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ECON302

Instructor: Nickesha Ayoade


Concordia University
Summer, 2018 Assignment 1 - solutions

1. (25 pts) A competitive firm has the following short-run cost function
C(y) = y 3 − 8y 2 + 30y + 5

(a) Derive the firm’s marginal cost function M C(y), average variable cost
function AV C(y), and average cost function AC(y) and show them
on a graph. (5 pts)
M C(y) = 3y 2 − 16y + 30
AV C(y) = y 2 − 8y + 30
AC(y) = y 2 − 8y + 30 + 5/y

Figure 1:

(b) At what output is the average variable cost AV C(y) minimized? At


what output is the marginal cost equal to the average variable cost(5

1
pts)
min AV C(y) = miny 2 − 8y + 30
FOC: 2y − 8 = 0
y=4
SOC: 2 ≥ 0
At the minimum M C(y) = AV C(y)
3y 2 − 16y + 30 = y 2 − 8y + 30
2y 2 = 8y
y=4
(c) Show the firm’s short-run supply curve on the same graph? (5pts)
p = M C(y) and p ≥ AV C(y)
Thus p(y) = 3y 2 − 16y + 30, ∀ ≥ 4 At y = 4, p(y = 4) = 14. Thus,
p ≥ 14.
(d) At what set of prices would the firm choose to shut down ? Why? Is
there any cost that the firm should still pay? (5 pts)
For any p < 14 firm would choose to shut down, y = 0. The revenue
from selling y doesn’t even cover the variable cost of production.
(e) At what price would the firm supply exactly 5 units of output? Cal-
culate the firm’s profit at that price. (5 pts)
p(y) = 3y 2 − 16y + 30
p(y = 5) = 25 Thus, y = 5 or p = 25 π = p(y) ∗ y − c(y) =
25 ∗ 5 − (53 − 8(52 ) + 30 ∗ 5 + 5) = 125 − 80 = 45 so π = 45

2. (25 pts) 2. A competitive firm has a long run cost function given by:
c(y) = y 2 + 10 for y > 0and c(0) = 0.

(a) Derive the firms marginal cost function and average cost function. (5
pts)
M C(y) = 2y
AC(y =) = y + 10/y
(b) At what output is the average cost minimized? At what output is
the marginal cost equal to the average cost? (5 pts)
min AC(y) = miny + 10/y
FOC: 1 − 10/y 2 = 0

y = 10
M C(y) = AC(y)
2y = y + 10/y

2
p
y= (10)
Thus, min AC(y) at M C(y) = AC(y) when y = sqrt(10)
(c) In a competitive market, what is the lowest price at which the firm
will supply a positive quantity in long-run equilibrium? (5pts)
p = minAC(y)
Thus, when y = sqrt(10)
p
min AC(y) = 2 (10)
p
Thus, p = 2 (10)
(d) How much would the firm supply at that price? Calculate the firms
total profit at that price. (5 pts)
p = 2y and also p ≥ minAC(y)
p p
At p = 2 (10), y = (10) π = p(y) ∗ y − c(y)
p p
2 (10) ∗ 10 − ( (10))2 − 10 = 0
(e) (e) Suppose the market price is lower than the price, you found in
(c). What will be the optimal choice of the firm? (5 pts)
p
If p ≤ 2 (10), then firm would go out of business and y = 0. Oth-
erwise, it will be losing money π < 0.

3. (25 pts) A monopolist faces a market demand curve given by P (y) =


100 − y. Its cost function is c(y) = y 2 + 20.

(a) Determine its profit-maximizing output level y ∗ and the market price
p(y ∗ ). (5 pts)
π(y) = p(y) ∗ y − c(y)
[100 − y]y − y 2 − 20
100y − y 2 − y 2 − 20
100y − 2y 2 − 20
First Order Conditions: 100 − 4y
100 = 4y
y = 25
p(y) = 100 − 25 = 75
(b) Calculate its total revenue, total cost, and profit at y. (5 pts)
T R(y) = p(y) ∗ y = 75 ∗ 25 = 1875
T C(y) = y 2 + 20 = 645
π = T R(y) − T C(y) = 1230
(c) Provide a graph for this monopolist indicating P (y), MR, MC, y ,
p(y ), CS, PS and DWL (5 pts)

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Figure 2:

(d) Calculate the value of consumer surplus (CS) and Producer surplus
(PS). What is the deadweight loss (DWL) equal to for this monopo-
list? (5 pts)
CS = area ABC = 1/2 ∗ 25 ∗ 25 = 312.5
P S = area BCDE = area BCDF+ area DEF
P S = 25 ∗ 25 + 1/2 ∗ 50 ∗ 25 = 625 + 625 = 1250
DW L = areaCDG = 1/2 ∗ 25 ∗ 100/3 = 416.66
(e) What the efficient (competitive) amount is of output ye ? (5 pts)
We need p = M C = 2y
100 − y = 2y
100 = 3y
y e = 100/3

4. (25 pts) 4. A monopolist sells in two different markets. The demand


curve in market 1 is given by D1 (p1 ) = 100 − p1 , while the demand curve
in market 2 is given by D2 (p2 ) = 120−1/2p2 . The firms total cost function
is given by C(y1 + y2 ) = (y1 + y2 )2 + 2000:

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(a) If the firm has to charge the same price in both markets, how much
output should it sell?(5 pts)
Total output y = 220 − p − 1/2p
y = 220 − 3/2p
so, 3/2p = 220 − y
p = 440/3 − 2/3y
Profit maximization problem:
π = [440/3 − 2/3y]y − y 2 − 2000
First Order Condition:
440/3 − 4/3y − 2y = 0
440/3 = 10/3y
y = 44
(b) Find the price the firm should charge to maximize its profit. How
much will that profit be?(5 pts)
The price, p = 440/3 − 2/3(44) = 352/3 = 117.33
ψ = p(y) ∗ y − y 2 − 2000 = 117.33 ∗ 44 − 442 − 2000
ψ = 1226.66
(c) If the firm can charge a different price in each market and wants to
maximize its profit, how much output should it sell in each market?
(5 pts) max π(y1 , y2 ) = T R(y1 ) + T R(y2 ) − c(y1 + y2 )
sinec p1 = 100 − y1 and p2 = 240 − 2y2
Thus, π(y1 , y2 ) = [100 − y1 ]y1 + [240 − 2y2 ]y2 − (y1 + y2 )2 − 2000
FOC:
M R(y1 ) = M C(y1 +y2 ) = 100−2(y1 ) = 2(y1 +y2 ) = 100 = 4y1 +2y2
M R(y2 ) = M C(y1 + y2 ) = 240 − 4y2 = 2(y1 + y2 ) = 240 = 2y1 + 6y2
From FOC 1:
y2 = 50 − 2y1
120 = y1 + 3(50 − 2y1 )
120 = y1 + 150 − 6y1
5y1 = 30
y1 = 6 and y2 = 38
(d) Find the price the firm should charge in each market. How much will
its total profit be? (5 pts)
P (y1 ) = 100 − y1 = 94
p(y2 ) = 240 − 2y2 = 164
π(y1 , y2 ) = p1 (y1 ) ∗ y1 + p2 (y2 ) ∗ y2 − c(y1 + y2 )

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π = 94 ∗ 6 + 164 ∗ 38 − (6 + 38)2 − 2000
π = 564 + 6232 − 1936 − 2000 = 2860
(e) Which profit is higher?
The case where a firm charges a different price in each market gives
higher profit.