You are operating a firm in a perfectly competitive market. In the short run, you have fixed costs of $30. Your variable costs are given in the following table:

Q / TVC
0 / 0
1 / 70
2 / 120
3 / 150
4 / 190
5 / 270
6 / 360

Complete the following table:

Market Price / Profit maximizing
level of output / Profit
$48 / 4 / -28
$52 / 4 / -12
$75 / 5 / 75
$85 / 5 / 125

Profit maximizing output:

For a perfect competitive firm profit maximizing output is achieved when its Price equals to MC.

P= MC

For $48 market price, if we look at matching MC in table 1 output 2 with MC 50 and output 4 with MC 40 are closer to $48. MC at2nd unit is more closer to $48, but we select MC at 40 at 4th unit this is because the MC at 2nd unit is declining, whilethe MC 4th unit is rising. So output 4 is the profit maximizing output for price $48.

Similarly different output levels are chosen at different given prices.

Profit: for finding the profit, we have to calculate the corresponding total cost and total revenue.

At 4th unit TC is 220 and TR is calculated by multiplying price x number of units.

Profit = TR- TC.

2.

A monopolist faces a demand curve given by:

P = 40 –Q, where P is the price of the good and Q is the quantity demanded. The marginal cost of production is constant and is equal to $2. There are no fixed costs of production.

A) What quantity should the monopolist produce in order to maximize profit?

B) What price should the monopolist charge in order to maximize profit?

C) How much profit will the monopolist make?

D) What is the deadweight loss created by this monopoly (hint: compare the monopoly outcome with the perfectly competitive outcome).

E) If the market were perfectly competitive, what quantity would be produced?

A) MR = MC
R = P*Q
=(40 –Q)*Q
MR = 40-2Q
40-2Q = 2
Q = 19 units
B) P = 40-19 =$21
C) Profit = r - cost = 21*19 - 2*19 =$361

D) Deadweight Loss:
½ (38-19) (21 -19) = $19

E) P = MC
40-Q = 2
Q = 38 units

3.

List the three conditions that must be met in order for a firm to successfully engage in price discrimination.

Condition 1

There must be some imperfection of the market. If there were perfect competition, price discrimination would be impossible since the individual producer could have no influence on price. At least some degree of monopoly power is therefore necessary so that producers have some ability to make rather than take the market price.

Condition 2

The discriminating supplier must be able to split the market into separate sections and keep them separate, such that it is difficult to transfer the seller’s product from one sector to another i.e. there must be no ‘seepage’ between markets in the sense that goods can be bought in the cheaper market and re-sold in the dearer.

Barriers between markets may be:

  • Geographicalin that customers are separated by distance e.g. the international dumping of cheap goods, where goods are sold overseas at prices below those in the home market, and often below the cost of production e.g. the East European Communist block countries used to sell their exports to the West at lower prices than those prevailing in domestic markets to earn hard foreign currency.
  • Temporalin that customers are separated by time e.g. it may be cheaper to travel by train after 9.30am than before 9.30 am, and the two markets can be kept separate as ticket office staff will not sell the cheaper tickets until after this time
  • According to customer typeso that customers are separated according to some easily identified feature of the customers themselves e.g. age, sex, income or occupation; examples of this would include cheaper theatre tickets for children, old age pensioners and the unemployed, reduced price rail travel for students and higher private physician consultation fees for those who are perceived as being able to pay more.

The two conditions discussed so far would make price discrimination possible, but for it to also be profitable a third condition must also be satisfied:

Condition 3

Price elasticity of demand in each market must be different; if this were the case , the discriminating supplier would increase price in the market with an inelastic demand curve, and reduce price where demand is elastic in order to increase total revenue and profits. If the elasticity of demand in each market was the same at each and every price, a common price would be charged in both markets as this price would represent the profit maximising price in each market where MC = MR. You might wish to refer back at this stage to where we discussed the relationship between price elasticity of demand and total revenue.

4.

Suppose a competitive firm can sell its output for $7 per unit. The following table gives the firm’s short run production function.

Labor / Output
0 / 0
1 / 15
2 / 40
3 / 70
4 / 86
5 / 94
6 / 98

In the table below, you will determine several points on the firm’s demand curve for labor. To do this, you must determine how many workers the firm should hire for different values of the wage rate in order to maximize profit. Complete the table below:

Wage Rate Per Worker / Quantity Demanded of Workers
$30 / 6
$75 / 5
$110 / 4
$120 / 4