A+B - TO MAXIMIZE ITS PROFIT FIRM 1 SHOULD CHARGE $15 AND...

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1. Suppose there are two firms with one demand function. This same (common) demand function is: Q = 1,000 – 40P with MR = 25 – 0.05Q However, each firm has its own cost function which is different. These two different cost functions are shown below respectively: Firm 1: 4,000 + 5Q Firm 2: 3,000 + 7Q a. What price should each firm charge if it wants to maximize its profit (or minimize its loss)? FIRM 1 FIRM 2 4000 + 5Q 3000 + 7Q MC = 5 MC = 7 MR = MC MR = MC 25 – 0.05Q = 5 25 – 0.05Q = 7 20 = 0.05Q 18 = 0.05Q 400 = Q 360 = Q P = 25 – .025Q P = 25 – .025Q P = 25 – .025(400) P = 25 - .025(360) P = $15 P = $16
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Unformatted text preview: TO MAXIMIZE ITS PROFIT FIRM 1 SHOULD CHARGE $15 AND FIRM 2 SHOULD CHARGE $16 b. If price war breaks out, most likely price will fall. Two most likely prices in that event are $13 and $12. Which company, firm 1 and firm 2, is more vulnerable to price war when P = $13 and why? Q = 1,000 40(13); Q = 480 TR = $13 x 480 = $6,240 FIRM 1 TC = 4000+5(480) = 6,400; 6,240 6,400 = LOSS OF $160 FIRM 2 TC = 3000+7(480) = 6,360; 6,240 6,360 = LOSS OF $120 THUS FIRM 1 IS MORE VULNERABLE TO A PRICE WAR WHEN P=$13 BECAUSE THEY HAVE MORE OVERHEAD COMPARED TO FIRM 2 ....
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