You are the manager of a firm that competes against four other firms by bidding

Question

You are the manager of a firm that competes against four other firms by bidding for government contracts. While you believe your product 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 = 1200 -8P and all five firms produce at a constant marginal cost of $70. 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 percent of a contract for 480 units at a contracted price of $90 per unit. If this legislation is passed, by how much should you expect your profits to change? Instruction: If you expect profits to fall, enter a negative number. $

Explanation / Answer

Q = 1200 -8P

Or, P = 1200/8 - Q/8 ---------------------------(1)

Multiply eq. 1 with Q gives total revenue (TR)

TR = Q*P = 150Q – Q^2/8 ---------------------- (2)

Differentiation of eq. 2 w.r.t. Q will give marginal revenue (MR)

MR = 150 – 2Q/8

Or

MR = 150-Q/4

To achieve profit maximization,

MR = MC

150-Q/4 = 70

Q = (150-70)*4 = 320

P = 150 – 320/8 = $110

Production to be done by each participant firm = 320/5 = 64 units at a price of $110

Thus, profit earned by each participant firm = 64*110 - 64*70 = $2560

Though, total demand is identified as 480 units at a price of $90.

Thus, share of each competitor firm = 480/5 = 96 units

Profit earned by each participant firm as per the legislation rule = 96*90 - 96*70 = $1920

Thus, Change in profit due to legislation rule = 1920 – 2560 = -$640       

So, there is a fall in profit of 640 per competitor firm due to proposed rule of price and quantity.           

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