Two clinics want to merge. The price elasticity of demand is -0.20, and each cli

Question

Two clinics want to merge. The price elasticity of demand is -0.20, and each clinic has fixed costs of $60,000. One clinic has a volume of 7,200, marginal costs of $60, and a market share of 2 percent. The other clinic has a volume of 10,800, marginal costs of $60, and a market share of 4 percent. The merged firm would have a volume of 18,000, fixed costs of $80,000, marginal costs of $60, and a market share of 6 percent.

1. What are the total costs, revenues, and profits for each clinic and the merged firm?

2. How does the merger affect markups and profits?   

Explanation / Answer

1. Both the firms individually and the merged firm will work to maximize profit. Profit is maximum at MR = MC

MR = P(1+1/e) = MC

or P = MC (e/(1+e)) = 60*-0.2/(1-0.2) = 15 for both the firms and the merged firm

For firm 1

TC = Fixed cost + Variable cost = 60000 + 60*7200 = 492000

TR = P*Q = 15*7200 = 108000

Profit = 108000-492000 = -384000

For firm 2

TC = Fixed cost + Variable cost = 60000 + 60*10800 = 708000

TR = P*Q = 15*7200 = 162000

Profit = 162000-708000 = -546000

For merged firm

TC = Fixed cost + Variable cost = 80000 + 60*18000 = 1160000

TR = P*Q = 15*18000 = 27000

Profit = 270000-492000 = -890000

2. The merger has reduced the overall loss which firms were suffering when operating individually.

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