Question

You are the manager of BlackSpot Computers, which competes directly with Condensed Computers to sell high-powered computers to businesses. From the two businesses’ perspectives, the two products are indistinguishable. The large investment required to build production facilities prohibits other firms from entering this market, and existing firms operate under the assumption that the rival will hold output constant. The inverse market demand for computers is P = 5,100 – .5Q and both firms produce at a marginal cost of $750 per computer. Currently, BlackSpot earns revenues of $6.38 million and profits (net of investment, R&D, and other fixed costs) of $1 million. The engineering department at BlackSpot has been steadily working on developing an assembly method that would dramatically reduce the marginal cost of producing these high-powered computers and has found a process that allows it to manufacture each computer at a marginal cost of $500. How will this technological advance impact your production and pricing plans? How will it impact BlackSpot’s bottom line?

Answer 1

To maximize profits, BlackSpot should manufacture at the level where MR = MC

Further, only marginal costs are taken into consideration while calculating profits. This is because generally for pricing decisions, variable costs are more important.

Thus with every extra unit produced, the marginal costs are the variable costs.

The situations before and after the technology advance are shown below:

Before the technological advance:

Here,

P = 5100 - 0.5Q

MC = 750

TR = P.Q

MR = dTR/dQ = 5100 - Q

Now equate MR = MC

5100 - Q = 750

Q = 4350

P = $2925

Profits at the profit maximizing condition (considering only marginal costs)

= TR - TC

= PQ - (VC*Q)

= $9,461,250

After the technological advance:

P = 5100 - 0.5Q

MC = 500

TR = P.Q

MR = dTR/dQ = 5100 - Q

MR = MC

5100 - Q = 500

Q = 4600

P = $2800

Profits at the profit maximizing condition (considering only marginal costs)

= TR - TC

= PQ - (VC*Q)

= $10,580,000

Comparing the situation before and after the technological advancement:

Before

Q = 4350

P = $2925

Profits = $9,461,250

After

Q = 4600

P = $2800

Profits = $10,580,000

Thus, the technological advancement brings down the cost of production, lowering the price, increasing the quantity produced, and increasing the profits for the firm.