Managerial Economics

Solution to Sub-zero and the Problem Set 1

BM - Term 1

Sumit Sarkar, XLRI Jamshedpur

Understanding Perfectly Competitive Market – The
case of Sub-Zero
 Demand side
 For each buyer (total 300 buyers)
 Max: U = x1/3y2/3 Sub. To: 9000 = px.x + pyy
 In equilibrium pyy = 2px.x
 Substituting in the budget eq: x = 9000/3px
 Mkt dd: Xd = 300x = 900000/px
Understanding Perfectly Competitive Market – The
case of Sub-Zero
 Supply side
 Finding supply by each supplier (total 100 suppliers)
 Prod. Fn x = 3K1/2L1/2 Fixed K: K0 = 1
 L-requirement: L = (x / 3)2
 Other costs: Power = 410 ut / day
 Factor prices: w = 180 / day; r = 2000 / day; e = 5 / ut
 VC = 180L = 20x2 FC = 2000 + 410*5 = 4050
 MC = 40x
 AVC = 20x
 AFC = 4050/x
Profit maximization and market supply

 For profit maximization px = MC = 40x => x = px / 40

 Each supplier’s supply: x = px / 40

 Market supply: Xs = 100x = 5px /2

Market equilibrium

XS
px Equating Xs = Xd
(equilibrium condition) we
get px = 600. Substituting in
either demand or supply
function we get
Xs = Xd = 1500
600

XD

1500 X
Rest of the problem
1. Output of Sub-zero: x = (px / 40) = 15
2. AVC = 20x = 300
3. AFC = 4050 / 15 = 270
4. Number of workers employed (per day): L = (15/3)2 = 25
Problem 1
The market for torque washers is perfectly competitive and the
market demand function is: P = 90 – 0.01 Q d, where P is the price of
torque washers in rupees per kilogram and Q d is the daily demand
for torque washers in kilograms. The supply function is P = 0.02 Q s,
where Qs is the daily supply of torque washers in kilograms.
What is the market clearing price of torque washers?
How much torque washers are sold every day?

Soln
The demand function is: Q = (90 –P) / 0.01
d
The supply function is: Q = P / 0.02
s
In equilibrium Q = Q
d s
Solving we get: P* = 60 and Q* = Q* = 3000
d s
Problem 1 (contd.)
The local government imposed a Rs. 3 per kilogram sales tax on
torque washers. Write down the equation of the post-tax supply
function.
What is the tax inclusive price that the buyers pay?
 How much tax revenue the government collects per day?

Soln
When a unit sales tax is imposed it shifts the MC upward by the

amount of unit tax. Therefore, the market supply function will shift up
by the magnitude of unit sales tax.
Post tax supply function : P = 0.02 Q + 3 => Q = (P -3) / 0.02
s s
Demand function remains unchanged: Q = (90 –P) / 0.01
d
In equilibrium Q = Q
d s
Solving we get: P` = 61 and Q` = Q` = 2900
d s
Tax revenue = Rs. (2900 x 3) = Rs. 8700
 Disturbance in the supply side – Sales tax

P MC MCnew
S2 ACnew
S1 MR MCold
S0
ACold

C c MR2
63
b MR1
61
60
B A
a MR0
D0

3000 X x1 x0 x
Xn
2900
Market Firm

Sumit Sarkar, XLRI

Tweeds A
Tweeds A
Tweeds A – Long-term equilibrium
Tweeds B
Tweeds – Graphical exposition
Sumit Sarkar, XLRI
 Entry of a firm with decreasing AC

Not
MC, MR MC, MR
P equilibrium.
SOC not
AC
S0 satisfied. More
it sells, higher
S1 MC is its profit

A a MR0
P0
B MR0 MR1
P1
b MR1
ACE
D MCE
X0 X1 X x1 x0 x x
Market One Incumbent Firm Entrant Firm

Sumit Sarkar, XLRI

Entry of a this firm results in monopolization.