Suppose you have been tasked with regulating a single monopoly firm that sells 5
ID: 1209048 • Letter: S
Question
Suppose you have been tasked with regulating a single monopoly firm that sells 50-pound bags of concrete. The firm has fixed costs of $10 million per year and a variable cost of $2 per bag no matter how many bags are produced. Instructions: Enter your answers as whole numbers. In part e, round your answer to 2 decimal places.
a. If this firm kept on increasing its output level, would ATC per bag ever increase? . Is this a decreasing-cost industry?
b. If you wished to regulate this monopoly by charging the socially optimal price, what price would you charge? $ 2 per bag. At that price, what would be the size of the firm’s profit or loss? n. Would the firm want to exit the industry?
c. You find out that if you set the price at $3 per bag, consumers will demand 10 million bags. How big will the firm’s profit or loss be at that price?
d. If consumers instead demanded 20 million bags at a price of $3 per bag, how big would the firm’s profit or loss be? At that price, the firm's equals $ ?
e. Suppose that demand is perfectly inelastic at 20 million bags, so that consumers demand 20 million bags no matter what the price is. What price should you charge if you want the firm to earn only a fair rate of return? Assume as always that TC includes a normal profit.
Explanation / Answer
(a) ATC will never increase. This is a decreasing cost industry. The intuition is that FC get distributed over more and more units so that ATC will fall asymptotically towards the $2 per bag marginal cost.
(b) Charge $2 per bag since the MC of all bags is $2 per bag. At that price, the firm would lose its $10 million fixed costs (since the price is just enough to cover variable costs). This firm would be losing money and will want to exit the industry
(c)
The firm's revenue equals $30,000,000 ( = $3 (price) x 10,000,000 (quantity)).
The firm's Fixed Cost equals $10,000,000 (given above).
The firm's Total Variable Cost equals $20,000,000 ( = $2 (variable cost of producing each bag) x 10,000,000 (quantity)).
The firm's Total Cost equals the sum of Total Fixed Cost and Total Variable Cost, $30,000,000 (=$10,000,000 (Total Fixed Cost) + $20,000,000 (Total Variable Cost)).
The firm's profit equals $0 (= $30,000,000 (revenue) - $30,000,000 (total cost)). The firm breaks even.
(d)
The firm's revenue equals $60,000,000 ( = $3 (price) x 20,000,000 (quantity)).
The firm's Fixed Cost equals $10,000,000 (given above).
The firm's Total Variable Cost equals $40,000,000 ( = $2 (variable cost of producing each bag) x 20,000,000 (quantity)).
The firm's Total Cost equals the sum of Total Fixed Cost and Total Variable Cost, $50,000,000 (=$10,000,000 (Total Fixed Cost) + $40,000,000 (Total Variable Cost)).
The firm's profit equals $10,000,000 (= $60,000,000 (revenue) - $50,000,000 (total cost)).
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