Question

A college professor at LeTall University, Professor Lai, makes mountains out of molehills. He can do this with almost no effort; so molehills are the only input used for producing mountains. Suppose it takes 100 molehills to make 1 mountain. The current market price of molehills is $20 each. A few years ago, Lai bought an option contract that allows him to buy up to 2, 000 molehills at $10 each. His option contract stipulates that he can buy fewer than 2, 000 molehills, but he cannot resell the molehills that he obtains under the contract. In order to get governmental permission to produce mountains from molehills, Lai paid $10, 000 for molehill-masher license. 1 (a) What is Lai’s marginal cost of producing a mountain if he produces fewer than or equal to 20 mountains? What is the marginal cost if he produces more than 20 mountains? (b) Suppose Lai is producing mountains out of molehills in a perfectly competitive market in which there is a great mass of other college professors doing the same. If the market price of mountains is $1, 600, how many mountains will Lai produce? (c) The government is considering raising the fee of the molehill-masher license. i. Lai claims that he would have gone out of business if the license had costed $11, 000. Is Lai telling the truth here? Why? ii. Lai is requested to renew the molehill-masher license. Suppose the production process goes over again under the same conditions (including having the same option contract) if only he renews the license. What is the maximum license fee so that Lai is willing to renew the license (you can assume that he will renew it when he is indifferent)?

Answer 1