: _______. d) The singleprice monopolists cause this much deadweight loss to society: ___________ e) A singleprice monopoly firm would need to go out of business in the long run if its ATC was as shown with the dotted line. However, a perfectly discriminating monopolist might make a profit under certain circumstances. Describe with letters what would need to be true for the perfectly discriminating firm to stay in business in the long run.

a) A+B b) C+D+E c) G+H d) E+M e) A+B>J.