Question

Suppose you have been tasked with regulating a single monopoly firm that sells 50-pound bags of concrete. The firm has fixed costs of $30 million per year and a variable cost of $4 per bag no matter how many bags are produced.
Instructions: Enter your answers as whole numbers. In part e, round your answer to 2 decimal places.

a. If this firm kept on increasing its output level, would ATC per bag ever increase? Yes or No.

Is this a decreasing-cost industry? Yes or No.

b. If you wished to regulate this monopoly by charging the socially optimal price, what price would you charge? $_______ per bag.
At that price, what would be the size of the firm’s profit or loss?
At that price, the firm's ( profit or loss ) equals $ ________million.
Would the firm want to exit the industry? Yes or No.

c. You find out that if you set the price at $5 per bag, consumers will demand 30 million bags.

How big will the firm’s profit or loss be at that price? $__________

d. If consumers instead demanded 40 million bags at a price of $5 per bag, how big would the firm’s profit or loss be?

At that price, the firm's ( profit or loss ) equals $__________ million.

e. Suppose that demand is perfectly inelastic at 40 million bags, so that consumers demand 40 million bags no matter what the price is.

What price should you charge if you want the firm to earn only a fair rate of return? Assume as always that TC includes a normal profit.$___________ per bag.

Answer 1

Answer:

Refer explanation

Explanation:

A. Average total cost (ATC) is the total cost divided by the number of units sold. It is unlikely to increase. This is especially because as more output is produced, fixed costs are spread over a larger number of units. Thus, the fixed cost per unit falls. The firm is also likely to exploit economies of scale (falling average costs due to rise in output). Thus, this is a decreasing cost industry.

B. The firm should charge $4 since the marginal cost i.e. the cost of producing an additional unit of output is $4. At this price, the firm would make a loss of $30 million since the price is enough only to cover the variable costs. It would not be able to cover the fixed costs of $30 million. The difficulty to make profits and the loss made would discourage the firm, causing it to exit the industry.

C. Profit = Total Revenue - Total Costs.

At price $5, total revenue = $5 x 30 million = $150 million. Total costs includes both variable and fixed costs. Fixed cost as provided is $30 million. Variable costs = $4 x 30 million = $120 million. Hence, total costs would be = $30 million + $120 million = $150 million. Profit/loss = $0 (150 million - 150 million). The firm is at the break-even point where TR is equal to TC and makes neither a profit nor a loss.

D. At 40 million bags demanded for $5, the total revenue would be = $5 x 40 million = $200 million. The total fixed cost would remain the same as provided in the question ($30 million). Total variable costs would now be $40 million x $4 = $160 million. Thus, the total costs are $160 million + $30 million = $190 million. Profit = $200 million (Total Revenue) - $190 million (Total Costs) = $10 million

E. The fair rate of return is the point where the economic profit is zero ($0). In order to identify the price, the costs are important. The firm’s fixed costs would remain as 30 million. The variable costs would be 40 million x $4 which is $160 million. The total cost would thus be $160 million + $30 million = $190 million.

It is important to then identity the total revenue. TR is equal to P x 40 million. This can then be substituted in the profit equation in order to obtain the price.

Profit = TR - TC

0 = 40P - $190 million

$190 million = 40P

P = $190 / 40

P = $4.75