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Exam 3 Problems

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1. Monopolistic Competition. Soft Lens, Inc., has enjoyed rapid growth in sales and high operating profits on its innovative extended-wear soft contact lenses. However, the company faces potentially fierce competition from a host of new competitors as some important basic patents expire during the coming year. Unless the company is able to thwart such competition, severe downward pressure on prices and profit margins is anticipated.
A. Use Soft Lens' current price, output, and total cost data to complete the following table:
Price ($) Monthly Output (mil.) Total Revenue (mil.) Marginal Revenue (mil.) Total Cost (mil.) Marginal Cost (mil.) Average Cost (mil.) Total Profit (mil.)
$20 0     $ 0      
19 1     12      
18 2     27      
17 3     42      
16 4     58      
15 5     75      
14 6     84      
13 7     92      
12 8     96      
11 9     99      
10 10     105      
(Note: Total costs include a risk-adjusted normal rate of return.)
B. If cost conditions remain constant, what is the monopolistically competitive high-price/low-output long-run equilibrium in this industry? What are industry profits?
C. Under these same cost conditions, what is the monopolistically competitive low-price/high-output equilibrium in this industry? What are industry profits?
D. Now assume that Soft Lens is able to enter into restrictive licensing agreements with potential competitors and create an effective cartel in the industry. If demand and cost conditions remain constant, what is the cartel price/output and profit equilibrium?
2. Cartel Pricing. An illegal cartel has been formed by three leading residential sanitation (trash pick-up) service companies in Honolulu, Hawaii. Total production costs at various levels of service per month are as follows:
  Total Cost ($000)
Pick-ups per Month (000) Aloha Pick-up Ltd. Beta Service, Inc. Delta Sanitation, Inc.
0 $ 2 $ 4 $ 0
1 7 10 2
2 11 14 5
3 14 17 9
4 16 22 14
5 25 30 20
A. Construct a table showing the marginal cost of production per firm.
B. From the data in part A, determine an optimal allocation of output and maximum profits if the cartel sets Q = 10(000) and P = $6.
C. Is there an incentive for individual members to cheat by expanding output when the cartel sets Q = 10(000) and P = $6?
3. Firm Supply. Wilson Fabricators, Inc., and Johnson City Metalworks, Ltd., are domestic suppliers of backyard basketball goals. Given the vigor of domestic competition, P = MR in this market. Marginal cost relations for each firm are:
MC W = $25 + $0.001Q W (Wilson Fabricators)
MC J = $75 + $0.00025Q J (Johnson City Metalworks)
where Q is output in units, and MC > AVC for each firm.
A. What is the minimum price necessary in order for each firm to supply output?
B. Determine the supply curve for each firm.
C. Based on the assumption that P = P W = P J , determine industry supply curves when P < $75 and P > $75.
4. Markup on Cost. Chim-Chimery, Inc., offers chimney sweepings in the Montpelier, Vermont area. The company recently initiated a policy of matching the lowest advertised competitor price. As a result, Chim-Chimery has been forced to reduce the average price for chimney cleaning by 4%, but has enjoyed an 8% increase in demand. Meanwhile, marginal costs have held steady at $25 per cleaning.
A. Calculate the point price elasticity of demand for chimney cleaning.
B. Calculate Chim-Chimery's optimal price and markup on cost.
Copyright 2008, by the Contributing Authors. Cite/attribute Resource . admin. (2009, January 27). Exam 3 Problems. Retrieved January 07, 2011, from Free Online Course Materials — USU OpenCourseWare Web site: http://ocw.usu.edu/economics/managerial-economics/exam3problems.htm. This work is licensed under a Creative Commons License Creative Commons License