Assignment 4 – Economics for managers

Name – S.Pravin kumar PRN – 21020741124

Problem 1
Suppose that the supply and demand equations for a perfectly competitive market are:
QD = 1625 - 50P
QS = 25 + 30P
1. Calculate the market-equilibrium price and quantity.
2. Suppose that there are 25 firms in the industry. How much does each firm in the industry produce?
3. Suppose that the total cost equation of each firm in the industry is
TC = 5 + 10Q + 0.2Q2. Is each firm producing at its profit maximizing level of output? If not,
when how should each firm alter its production?
4. Is each firm in the industry in long-run competitive equilibrium?
Ans
1. To calculate market equilibrium Price and quantity, we should equate QD to QS
Therefore, applying this, we get
QD = QS
=>1625 - 50P = 25 + 30P
=>1600 = 80P => P = 20
Putting this in QS = 25 + 30P , we get Q = 625
So, we can say that the market equilibrium price is 20 and Quantity is 625

2. As it is a perfectly competitive market, and we have Q = 625 with 25 firms in the industry, we can
say that each firm in the industry produces 625/25 = 25.

3. To maximize profits in a perfectly competitive market, firms should equate MR to MC

=> MR = MC
=> MR = 𝑑𝑇𝑅/𝑑𝑄
=> TR = P x Q
=> TR = (32.5 – 0.02Q) x Q = 32.5Q – 0.02Q2
Putting this in equation for MR, we get
MR = 𝑑𝑇𝑅/𝑑𝑄 = 𝑑 𝑑𝑄 (32.5𝑄 − 0.02𝑄 2 ) = 32.5 − 0.04𝑄
MC = 𝑑𝑇𝐶/𝑑𝑄 = 𝑑 𝑑𝑄 (5 + 10Q + 0.2Q2 ) = 10 + 0.4Q
=> MR = MC, we get 32.5 – 0.04Q = 10 + 0.4Q Q = 51

As each firm is producing only 25, so we can say that the firms are not producing at their profit
maximizing level of output. The firms should increase production by 26 more to reach profit maximizing
level of output.

4. For long run equilibrium in a competitive market, we will have MR = MC = ATC

Q = 25, MR = 31.5 MC = 20
ATC = 𝑇𝐶/𝑄 = 380/25 = 15.2
So, firms in the industry are not in long run competitive equilibrium

Problem 2
Consider a perfectly competitive market in the short run. Assume that market demand is
P= 100 - 4QD and market supply is P=QS.
Denoting firm level quantity by q,
TC=50+4q+2q2
1. What is the market equilibrium price and quantity
2. How many firms are in the industry in the short run?
3. What is the profit/loss the firms are making in the short run?
4. Describe the factors that drive profits to zero in perfectly competitive markets in the long run.
Ans
1. To calculate market equilibrium Price and quantity, we should equate QD to QS
=> QD = 25 – 0.25 P
=> QD = QS
=> 25 – 0.25P = P => P = 20
Putting this in QS = P we get Q = 20
So, we can say that the market equilibrium price is 20 and Quantity is 20.

2. We know that, in a perfectly competitive market, P = MC

=> to calculate MC
=> MC = 𝑑𝑇𝐶/𝑑𝑄 = 𝑑/𝑑𝑄 (50 + 4𝑞 + 2𝑞 2 )
=> MC = 4+4q
From above, we know P = 20 and P = MC
=> P = 4+4q => 20 = 4+4q =>q = 4
So, we can see that each firm is producing 4. As the market output is 20, there will be 20/4 = 5 So,
we have 5 Perfectly competitive firms in the industry for the short run

3. To find whether firms are making a profit or loss in the short run, we can calculate firm level TR
and TC.

=>TR = P x q TR = 20 x 4
=>TR = 80
=>TC = 50 + 4𝑞 + 2𝑞2
=>TC = 98
As we can see that TR is less than TC, so we can say that firms are making a loss in the short run.

4. The biggest factor driving this is the free entry/exit of firms in the long run, and that firms are
selling identical products. With firms being able to enter and exit the market as they wish, profit
opportunities cannot last. If I observe another firm making positive profits, there is an incentive
for me to enter the industry (at no cost) and try to take advantage of some of these profits. Since
there are many identical firms, there will be many firms entering the industry to take advantage of
these profit opportunities. However, when many firms compete, the market price decreases, and
the profit opportunities disappear.
Problem 3
If a firm’s total revenue function is given as TR = 110Q – 5Q2,
and total cost function is TC = 10Q – Q2 + 0.33Q3
Find
1. MR and AR,
2. MC and AC,
3. The output level that maximizes TR,
4. The output level that minimizes average cost.
Ans
We have Total Revenue Function as TR = 110Q-5Q2 and Total cost function as TC = 10Q – Q2 + 0.33Q3

1. We know that MR =
𝑑𝑄
putting the given value of TR in the above equation. we get
𝑑 (110𝑄 − 5𝑄2) = 110 − 10𝑄
MR =
𝑑𝑄

AR = TR/Q

putting the given value of TR in the above equation. we get

(110𝑄−5𝑄2)
AR = = 110 − 5𝑄
𝑄

2. We know that MC = 𝑑𝑇𝐶

𝑑𝑄
Therefore, putting the given value of TR in the above equation.

