Suppose you have been tasked with regulating a single monopoly firm that sells 5

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 dollar 10 million per year and a variable cost of dollar 1 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. If this firm kept on increasing its output level, would ATC per bag ever increase? Is this a decreasing-cost industry? ATC will never industry. If you wished to regulate this monopoly by charging the socially optimal price, what price would you charge? Dollar per bag. At that price, what would be the size of the firm's profit or loss? At that price, the firm's Q equals dollar million. Would the firm want to exit the industry? You find out that if you set the price at dollar 2 per bag, consumers will demand 10 million bags. How big will the firm's profit or loss be at that price? Dollar If consumers instead demanded 20 million bags at a price of dollar 2 per bag, how big would the firm's profit or loss be? At that price, the firm's equals dollar million. 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. dollar per bag.

Explanation / Answer

(a) Unit variable cost (AVC) is unchanged at $1. Fixed cost is $10 million, so Average fixed cost (AFC) falls as output rises.

Average total cost (ATC) = AVC + AFC

Therefore, as output increases, ATC falls.

Answer: ATC will never decrease. It is a decreasing cost industry.

(b) Socially optimal price will be its Marginal (Variable cost) of $1.

At that price, Loss = Fixed cost = $10 million.

Making a loss, firm will exit the industry.

(c) Profit = Quantity x (Price - Variable cost) - Fixed cost

= 10 million x $(2 - 1) - $10 million

= $10 million - $10 million

= 0

(d) Profit = 20 million x (2 - 1) - $10 million

= $20 million - $10 million

= $10 million

(e) Fair-return price = [Fixed cost / Quantity] + Unit variable cost

= [$10 million / 20 million] + $1 = $0.5 + $1

= $1.50

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