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 $10 million per year and a variable cost of $3 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?

(Click to select)  Yes  No

     Is this a decreasing-cost industry?

      (Click to select)  Yes  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?

   

     Would the firm want to exit the industry?

      (Click to select)  Yes  No

c. You find out that if you set the price at $4 per bag, consumers will demand 10 million bags. How big will the firm’s profit or loss be at that price?

d. If consumers instead demanded 20 million bags at a price of $4 per bag, how big would the firm’s profit or loss be?

e. Suppose that demand is perfectly inelastic at 20 million bags, so that consumers demand 20 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. No. This is because the variable cost is fixed and this implies ATC is 10/Q + 3. With increase in Q, ATC declines only.

Yes. It is a decreasing-cost industry because ATC is declining.

b. A socially optimal price is P = MC, hence, you should charge a price of P = MC = $3. At that price, firm loses all its fixed cost so that the loss is $10 million.

Yes, the firm wants to exit the industry because it runs consistent economic losses.

c. At a price of $4 per bag, consumers will demand 10 million bags. Total revenue is $40 million and total cost is 10 million + 3*10 million = $40 million. Hence there is 0 economic profit or loss.

d. If consumers instead demanded 20 million bags at a price of $4 per bag, revenues are $80 million and cost is 10 + 3*20 = $70 million. Hence, profit is $10 million.

e. Sales are fixed at Q = 20 million bags. A fair rate of return has Zero economic profits so that revenue equals cost. This gives 20 million x P = $10 million + $3*20 million. This gives P = $3.5 per bag.