Question

Question:23. Evaluate the following: "Since a rival's profit-maximizing price and output depend on its marginal cost and not its fixed costs, a firm cannot profitably lessen competition by implementing a strategy that raises its rival's fixed costs."

Short answer

Answer:

If a company decides to implement a strategy that seeks to increase the fixed costs of the rival, it must take into account that the strategy must be in the medium and long term. This is so because this can increase the profits of the implementing firm.

Step-by-step solution

 Step 1: Fixed costs

This claim that increasing fixed costs rather than variable costs does not hurt profits is true in some situations and can be false in other situations. In one market, it is true that a company maximizes profits and production if marginal cost equals marginal income, but for example, if it increases the cost of inputs required to produce a particular commodity, it increases the variable cost. Their variable costs affect a company's profits in the short term and can withdraw from the market or reduce market share, but in the long term this strategy will help to maintain the monopoly position of the implementing firm, given the market is a monopoly.

Competition lessens

On the other hand, in the long term, changes in fixed costs can have an impact on the company's profits. If a company decides to influence the fixed costs of the competition such as rents, insurance, labor and administration expenses, it may affect the total profits of the company, since the total costs are determined as the sum of the variable costs and fixed costs.

Thus, if the company decides to raise fixed costs by requirement of license acquisition from the government, it would decrease competition as rivals would be demotivated to enter the market by bearing additional costs.