In the short run, output falls relatively by 20% in the hospital market which is relatively price-elastic, and less dramatically, by 10%, in the less price-elastic medical laboratory market.
Government in the Market Economy Presented by Suong Jian & Liu Yan, MGMT Panel , Guangdong University of Finance. - 613 - P20.4 Incidence of Regulation Costs. The Smokey Mountain Coal Company sells coal to electric utilities in the southeast. Unfortunately, Smokey = s coal has a high particulate content, and, therefore, the company is adversely affected by state and local regulations governing smoke and dust emissions at its customers = electricity- generating plants. Smokey = s total and marginal cost relations are TC = $1,000,000 + $5Q + $0.0001Q 2 MC = 0 TC/ 0 Q = $5 + $0.0002Q where Q is tons of coal produced per month and TC includes a risk-adjusted normal rate of return on investment. A. Calculate Smokey = s profit at the profit-maximizing activity level if prices in the industry are stable at $25 per ton and therefore P = MR = $25. B. Calculate Smokey = s optimal price, output, and profit levels if a new state regulation results in a $5-per-ton cost increase that can be fully passed on to customers. C. Determine the effect on output and profit if Smokey must fully absorb the $5- per-ton cost increase. P20.4 SOLUTION A. Set MR = MC to find the profit maximizing activity level: MR = MC $25 = $5 + $0.0002Q 0.0002Q = 20 Q = 100,000 ʌ = TR - TC = $25(100,000) - $1,000,000 - $5(100,000) - $0.0001(100,000 2 )
Chapter 20 Presented by Suong Jian & Liu Yan, MGMT Panel , Guangdong University of Finance. - 614 - = $0 B. If the $5 regulation-induced cost increase can be fully passed on to customers, then MR = $30. Therefore, the optimal P = MR = $30 and the optimal activity level is unaffected because: MR = MC + $5 $30 = $10 + $0.0002Q 0.0002Q = 20 Q = 100,000 ʌ = TR - TC = $30(100,000) - $1,000,000 - $10(100,000) -$0.0001(100,000 2 ) = $0 C. In the short-run, prices remain stable at P = MR = $25 and Smoky will be forced to curtail output and suffer losses: MR = MC + $5 $25 = $10 + 0.0002Q 0.0002Q = 15 Q = 75,000 ʌ = TR - TC = $25(75,000) - $1,000,000 - $10(75,000) - $0.0001(75,000 2 ) = -$437,500 (a loss)