Question

A possible reason for monopoly is economies of scale. Consider the market for books and the production of a book.

1. Explain what is meant by economies of scale and the cost structure in a case like this.
2. Explain why/how the production of a book can have economies of scale.
3. Assume that the production of the book «Monster» has the following cost function: C(X) = 200 + 5X. Calculate an expression for the average cost, and draw this in a figure with dollars on the vertical axis, and the production quantity/amount on the horizontal axis.
   
4. Calculate an expression for the marginal cost. Draw this into the figure from c). Explain why the average cost always will be higher than the marginal cost.

e.   Assume that the market price on the book equals the marginal cost. Explain why the company will lose with a price strategy like this.

Answer 1

A). Economies of scale is a occurs when as production increases average cost decrease.in other words when economy of scale occurs higher output can be produced at lower cost .in this situation average cost curve is downward sloping.the marginal cost is can be fixed or decreasing means every additional unit of output can be produced at same cost or lower than previous one.total cost is upward sloping but concave or straight line from origin.means it increase at decreasing rate or constant rate.

B). Production of book or in other words printing of book.the publisher have two fixed cost one setting up the printing system and the author charge .as both are fixed ,and these are also his total cost.so as he will publish more copies ,the per copy cost will decrease.for example a publisher buy the right of a book to publish from an author in 20,000$ and setting up the printing system cost him 10,000$ and hired two workers to print costing 10,000$ .his total cost is 40,000.let say he print 1000 copies.his average cost would be 40 .as he increase printed copies to 10,000 average cost decrease to 4.

C). Average cost=Total cost/quantity produced=C(x)/x

AC(x)=5+200/x

As you can x increases 200/x part will decrease ,so the average cost.

D). MC=∆TC/∆x= derivative of cost function with respect to x

MC =5

This means every additional unit can be produced at 5$.

Marginal cost tells the cost that occurs due to additional unit of output. It doesn't include fixed cost on other hand average cost tells what every unit cost . because it also affected by all previous unit and most importantly it includes fixed cost which isn't included into marginal cost .so due to fixed cost and contribution of all units average cost remain always higher than Marginal curve.

Note: in case of decreasing return or dis economics of scale average cost remain lower than marginal cost.