Question

In: Economics

Suppose you have been tasked with regulating a single monopoly firm that sells 50 kilogram bags...

Suppose you have been tasked with regulating a single monopoly firm that sells 50 kilogram bags of concrete. The firm has fixed costs of $10 million per year and a variable cost of $2 per bag no matter how many bags are produced.

a. If this firm kept on increasing its output level, would ATC per bag ever increase? (Click to select)YesNo.

     Is this a decreasing-cost industry? (Click to select)YesNo.

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

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

     At that price, the firm's (Click to select)profitloss equals $ million.

     Would the firm want to exit the industry? (Click to select)YesNo.

c. You find out that if you set the price at $3 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 $3 per bag, how big would the firm’s profit or loss be?

     At that price, the firm's (Click to select)profitloss equals $ million.

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.$ per bag.

Solutions

Expert Solution


a. If this firm kept on increasing its output level, would ATC per bag ever increase? No

This is because since AVC is fixed at $2 and AFC declines as Q increases, it will lead to a falling ATC as Q increases

Hence, it is not a decreasing-cost industry?

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

Optimal price is where P = MC

This will take place at P = $2

Profit = (P-MC)Q – FC = -$10 million

No, the firm will not want to exit the industry as it will still be able to cover its variable costs

c. You find out that if you set the price at $3 per bag, consumers will demand 10 million bags.

Profit = (P-MC)Q – FC = (3-2)10 – 10 = $0 million

d. If consumers instead demanded 20 million bags at a price of $3 per bag, how big would the firm’s profit or loss be?

Profit = (P-MC)Q – FC = (3-2)20 – 10 = $10 million

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.$ per bag.

At this point of fair rate of return, profits must be 0

Profit = (P-MC)Q – FC = (P-2)20 – 10 = 0

This makes P = $2.5


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