1) Consider a transportation service industry in which the firm’s cost function

Question

1) Consider a transportation service industry in which the firm’s cost function exhibits IRTS. Determine whether the following remark is true or false and briefly explain your answer:

a. The height of the inverse demand curve indicates the marginal cost of adding an additional

passenger to the service.

b. The welfare-maximizing pricing strategy equates the fare per passenger at the cost per

passenger incurred by the firm.

c. A sunk cost must be ignored in deciding whether or not to accommodate an additional

passenger.

Explanation / Answer

a. False, because inverse demand curve is used to derive Total revenue and marginal revenue and Marginal cost can be derived through first order derivative of total cost function.

b. False, because profit maximizing condition is

Marginal revenue = Marginal cost, where marginal cost curve intersect marginal revenue curve from below.

But fare per passenger is average revenue and cost per passenger is average cost.

c. True, because sunk cost is that cost which already has been incured and cannot be recovered

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