Week 4 Discussion Question

A manufacturer of electronics products is considering entering the telephone equipment business. It estimates that if it were to begin making wireless telephones , its short-run cost functions would be as follows: Average Quantity Variable Cost Average Total Marginal Cost (Thousands) (AVC) Cost (ATC) (MC) 9 $41.10 $52.21 $30.70 10 $40.00 $50.00 $30.10 11 $39.10 $48.19 $30.10 12 $38.40 $46.73 $30.70 13 $37.90 $45.59 $31.90 14 $37.60 $44.74 $33.70 15 $37.50 $44.17 $36.10 16 $37.60 $43.85 $39.10 17 $37.90 $43.78 $42.70 18 $38.40 $43.96 $46.90 19 $39.10 $44.36 $51.70 20 $40.00 $45.00 $57.10 a. Suppose the average wholesale price of a wireless phone is currently $50. Do you think this company should enter the market? Explain. Let us see the marginal cost column. We find that MC is less than average price i.e. $50 for output level of 18 thousand units. Optimal level of output should be 18 thousand units. Any increase in output from this level will pull down the profits. At this level ATC is $43.96 which is less than current average price level. Profit at this level=(P-ATC)*Q=(50-43.96)*18000= 108.72 thousand dollars We see that firm has an opportunity to make economic profits currently. It should enter into the marker. b. Suppose the firm doesn't enter the market and that over time increasing competition causes the price to fall to $35. What impact will this have on the firm's production levels and profits? Explain. What would you advise this firm to do? Let us again see the marginal cost column. We find that MC is less than average price i.e. $35 for output level of 14 thousand units. Optimal level of output should be 14 thousand units. Any increase in output will pull down the profits. At this level AVC is $37.60 which is higher than current average price level. It means that firm will not be able to cover its variable costs even. Profit at this level=(P-ATC)*Q=(35-44.74)*18000= Firm will make a loss of -136.36 thousan dollars if enters. -136.36 thousand dollars

I would advise the company to stay away from the market in the current scenario. Solution Guide Please consider the following when you solve this problem: 1. Under perfect competition, price is equal to marginal revenue. 2. Use the marginal rule (MR=MC which under perfect competition is modified to P = MC) to find the profit-maximizing/loss-minimizing quantity, i.e., find the quantity at which the price is closest to marginal cost but is not below it. 3. Total profit = Total Revenue - Total Cost 4. Total cost = ATC times Q 5. Total Revenue = Price times Quantity 6. Total Fixed cost = (ATC-AVC) times Quantity.