Chapter 8: Answers to Questions and Problems

1.
a. 7 units.
b. $28.
c. $224, since $32 x 7 = $224.
d. $98, since $14 x 7 = $98.
e. $126 (the difference between total cost and ariable cost!.
f. "t is earnin# a loss of $28, since ($28 $$32! x 7 = $ $28.
#. $ $126, since its loss will e%ual its fixed costs.
h. &hut down.
2.
a. &et ' = () to #et $8* = 8 + 4,. &ole for , to #et , = 18 units.
b. $8*.
c. -eenues are - = ($8*!(18! = $144*, )osts are ) = 4* + 8(18! + 2(18!
2
=
$832, so .rofits are $6*8.
d. /ntr0 will occur, the 1ar2et .rice will fall, and the fir1 should .lan to reduce
its out.ut. "n the lon#$run, econo1ic .rofits will shrin2 to 3ero.
3.
a. 7 units.
b. $13*.
c. $14*, since ($13* 4 11*! x 7 = $14*.
d. 5e1and will decrease oer ti1e as new fir1s enter the 1ar2et. "n the lon#$
run, econo1ic .rofits will shrin2 to 3ero.
4.
a. (- = 2** 4 4, and () = 6,. &ettin# (- = () 0ields 2** 4 4, = 6,.
&olin# 0ields , = 2* units. 6he .rofit$1axi1i3in# .rice is obtained b0 .lu##in#
this into the de1and e%uation to #et ' = 2** $ 2(2*! = $16*.
b. -eenues are - = ($16*!(2*! = $32** and costs are ) = 2*** + 3(2*!
2
=
$32**, so the fir17s .rofits are 3ero.
c. /lastic.
d. 6- is 1axi1i3ed when (- = *. &ettin# (- = * 0ields 2** 4 4, = *. &olin#
for , 0ields , = 8* units. 6he .rice at this out.ut is ' = 2** 4 2(8*! = $1**.
e. 9sin# the results fro1 .art d, the fir17s 1axi1u1 reenues are - = ($1**!
(8*! = $8,***.
f. 9nitar0.
Managerial Economics and Business Strategy, 4e Page 1
8.
a. : .erfectl0 co1.etitie fir17s su..l0 cure is its 1ar#inal cost cure aboe
the 1ini1u1 of its :;) cure. <ere,
2
8* 8 3
i i i
MC q q = + and
2 3
2
8* 4
8* 4
i i i
i i i
i
q q q
AVC q q
q
+
= = +
. &ince () and :;) are e%ual at the
1ini1u1 .oint of :;), set ()i = :;)i to #et
2 2
8* 8 3 8* 4
i i i i
q q q q + = + , or
2
i
q =
. 6hus, :;) is 1ini1i3ed at an out.ut of 2 units, and the corres.ondin#
:;) is ( ) ( )
2
8* 4 2 2 46
i
AVC = + = . 6hus the fir17s su..l0 cure is described
b0 the e%uation
2
8* 8 3
i i
P q q = + if $46 P = otherwise, the fir1 .roduces 3ero
units.
b. : 1ono.olist .roduces where (- = () and thus does not hae a su..l0
cure.
c. : 1ono.olisticall0 co1.etitie fir1 .roduces where (- = () and thus does
not hae a su..l0 cure.
6.
a. , = 3 units= ' = $7*.
b. , = 4 units= ' = $6*.
c. ( ) ( )
1
$7* $4* 1 $18.
2
DWL = =
7.
a. &ole for ' to #et 2' = 2* 4 ,. 6hus, the inerse de1and function is ' = 1* 4 .
8,.
b. (- = 1* 4 , and () = 414 + 2,. &ettin# (- = () 0ields 1* 4 , = 414 +
2,. &olin# for , 0ields , = 8 units. 6he o.ti1al .rice is ' = 1* 4 .8(8! = $6.
c. -eenues are - = ($6!(8! = $48. )osts are ) = 1*4 4 14(8! + (8!
2
= $86. 6hus
the fir1 earns a loss of $8. <oweer, the fir1 should continue o.eratin# since it is
coerin# ariable costs.
d. "n the lon# run exit will occur and the de1and for this fir17s .roduct will
increase until it earns 3ero econo1ic .rofits. >therwise, the fir1 should exit the
business in the lon# run.
8.
a. 6he o.ti1al adertisin# to sales ratio is #ien b0
,
,
*.1
*.*8
2
Q A
Q P
E
A
R E
= = =

