microeconomics book solution 15

# Each firm believes that it will sell 1 fewer airplane

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Each firm believes that it will sell 1 fewer airplane if it raises the price by \$5,000. And each firm also believes that it can sell 1 more airplane if it lowers the price by \$10,000. That is, each firm has a kinked demand curve. a. How much additional revenue will a firm generate if it produces 1 more (the 11th) airplane? b. How much revenue will a firm lose if it produces 1 fewer airplane? c. If the marginal cost of producing an airplane is \$120,000, how many airplanes will each firm produce, and at what price? d. If the marginal cost of producing an airplane is \$140,000, how many airplanes will each firm produce, and at what price? C H A P T E R 1 5 O L I G O P O LY S-219 S209-S220_Krugman2e_PS_Ch15.qxp 9/16/08 9:23 PM Page S-219

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Solution 12. a. Currently, a firm has revenue of \$200,000 × 10 = \$2,000,000. If it produces 11 airplanes, it has to lower the price for each of its airplanes to \$190,000. If it did so, it would have revenue of \$190,000 × 11 = \$2,090,000. That is, as it produces 1 more (the 11th) airplane, its marginal revenue is \$2,090,000 \$2,000,000 = \$90,000. b. Currently, a firm has revenue of \$200,000 × 10 = \$2,000,000. If it produces 9 air- planes, it raises the price for each of its airplanes to \$205,000. If it did so, it would have revenue of \$205,000 × 9 = \$1,845,000. As it produces 1 fewer air- plane, its revenue decreases by \$2,000,000 \$1,845,000 = \$155,000. The margin- al revenue of the 10th airplane is \$155,000. c. Each firm’s marginal revenue curve has a break at the 10th airplane, where mar- ginal revenue drops from \$155,000 to \$90,000. If the marginal cost is \$120,000, the firm will produce 10 airplanes at the price of \$200,000 each. This is because producing the 11th airplane would create less additional revenue (\$90,000) than the additional cost of producing the 11th airplane (\$120,000). Similarly, produc- ing 1 fewer airplane would lose the firm more revenue (\$155,000) than it creates in cost savings (\$120,000). d. If the marginal cost is \$140,000, the firm will still produce 10 airplanes at the price of \$200,000 each: producing the 11th airplane would create less additional revenue (\$90,000) than the additional cost of producing the 11th airplane (\$140,000). Similarly, producing 1 fewer airplane would lose the firm more rev- enue (\$155,000) than it creates in cost savings (\$140,000). In other words, small changes in marginal cost do not influence output and prices. S-220 C H A P T E R 1 5 O L I G O P O LY S209-S220_Krugman2e_PS_Ch15.qxp 9/16/08 9:23 PM Page S-220
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