4. Assume that the Good Tire company needs outside legal help and that the expec

Question

4. Assume that the Good Tire company needs outside legal help and that the expected marginal benefit of this help is given by MB=$200- 2-L, where L equals hours per week of legal services. At the same time assume that the marginal cost to the law firm for providing these legal services is constant and equal to $100 per hour. In this context, discuss how different assumptions about market structure, information availability and agency cost will yield different conclusions about the amount of legal services provided and also about the charge for these services.

Explanation / Answer

MB = MC is the equilibrium level of any sort of market structure.

Given, MB = 200 – 2 – L

            MC = 100

Therefore, MB = MC

200 – 2 – L = 100

L = 98

Answer: 98 hours per week of legal services should be provided.

Perfect competition: This is the market structure where there are many buyers and many sellers, dealing with almost identical products, and they have free entry and exit facilities. In this market the price would be equal to MR or MB. Therefore, P = MB = 200 – 2 – L = 200 – 2 – 98 = $100

Monopoly: This is the market structure where there is only one seller but many buyers. Here P = Demand = AR = TR/Q. Since in this case AR = MB, the price would be $100.

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