Rising Phoenix Studios (RPS) can produce DVDs at a constant average variable cos

Question

Rising Phoenix Studios (RPS) can produce DVDs at a constant average variable cost of $5 per disk, and the studio has just released the DVD for its latest hit film, “King Kong Goes to Washington”. RPS’s marketing team estimated the demand curve for this film to be P = 40 – 0.0002Q, where Q is the number of DVDs and P is the price in dollars.

The retail price of the DVD was set at $25. Has RPS selected the profit-maximizing retail price for this DVD?

A. Yes, P = $25 is the profit-maximizing price.

B. No, because average variable cost is constant, marginal cost is equal to zero and the retail price should be the revenue-maximizing price P = $20.

C. No, the retail price should be P = $22.5.

D. No, the retail price should be equal to average variable cost, P = $5, which would guarantee higher sales and maximize profit.

E. No, RPS should exploit more its market power, and should charge a retail price higher than $25.

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Explanation / Answer

MC=AVC=5

P=40-0.0002Q

MR=40-0.0004Q

Profit is maximised where MR=MC

40-0.0004Q=5

Q=35/0.0004=87500

P=40-0.0002(87500)=22.5

Thus ans is C

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