𝑑 (10𝑄 – 𝑄2 + 0.33𝑄3) = 10 − 2𝑄 + 0.99𝑄2

MC =
𝑑𝑄

Similarly, we know that AC =

putting the given value of TR in the above equation. we get

(10𝑄 –𝑄2+ 0.33𝑄3)
AC = = (10 – 𝑄 + 0.33𝑄2)
𝑄

3. For maximum TR, we have to have MR = 0

Therefore, equating the value of MR to 0, we get MR
= 110 – 10Q = 0
Q = 11
Therefore, the output level that maximizes TR is
Q=11
4. To minimize AC, we have to have 𝑑𝐴𝐶/𝑑𝑄 = 0

Therefore, 𝑑𝐴𝐶/𝑑𝑄 = 𝑑(10 –𝑄 + 0.33𝑄 2 )/dQ = 0

 -1 + 0.66Q = 0

 Q = 1.515

Therefore, the output level that minimizes average cost is Q = 1.515

Problem 4

1. An industry consists of five firms with sales of $200 000, $500 000, $400 000, $300 000, and
$100 000.
a. Calculate the Herfindahl-Hirschman index (HHI).
b. Calculate the four firm concentration ratio (C4).
2. State which market structure each of the following represent
a. Industry A has a four firm concentration ratio of 0.005 percent and a Herfindahl-
Hirschman index of 75. A representative firm has a Lerner index of 0.45 and a Rothschild
index of 0.34.
Industry A is a _____________.

b. Industry B has a four firm concentration ratio of 0.0001 percent and Herfindahl-
Hirschman index of 55. A representative firm has a Lerner index of 0.0034 and
Rothschild index of 0.00023.
Industry B is a ___________.
c. Industry C has a four firm concentration ratio of 100 percent and Herfindahl-Hirschman
index of 10 000. A representative firm has a Lerner index of 0.4 and Rothschild index of
1.0.
Industry C is a ________.
d. Industry D has a four firm concentration index of 100percent and Herfindahl-Hirschman
index of 5 573. A representative firm has a Lerner index equal to 0.43 and Rothschild
index of 0.76.
Industry D is a __________.

Ans

1. Part 1

a. for HHI, we have to first calculate the Market Shares of the 4 firms in the Industry.

The total sales of the industry are $1,500,000, so we get the market shares as follows

Firm A = 0.133 = 13.3%

Firm B = 0.333 = 33.3%

Firm C = 0.266 = 26.6%

Firm D = 0.2 = 20%

Firm E = 0.066 = 6.6%

Now, we know that HHI = 10000Σ𝑊𝑖 2 = 10000 (0.1332 + 0.332 + 0.2662 + 0.2 2 + 0.062 ) = (176.89 +
1108.89 + 707.56 + 400 + 43.56) HHI = 2436.9

b. To Calculate the Four-Firm concentration ratio, we sum the market shares of the 4 largest firms: So,
(0.133 + 0.333 + 0.266 + 0.2) = 0.934 = 93.4%
2. Part 2

a. As the four-firm concentration and the HHI are low, the Lerner and the Rothschild index indicate
economic profits and product differentiation. Industry A is a monopolistic competition.

b. As the four-firm concentration and the HHI are very low, the Lerner and the Rothschild index indicate
small economic profits and little product differentiation. Sounds very close to perfect competition.

c. As the four-firm concentration and the HHI are as high as can be, that is, there is one firm. The Lerner
index tells us that there is a fair degree of markup, and the Rothschild index also indicates that there is
one firm. This is a monopoly.

d. As the four-firm concentration and the HHI are high, and the Lerner index tells us that there is a fair
degree of markup, and the Rothschild index also indicates product differentiation. This is an Oligopoly.

Problem 5

The total cost of a perfectly competitive firm is given as TC = 1000+ 200Q – 20Q2+2Q3. Below
what price of the product may the firm decide to shut down its operations?

Ans

shutdown price occurs when AVC = MC

To calculate MC
MC = MC = 𝑑𝑇𝐶/𝑑𝑄 = 𝑑(1000 + 200𝑄– 20𝑄 2 + 2𝑄 3 )/dQ
=> 200– 40𝑄 + 6𝑄^2
We also know that AVC = 𝑉𝐶/𝑄 = 200𝑄–20𝑄^2+2𝑄^3/𝑄
=> 200 – 20Q + 2𝑄^2
AVC = MC, we get
200 – 20Q + 2𝑄^2 = 200– 40𝑄 + 6𝑄^2
=>Q = 5
We know that, in a perfectly competitive market, P = MC
So, putting the equation of MC above and substituting Q = 5, we get
P = 200– 40𝑄 + 6𝑄^2 = 200– 40(5) + 6(5^2 ) = 150
we can conclude that the firm will shut down its operations below the price of 150

Problem 6

A monopoly firm’s total cost function is given by TC = 50 +40Q and the demand equation for its
product is given as P= 100 – 2Q. Find the profit maximizing level of output and its corresponding
price. Also calculate the level of profit at this price and quantity combination.

Ans

We know that to have profit maximizing level of output in a monopoly, we have to equate MR to MC,
i.e., MR = MC
We know that MC = dTc/dQ = d(50+40Q)/dQ = 40
for MR, we have to find TR
We know that TR = P x Q
Therefore,
TR = (100 – 2Q) x Q
TR = 100Q – 2Q^2
Now, MR = 𝑑𝑇𝑅/𝑑𝑄 = 𝑑(100𝑄 − 2𝑄 2 )/dQ = 100 − 4𝑄
to maximize the level of output, i.e., Q
MC = MR
40 = 100 - 4Q
Q = 15
Now, from the given demand equation, we can calculate corresponding price;
P = 100 – 2Q
P = 100 – 30
P = 70
the level of profit at this price and Quantity combination can be calculated as Profit = TR – TC Profit =
(100Q - 2Q^2 ) – (50 +40Q)
Profit = 400