Question

Mr. Wong buys gold from gold mines and resells it in the retail market in Country A. Before the gold is sold in the retail market, Mr. Wong needs to store the gold in a warehouse and the storage cost is $10 per kg of gold per day. For examples, if Mr. Wong buys 1kg of gold on 22 April 2020 and sells it on the same day, Mr. Wong has to pay a storage cost of $10. If Mr. Wong buys 1kg of gold on 22 April 2020 and sells it on the next day, Mr. Wong has to pay a storage cost of $10 x 2 = $20. There is no fixed cost in Mr. Wong’s gold business.

Mr. Wong is the sole retailer of gold in Country A and he would like to maximize the profit of his business.

The market demand for gold is Q^d = 3000-75P and

The corresponding marginal revenue is MR = 40 – 2Q/75,

where Q^d is the quantity demanded for gold (kg/day) and P is the price of gold per kg.

For instance, when P = 20, Q^d = 3000-75(20) = 1500 and MR = 40-2(1500)/75 = 0.

(i) Suppose that Mr. Wong buys gold at a price of $10 per kg. What should be the price of gold set by Mr. Wong in the retail market and what is the quantity of gold sold in the retail market? What is the profit of Mr. Wong’s business?      

(ii) Suppose that the government of Country A requires Mr. Wong to pay for a licensing fee for operating his gold business. After paying for a licensing fee of $2,000 per day, Mr. Wong can sell whatever amount of gold in the retail market in Country A. Briefly discuss how this licensing fee may affect your answers in (i).

(iii) Now, Mr. Wong does not need to pay any licensing fee. Yet, because of a logistical problem, gold purchased today can only be sold on the next day. Briefly discuss how this logistical problem will affect your answers in (i).   

(iv) Now, Mr. Wong does not need to pay any license fee and there is no logistical problem. On 22 April 2020, after Mr. Wong purchased 750kg of gold at a price of $10/kg, the government of Country A announced that the people of Country A cannot buy gold anymore. On the same day, a foreign businessman contacted Mr. Wong suggesting to buy 750kg of gold from him at a price of -$5 (minus $5 per kg). This is the only offer to Mr. Wong on that day. If you were Mr. Wong, will you accept this offer and sell your gold at a negative price?  

(v) “A futures contract for U.S. crude (oil) prices dropped more than 100% and turned negative for the first time in history on Monday, showing just how much demand has collapsed due to the coronavirus pandemic (CNBC April 19, 2020)”. With reference to your answer in (iv), briefly explain why crude oil price could be negative.

Answer 1