Question

2. Bud Owen operates Bud's Package Store in a small college town. Bud sells six packs of beer for off-premises consumption. Bud has very limited store space and has decided to limit his product line to one brand of beer, choosing to forego the snack food lines that normally accompany his business. Bud's is the only beer retailer physically located within the town limits. He faces considerable competition, however, from sellers located outside of town. Bud regards the market as highly competitive and considers the current $2.50 per six pack selling price to be beyond his control. Bud's total and marginal cost functions are: TC = 2000 + 0.0005Q2 MC = 0.001Q where Q refers to six packs per week. Included in the fixed cost figure is a $750 per week salary for Bud, which he considers to be his opportunity cost. a. Calculate the profit maximizing output for Bud. What is his profit? Is this an economic profit or an accounting profit? b. The town council has voted to impose a tax of $.50 per six pack sold in the town, hoping to discourage beer consumption. What impact will the tax have on Bud? Should Bud continue to operate? What impact will the tax have on Bud's out-of-town competitors? New MC = 0.001Q + 0.5

Answer 1

2 (a) Given marginal cost is . The profit maximizing output will be where the marginal cost will be equal to the price, ie or or . The profit will be , TR being total revenue, and hence or or dollars. This is an economic profit.

(b) Tax imposition can be seen as either reduction in price by tax, or increasing in marginal cost by tax. As given, the new marginal cost is . Equating again with price, we have the profit maximizing quantity as or . Hence, effect of tax on Bud is that his profit maximizing quantity has reduced. The new profit will be hence, , ie or dollars. Hence, Bud's profit will be reduced. Yet profit is reduced, it is still non-negative, and Bud will continue to operate. Bud's out-of-town competitors however, would make relatively more profit than before, as supply of Bud is reduced due to tax, but his competitors are still producing at no-tax quantity.