303ex4-Notes

303ex4-Notes - ECON 303 Notes for Exam 4 1 Determining...

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ECON 303 Notes for Exam 4 1. Determining profit-maximizing output and maximum profit for a monopolistic firm given its cost function and the demand function for its product (Ch. 8, p. 283- 289) Characteristics of a monopolistic market: Only a single seller of a particular product Lack of acceptable substitutes for the product Barriers to entry into the market in such forms as legal barriers, economies of scale, and/or control of essential resources. In a monopolistic market, the single firm is the market itself. Thus, the firm sets the price for its product (i.e., act as a price setter) and has market power. A monopolistic firm first determines the optimal output following the rule for profit maximization and then sets the price for the product. Because a monopolistic firm is the market itself, it faces a negatively sloped demand curve for its product. The firm has to lower the price in order to sell more or sell less in order to charge a higher price. Because of this, marginal revenue (MR) is always less than price (P) except for the first unit sold. Suppose, C(Q) = 10 + 3Q + Q 2 and Q d = 60 - 5P. At the optimal output, MR = MC. Derive the inverse demand function from the demand function: Q d = 60 - 5P => P = 12 - 0.2Q. Use the P from the inverse demand function to derive the TR function: TR = PQ = (12 - 0.2Q)Q = 12Q - 0.2Q 2 Derive the MR function from the TR function: MR = dTR/dQ = 12 - 0.4Q. Derive the MC function from the cost function: MC = dC(Q)/dQ = 3 + 2Q. Set MR = MC and solve for the optimal Q: 12 - 0.4Q = 3 + 2Q => 2.4Q = 9 => Q = 3.75. Substitute the value of Q into the inverse demand function to determine the corresponding P: P = 12 - 0.2Q = 12 - 0.2(3.75) = 11.25. Page 1 of 10

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ECON 303 Notes for Exam 4 Substitute the values of P and Q into the Π function to calculate the maximum Π: Π = TR - TC = PQ - C(Q) = 11.25(3.75) - [10 + 3(3.75) + (3.75) 2 ] = 42.2 - 35.3 = \$6.9. 2. Determining profit-maximizing output and maximum profit for a monopolistically competitive firm given its cost function and the demand function for its product (Ch. 8, p. 293-301) Characteristics of a monopolistically competitive market: Many sellers of a particular product Product differentiation across the sellers in such forms as quality, physical characteristics, customer service, brand name, and store location Relatively easy entry into the market Because of product differentiation, consumers view the products sold by different firms as close but not perfect substitutes. Product differentiation provides individual firms the ability to set the prices for their products and thus market power. Higher degree of product differentiation provides higher degree of market power and vice versa. A monopolistically competitive firm faces a negatively sloped demand
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303ex4-Notes - ECON 303 Notes for Exam 4 1 Determining...

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