Bud Owen operates Bud\'s Package Store in a small college town. Bud sells six pa

Question

Bud Owen operates Bud's Package Store in a small college town. Bud sells six packs of beer for off-premises consumption. Bud has very limited store space and has decided to limit his product line to one brand of beer, choosing to forego the snack food lines that normally accompany his business. Bud's is the only beer retailer physically located within the town limits. He faces considerable competition, however, from sellers located outside of town. Bud regards the market as highly competitive and considers the current $2.50 per six pack selling price to be beyond his control. Bud's total and marginal cost functions are:

TC = 2000 + 0.0005Q2

MC = 0.001Q,
where Q refers to six packs per week. Included in the fixed cost figure is a $750 per week salary for Bud, which he considers to be his opportunity cost.

a. Calculate the profit maximizing output for Bud. What is his profit? Is this an economic profit or an accounting profit?
b. The town council has voted to impose a tax of $.50 per six pack sold in the town, hoping to discourage beer consumption. What impact will the tax have on Bud? Write down Bud's new total cost function and marginal cost function. Should Bud continue to operate? What impact will the tax have on Bud's out-of-town competitors?

Explanation / Answer

a) We can see the competitive nature of the market , so Bud should equate P = MC
=> 2.50 =0.001Q
=> Q = 2500
TR = 2.5*2500 = 6250
TC = 2000+ 0.0005 (2500)^2
TC= 2000+3125
TC = 5125
Profit = 6250-5125 = 1125
As we can see cost function is an economic cost function , we can conclude by saying that it is an economic profit.
b) Imposing tax shifts the total cost curve as :
TC = 2000+ 0.0005Q2 + 0.5 Q
and MC = 0.001Q +0.5
Now we know that P= MC
=> 2.50 = 0.001Q+0.5
=> Q = 2000
TR = 2.5*2000
=> TR= 5000
TC = 2000 + 0.0005(2000)2 +0.5(2000)
TC = 2000+2000+ 1000
=> TC = 5000
368 Profit = 5000-5000
=> Profit = 0
Given that this is the zero economic profit , Bud should continue to operate. The impact upon Bud's competitors will be favourable or neutral. As he curtails output, 500 six packs worth of business will either shift elsewhere or choose temperance.

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