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Econ Set 2

# Econ Set 2 - 1 There are two firms with the same(common...

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1. There are two firms with the same (common) demand function: Q = 1,000 – 40P with MR = 25 – 0.05Q Each firm has a different cost function: 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 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 c. Which firm is more vulnerable to price war when P = \$12 and why? Q = 1,000 – 40(12); Q = 520 TR = \$12 x 520 = \$6,240 FIRM 1 TC = 4000+5(520) = 6,600; 6,240 – 6,600 = LOSS OF \$360 FIRM 2 TC = 3000+7(520) = 6,640; 6,240 – 6,640 = LOSS OF \$400 THUS FIRM 2 IS MORE VULNERABLE TO A PRICE WAR WHEN P=\$12 BECAUSE THEY HAVE MORE OVERHEAD COMPARED TO FIRM 1. 1

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d. In view of your answers in (b) and (c), discuss advantage and disadvantage of cost structure between firm 1 and firm 2. e. Long run average cost curve decreases when output elasticity is greater than one. What is the implication of your answer in (b) and (c) for the shape of long run average cost curve? 2. A firm in an oligopolistic industry has identified two sets of demand curve. If the firm is the only one that changes price (i.e., other firms do not follow), its demand curve takes
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