PROBLEM SET #6 – 6 lines for each question unless otherwise stated
1. Heard in a meeting: “It is quite obvious using elementary math that producing and selling twice
as much when total costs double will not lead to any extra profit if the price stays unchanged.”
Do you agree? Why or why not?
Ans. no, I don’t agree, because if you double your revenue, and costs, the profit will also double.
For eg.,
If revenue is 60 cost is 40 then profit is 20, then if we double it the profit also doubles.
i.e. 120-80=40.
If there is loss, then your losses double as well. (negative value, revenue is 60, cost is80, then
profit is -20)
2. Heard in the MBA Lounge: “It is obvious that economic profits are positive when price is greater
than average cost. Therefore it is easily inferred that profits will be maximized when average
costs is at a minimum” Do you agree? Why or why not?
Ans. no, because profit maximization is MC=MR, it doesn’t have to be the lowest point of
average cost, it has nothing to do with question.
3. Why does the price increase when variable costs rise? Do variable costs and price rise by the
same proportion?
Ans. no, VC goes up, that means Cost of production increases, which also means sales decreases,
therefore, only if the demand curve is downward sloping then prices will go up. (dd curve has
different shapes)
No, it depends on the elasticity of demand, so price wouldn’t change by the same proportion.
4. Two brothers, Saber and Thiago, inherit a firm with monopoly power. While Saber has a degree
in Business Administration, Thiago has a degree in art. Saber is the CEO while Thiago sits on the
board and collects dividends as a shareholder. In a private conversation, Thiago says to Saber
“Look, big brother, I need more money to pay for my mansions, yachts and art collections. Can’t
you make more money for me? Look our firm has monopoly power. Just raise the price and we
will both make more money. Forget social constraints when it is so easy to make even more
money when you have a monopoly!” Having taken a first lesson in business economics, what
should Saber say to his brother?
Ans. monopoly has a downward sloping demand curve, downward sloping demand curve has
three elasticities and if we are inelastic stage then only we can make more money, i.e. when
demand is inelastic, and you increase the price, the total revenue goes up.
5. Heard in a managers’ meeting: “By definition, a monopoly makes economic profits both in the
short run and the long run.” Do you agree? Why or why not?
Ans. I make profit when price is more than average cost.
No, Monopolies don’t always make profits all the time, because if average cost is (sufficiently
higher) more than price than you make loss.
6. Heard in an MBA seminar class: “If it is stated that in competitive markets there is no economic
profit in the long run. There is absolutely no reason for firms to enter the kind of industry when
there is no profit.” Do you agree? Why or why not?
Ans. you enter the market because in the short run you will make profit and then maybe exit,
because in long run there will be zero profits. For example, mc Donald’s enters market with a
product as burger king for short time to make profits.
These short run profits encourages us to enter the market.
7. Suppose Ahn manages a firm in an industry that closely resembles that of perfect competition
Last week, fixed costs increased for each producer and potential producer in the industry. What
happens to price, output and profits of Ahn’s firm in the short run? What would be the long run
adjustment? Explain fully and illustrate with graphs assuming an initial situation of P=AC
(breakeven point). (7 lines + graph)
Ans. you start from P=AC, in short run, when average cost increases, marginal cost doesn’t
change, price doesn’t change, we make economic loss.
In long run, the supply line shifts to left, the price will have to be increases to compensate for
the fixed cost, we make zero economic profits.
8. Tam manages a firm that “competes” against other firms in an industry. Over the last decade,
several firms have found it increasing difficult to enter this industry even though Tam’s company
and others in the industry have been enjoying returns on their investments that are higher than
the prevailing interest rate. Furthermore, the four-firm concentration ratio and the HerfindahlHirschman Index are both high. Tam’s Rothschild index is significantly greater than zero but less
than 1 and her Lerner Index is greater than zero as well, specifically roughly 0.59. Based on
these information, which market structure best characterizes Tam’s industry? Explain fully (4
lines
Ans. there are barriers to entry, so it’s either monopoly or oligopoly, RI is 0.59, it is inelastic but
tam is not the market, so it is not monopoly.
Reconfirm this answer with others.
9. Big Apple Music, Inc., enjoys an exclusive copyright on music written and produced by the Fab
Four, a legendary British rock group. The monthly costs and demand functions for this
operation are given by TC (Q)  104  20Q  Q 2 and Q  20  2 P respectively.
Answers in whatsapp
a. What is the firm's inverse demand function?
Ans. P=10-Q/2
b. Calculate the profit maximizing Q, P and profits for the company
Ans.
c. Suppose the copyright was expired by mid-February 2019. Calculate the optimal output and
profit in the period following expiration of the copyright protection if the competitive
market Price = 2.
d. What will be the long run adjustment in this new industry after the copyright expires?