Question

Suppose you have been tasked with regulating a single monopoly firm that sells 50-pound bags of concrete. The firm has fixed costs of $30 million per year and a variable cost of $5 per bag no matter how many bags are produced.

Instructions: Enter your answers as whole numbers. In part e, round your answer to 2 decimal places.

a. If this firm kept on increasing its output level, would ATC per bag ever increase?

            YES OR NO

     Is this a decreasing-cost industry?

            YES OR NO

b. If you wished to regulate this monopoly by charging the socially optimal price, what price would you charge?

     At that price, what would be the size of the firm’s profit or loss?

   At that price, the firms _________Equals________millions.

   

     Would the firm want to exit the industry?

            YES OR NO

c. You find out that if you set the price at $6 per bag, consumers will demand 30 million bags. How big will the firm’s profit or loss be at that price?

d. If consumers instead demanded 40 million bags at a price of $6 per bag, how big would the firm’s profit or loss be?

At that price, the firms _________Equals________millions

e. Suppose that demand is perfectly inelastic at 40 million bags, so that consumers demand 40 million bags no matter what the price is. What price should you charge if you want the firm to earn only a fair rate of return? Assume as always that TC includes a normal profit.

Answer 1

A supply curve gives the cost of production. The cost structure of an industry can be explained through the supply curve. In an increasing cost industry the costs increases with greater industry output and this generates upward sloping supply curve. In constant cost industry the cost does not change with the change in industry output and this generates flat supply curve. In decreasing cost industry, costs decrease with greater industry output and this generates a downward slopping supply curve.

In this case as the variable cost remains constant no matter what the output level is, as output increases, the average total cost decreases.. Therefore, the industry is a decreasing cost industry.

The socialy optimal level of output occurs where P = MR = MC = ATC. Therefore, the price that will be charged in socially optimal level is $5 per bag. At this price, TR=TVC. Therefore profit is given as

[\Pi =TR-TC=TR-(TFC+TVC)=TR-TFC-TR=-TFC]

Therefore, the firm will earn a loss equal to the total fixed cost. Therefore, the size of loss is -$30 billion.

In a competitive industry the firms don’t have much influence on price of their product. Each firm has the objective to maximize profit. To maximize profit the firm should produce the quantity such that marginal revenue equals marginal cost, which for a firm in a competitive industry means produce up until P=MC.

Even if the firm incurs a negative economic profit it will not shut down in the short run as long as it can cover its variable cost. This is because; in the short run the firm has to pay the fixed cost even if it shuts down. As it continues its production it can earn as much to cover its variable cost and can minimize its loss from shutting down.

A firm should operate in the market as long as the price in the market is greater than its minimum average variable cost. At minimum average variable cost the firm’s marginal cost equals to its average variable cost.

At $6 per bag of 30 million bags, the total revenue is $180 million. The total cost of producing 30 million bag is

[TC=FC+Q\times VC=180]

Therefore, profit is given as

[\Pi =TR-TC=0]

Similarly, at $6 per bag 40 million bags total revenue is $240 million. Total cost is

[TC=FC+Q\times VC=230]

Therefore, profit is given as

[\Pi =TR-TC=10]

The total cost of producing 40 million bags is $230 million. For normal profit, TR=TC=230

[\therefore P=\frac{TR}{Q}=5.75]