18. You are the manager of a firm that competes against four other firms by bidd

Question

18. You are the manager of a firm that competes against four other firms by bidding for government contracts. While you believe your products is better than the competition, the government purchasing agent views the products as identical and purchases from the firm offering the best price. Total government demand is Q = 750 – 8P and all five firms produce at a constant marginal cost of $50. For security reasons, the government has imposed restrictions that permit a maximum of five firms to compete in this market; thus entry by new firms is prohibited. A member of Congress is concerned because no restrictions have been placed on the price that the government pays for this product. In response, she has proposed legislation that would award each existing firm 20% of a contract for 270 units at a contracted price of $60 per unit. Assuming you are a profit-maximizer, would you support or oppose this legislation? Explain.

Explanation / Answer

I will maximize profit by equating my marginal revenue with marginal cost.

Q = 750 - 8P

Or,

P = (750 - Q) / 8

So, Total revenue, TR = P x Q = (750Q - Q2) / 8

Marginal revenue, MR1 = dTR / dQ = (750 - 2Q) / 8 = (375 - Q) / 4

Equating with MC:

(375 - Q) / 4 = 50

375 - Q = 200

Q = 375 - 200 = 175

P = (750 - Q) / 8 = (750 - 175) / 8 = 575 / 8 = 71.875

Optimal Profit = Q x (P - MC) = 175 x (71.875 - 50) = 3,828

Proposed revenue = (270 x 60) + 0.20 x (270 x 60)

= 19,440

Profit from proposed revenue = Q x (P - MC) = 270 x (60 - 50) = 2,700

Since the proposed legislation will generate lower profit, I will not support it.

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