Barnacle Industries was awarded a patent over 15 years ago for a unique industri

Question

Barnacle Industries was awarded a patent over 15 years ago for a unique industrial strength cleaner that removes barnacles and other particles from the hulls of ships. Thanks to its monopoly position, Barnacle has earned more than $160 million over the past decade. Its customersspanning the gamut from cruise lines to freightersuse the product because it reduces their fuel bills. The annual (inverse) demand function for Barnacles product is given by P = 380 -0.00009Q, and Barnacles cost function is given by C(Q) = 270Q. Thanks to subsidies stemming from an energy bill passed by Congress nearly two decades ago, Barnacle does not have any fixed costs: The federal government essentially pays for the plant and capital equipment required to make this energy-saving product. Absent this subsidy, Barnacles fixed costs would be about $9 million annually. Knowing that the companys patent will soon expire, Marge, Barnacles manager, is concerned that entrants will qualify for the subsidy, enter the market, and produce a perfect substitute at an identical cost. With interest rates at 6 percent, Marge is considering a limit-pricing strategy. What would Barnacle's profits be if Marge pursues a limit-pricing strategy if the subsidy is in place? $ Instruction: Round all answers to the nearest penny (two decimal places). What would Barnacle's profits be if Marge convinces the government to eliminate the subsidy? $ What would be the profit of a new entrant if the subsidy is eliminated and Barnacle continues to produce the monopoly level of output? $ Which strategy is more beneficial to Barnacle? Limit pricing Eliminating the subsidy and continuing to produce the monopoly output Comment

Explanation / Answer

If Barnacle excercisses Limit Pricing:

First lets calculate Profit maximizing price as follows-

P = 380 -0.00009Q and C = 270Q thus MC = dC/dQ = 270

TR = P*Q =380Q -0.00009Q2

MR = dTR/dQ = 380-0.00018Q

Equating MR and MC

380-0.00018Q = 270

Q = 611111.1 = 611111 approx.

And P= 380-0.00009(611111.1) = $325.

And Profit = TR - TC = 611111*325 - 270*611111 = $33611105

And average cost = TC/Q = 270

Thus to excercise limit pricing, the company will charge price below AC that would be $270 or lower to $270.

At this level of price, the firm will not earn any supernormal profit.

If The company convince government to eliminate subsidy, it will have to bear fixed cost as well.

Thus new TC = 270Q + 9000000

New Profit = TR - TC = 270(611111) + 9000000 - 611111*325 = $24611105.

Eliminating subsidy and continuing is more profitable stratgey.

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