Krugman_SolMan_CH15

Krugman_SolMan_CH15 - Krugman_SolMan_CH15 11/11/04 4:24 PM...

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chapter Oligopoly 1. a. If BASF produces 10 tons more, it now produces 50 tons and the price would fall to $3 per ton. That is, on each of the 40 tons it was already producing, it would lose $1. So the price effect is 40 × ($ 1) = $ 40. Since BASF produces an addi- tional 10 tons and sells them at $3, the quantity effect is 10 × $3 = $30. So BASF gains $30 revenue from producing 10 additional tons, but it loses $40 revenue from producing those 10 additional tons. Since the marginal cost is zero, addi- tional production does not change BASF’s cost. Since BASF loses revenue, it has no incentive to produce the 10 additional tons. b. If BASF produces 10 tons more, the total produced is now 50 tons and the price would fall to $3. That is, on each of the 20 tons it was already producing, it would lose $1. So the price effect is 20 × ($ 1) = $ 20. Since BASF produces an addi- tional 10 tons and sells them at $3, the quantity effect is 10 × $3 = $30. So BASF gains $30 revenue from producing 10 additional tons, and it loses only $20 rev- enue, resulting in an overall increase in revenue of $10. Since the marginal cost is zero, there is no change to BASF’s cost. Since producing the 10 additional tons raises BASF’s revenue by $10, BASF does have an incentive to produce 10 additional tons. 2. a. The accompanying table shows the total revenue and the marginal revenue for the cartel. Since a cartel acts like a monopolist, it will maximize profits by producing up to the point where marginal cost equals marginal revenue. For all gallons up to 2,000 gallons, marginal revenue is greater than marginal cost. Producing any more would mean that marginal revenue is less than marginal cost. So the cartel will produce 2,000 gallons and sell them at $80 each. Since the two families share the market equally, each family has revenue of 1,000 × $80 = $80,000. The mar- ginal cost per gallon is constant at $40, so the total cost (remember there is no fixed cost!) of producing 1,000 gallons is $40,000. Each family therefore makes a profit of $80,000 $40,000 = $40,000. 125 15 Price of olive oil Quantity of olive oil (per gallon) demanded (gallons) Total revenue Marginal revenue $100 1,000 $100,000 $70 90 1,500 135,000 50 80 2,000 160,000 30 70 2,500 175,000 10 60 3,000 180,000 10 50 3,500 175,000 30 40 4,000 160,000 50 30 4,500 135,000 70 20 5,000 100,000 90 10 5,500 55,000 Krugman_SolMan_CH15 11/11/04 4:24 PM Page 125
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b. Now the Sopranos sell 1,500 gallons and the Contraltos sell 1,000 gallons, for a total output of 2,500 gallons. So the price falls to $70 per gallon. The Sopranos have revenue of 1,500 × $70 = $105,000 and cost of 1,500 × $40 = $60,000. So their profit is $105,000 $60,000 = $45,000. The Contraltos have revenue of 1,000 × $70 = $70,000 and cost of 1,000 × $40 = $40,000. So their profit is $70,000 $40,000 = $30,000. c. If both the Contraltos and the Sopranos sell 1,500 gallons each, the total output in this duopoly is 3,000 gallons, and the price falls to $60 per gallon. Each family has revenue of 1,500 × $60 = $90,000 and cost of 1,500 × $40 = $60,000. Each family’s profit therefore is $30,000.
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