Question

Q5-Sticky Stuff produces taffy in a monopolistically competitive (CwDP) market. The inverse demand for its product is P = 50 – Q where quantity is measured in thousands of cases per year and price is measured in dollars. Assume Sticky Stuff has a constant marginal cost of $10 per case and has no fixed cost. Its total cost curve is TC = 10Q.

Answer the following questions:

a-To maximize profit, how many cases of taffy should Sticky Stuff produce each year?

b-What price will cases of taffy sell for?

c-How much profit will Sticky Stuff earn each year?

d-In reality, firms in monopolistic competition face fixed costs in the short run. Given the answers to the previous questions, what would Sticky Stuff’s fixed costs have to be in order for this industry to be in long-run equilibrium? Explain

Answer 1

Question 5

(a)

P = 50 - Q

Calculate TR -

TR = P * Q = (50 - Q) * Q = 50Q - Q²

Calculate MR -

MR = dTR/dQ = d(50Q - Q²)/dQ = 50 - 2Q

MC = 10

A monopolistically competitive firm maximizes profit when it produce that level of output corresponding to which MR equals MC.

MR = MC

50 - 2Q = 10

2Q = 40

Q = 20

So,

To maximize profit, Sticky Stuff should produce 20,000 cases each year.

(b)

Calculate the Price -

P = 50 - Q

P = 50 - 20

P = 30

So,

The cases of taff should sell for $30 per case.

(c)

Calculate the profit -

Profit = Total Revenue - Total Cost

Profit = (P * Q) - 10Q

Profit = (30 * 20000) - (10 * 20000) = $400,000

So,

Sticky Stuff will earn $400,000 as profit each year.

(d)

When a monopolistically competitive firm is in long-run equilibrium, it earns zero economic profit.

In given case, in short-run, firm is earning $400,000 as economic profit.

If Sticky Stuff's fixed cost would be $400,000 then in that case its economic profit would be reduced to $0.

As economic profit will be reduced to $0, industry would be in long-run equilibrium.

So,

Sticky Stuff's fixed cost have to be $400,000.