.
b. ( ) ( )
,
,
*.1
.*8 $8*, *** $2, 8**
$8*, *** 2
Q A
Q P
E
A A
A
R E
= = = =

.
9. )hastise the 1ana#er. 'rofit 1axi1i3ation re%uires .roducin# where (- = ().
Page 2 Michael R. Bae
1*. &ince 0ou are a .erfectl0 co1.etitie fir1, the .rice 0ou char#e is deter1ined in a
co1.etitie 1ar2et. 6he two eents su11ari3ed will result in a decrease in 1ar2et
su..l0 and an increase in the 1ar2et de1and, resultin# in a hi#her 1ar2et .rice (fro1
'* to '1 in the #ra.hs below!. ?our .rofit$1axi1i3in# res.onse to this hi#her .rice is
to increase out.ut. 6his is because we are a .rice ta2er (hence ' = (- = the de1and
for our .roduct! and the increase in .rice fro1 '* to '1 1eans that (- @ () at our
old out.ut. "t is .rofitable to increase out.ut fro1 %* to %1, as shown below.
11. "t co1.etes in a 1ono.olisticall0 co1.etitie 1ar2et. &hort run .rofits 1a0 be
earned b0 introducin# new .roducts 1ore %uic2l0 than rials. >er ti1e, other fir1s
will innoate too so in the lon# run 'i33a <ut earns 3ero econo1ic .rofits.
12. 'rofit 1axi1i3ation re%uires e%uatin# (- and (). &ince
1 1 2.8
$1.28 $*.78
2.8
E
MR P
E
+

= = =

and () = $*.28, (- @ (). 6his 1eans
0our fir1 can increase .rofits b0 reducin# .rice in order to sell 1ore .ills.
13. Aotice that (- = 1,*** 4 1*,, ()1 = 1*,1 and ()2 = 4,2. "n order to 1axi1i3e
.rofits (or 1ini1i3e its losses!, the fir1 e%uates (- = ()1 and (- =()2. &ince ,
= ,1 + ,2, this #ies us
( )
( )
1 2 1
1 2 2
1*** 1* 1*
1*** 1* 4
Q Q Q
Q Q Q
+ =
+ =
.
&olin# 0ields
1
2**
22.22
9
Q = units and
2
8**
88.86
9
Q = units. 6he o.ti1al .rice
is the a1ount consu1ers will .a0 for the
1 2
2** 8** 7**
77.78
9 9 9
Q Q + = + = units,
and is deter1ined b0 the inerse de1and cureB
7** $8, 8**
1, *** 8 $611.11
9 9
P

= =


. :t this .rice and out.ut, reenues are - =
($611.11!(77.78! = $47,832.14, while costs are
( )
( )
( )
( )
2 2
1 2
1*, *8* 8 22.22 8, *** 2 88.86 $23,692.47 C C + = + + + =
. 6he fir1 thus
earns .rofits of $23,839.67.
Managerial Economics and Business Strategy, 4e Page !

(ar2et 'rice
(ar2et ,uantit0
'1
'*
&1
&*
51
5*

'ri ce
%* %1 Cir 17 s >ut.ut

()


'1

'*
14. )olle#e )o1.uters is a 1ono.olisticall0 co1.etitie fir1 and faces a downward
slo.in# de1and for its .roduct. 6hus, 0ou should e%uate (- = () to 1axi1i3e
.rofits. <ere, (- = 1*** 4 2, and () = 2,. &ettin# 1*** 4 2, = 2, i1.lies that
0our o.ti1al out.ut is 28* units .er wee2. ?our o.ti1al .rice is ' = 1*** 4 28* =
$78*. ?our wee2l0 reenues are - = ($78*!(28*! = $187,8** and 0our wee2l0 costs
are ) = 2*** + (28*!
2
= $64,8**. ?our wee2l0 .rofits are thus $123,***. ?ou should
ex.ect other fir1s to enter the 1ar2et= 0our .rofits will decline oer ti1e and 0ou
will lose 1ar2et share to other fir1s.
18. ?our aera#e ariable cost of .roducin# the 1*,*** units is $6** (de.reciation is a
fixed cost!. &ince the .rice 0ou hae been offered ($68*! exceeds 0our aera#e
ariable cost ($6**!, 0ou should acce.t the offer= doin# so adds $8* .er unit (for a
total of $8**,***! to 0our fir17s botto1 line.
16. Aote first that oerhead costs are irreleant, as the0 are a fixed cost. &econd, the
ex.licit (accountin#! () is $2.78. 6hird, we 1ust consider o..ortunit0 costB D0
.roducin# 60.e : bolts we lose the o..ortunit0 to .roduce t0.e D bolts. &ince each
60.e D bolt .roduced would net $4.78 $ $2.78 = $2, the i1.licit () is $2. 6hus, the
releant () is the su1 of these ex.licit and i1.licit costs, or $2.78 + $2 = $4.78. 6o
deter1ine the .rofit$1axi1i3in# leel of 60.e : bolts to .roduce, we 1ust co1.are
(- and (). Eien the 1ar2etin# data, we can co1.ute the (- as shown in the
acco1.an0in# table. :s shown in the table, (- @ () u. to 3 units, so to 1axi1i3e
.rofits the fir1 should .roduce 3 units of 60.e : bolts.

,uantit0 'rice TR
0
MR MC
* 1* 0 - 4.75
1 9 9 9 4.75
2 8 ! 7 4.75
3 7 " 5 4.75
4 6 "4 # 4.75
8 8 "5 4.75
17. ( ) ( )
, ,
,
,
.*68 .*68 4.8 *.2928
4.8
Q A Q A
Q A
Q P
E E
A
E
R E
= = = =

. 6hus, Eillette7s
adertisin# elasticit0 is a..roxi1atel0 *.29. Eillette7s de1and is less res.onsie to
adertisin# than its rials= their hi#her adertisin#$to$sales ratios i1.l0 a #reater
adertisin# elasticit0.
Page " Michael R. Bae