California State University, Fullerton Fall Semester, 2014

Economics 315 P. Rottschaefer

Problem Set 4

1. "In the long-run equilibrium, every firm in a competitive industry earns zero profit. Thus, if
price falls, all of these firms will be unable to stay in business." Do you agree with this
statement? Why, or why not?

2.
D: P = 75 - 1.5Q
S: P = 25 + 0.5Q

The demand and supply for a type of carpet known as KS-12 has been estimated in the above
equations (where P is the price ($/yard), and Q is output (thousands of yards per month)). A
typical competitive firm that markets this type of carpet has a marginal cost of production
given by

MC = 2.5 + 10q.

a. Determine the market equilibrium price and quantity for this type of carpet.
b. Determine how much the typical firm will produce per month at the equilibrium price.
c. If all firms had the same cost structure, how many firms would compete at the equilibrium
price computed in part a.?
d. Calculate the producer surplus the typical firm receives.

3. Assume the market for tortillas is perfectly competitive. The market supply and demand
curves for tortillas are given as follows:

D: P = 11 - .00002Q
S: P = .000002Q

The short run marginal cost curve for a typical tortilla factory is:

MC = .1 + .0009q

a. Determine the equilibrium price for tortillas.

b. Determine the profit maximizing short run equilibrium level of output for a typical tortilla
factory.
c. At the level of output determined in part b above, is the factory making a profit, breaking
even, or making a loss? Explain.
d. Assuming that all of the tortilla factories are identical, how many tortilla factories are
producing tortillas?
4. You are the manager of a small pharmaceutical company that received a patent on a new drug
three years ago, Despite strong sales ($150 million last year) and a low marginal cost of
producing the product ($0.50 per pill), your company has yet to show a profit from selling the
drug. This is, in part, due to the fact that the company spent $1.7 billion developing the drug
and obtaining FDA approval. An economist has estimated that, at the current price of $1.50
per pill, the own price elasticity of demand for the drug is -2. Based on this information,
what can you do to boost profits? Explain.

5. What effect would the following taxes have on a monopolist’sprice and quantity?
a. A franchise tax. (A lump sum paid each year for the right to do business.)
b. A profits tax. (Taking a constant percentage of profits.)
c. A specific tax. (i.e., 10 cents per unit sold.)
d. Is it possible for the price to the consumer to increase by more than the amount of the
specific tax? Why?
6. You are the manager of a monopoly, with the following demand and cost functions:

D: P = 200 – 2Q

TC: TC = 2,000 + 3Q2

a. What price and quantity combination maximizes your firm’s profit?

b. Calculate the maximum profit.
c. Is demand elastic, inelastic or unit-elastic at the profit –maximizing price-quantity
combination?
d. What price and quantity combination maximizes your firm’s total revenue?
e. Calculate the maximum total revenue.
f. Is demand elastic, inelastic or unit-elastic at the revenue–maximizing price-quantity
combination?
7. The accompanying diagram shows the demand, marginal revenue, and marginal cost of a
monopolist:

a. What is the profit maximizing output and price?

b. What price and output would prevail if this firm’s product were sold by a price-taking
firm in a perfectly competitive market?
8. You are the manager of a monopolistically competitive firm, and your demand and cost
functions are:

D: Q = 20 – 2P

TC: TC = 104 – 14q + q2

a. Find the demand-price function for your firm’s product.

b. What is the profit-maximizing quantity and price?
c. How much profit are you going to make at this price-quantity combination?
d. What long-run adjustments would you expect to see? Explain.