1. Suppose that you have one domestic production facility that supplies both the

Question

1.     Suppose that you have one domestic production facility that supplies both the domestic and foreign markets. Assume that the demand for your product in the domestic market is

Q = 2,000 %u2013 3P and in the foreign market, demand is given by Q* = 2,000 %u2013 2P*. Assume that your domestic marginal cost of production is 600. If the initial real exchange rate is 1, what are your optimal prices and quantities sold in the two markets? By how much will you change the relative prices of your product if the foreign currency appreciates in real terms by 10%? What will you do to production?u

Explanation / Answer

For domestic Market :

Total Revenue = Price * Q ;

P = 2000/3 - Q/3

TR = P*Q = 2000Q/3 - Q^2/3 ;

MR = dTR/dQ = 2000/3 - 2Q/3 ;

MR = MC = 600

2000/3 - 2Q/3 = 600 ;

Q = 100;

P = $633.33 ;

For Foreign market ;

P* = 1000 - Q*/2 ;

so TR = PQ = 1000Q - Q^2/2 ;

MR = dTR/dQ* = 1000 - Q* ;

MR= MC = 600

1000 - Q* = 600

Q* = 400

P* =$ 800 ;

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