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Chapter 12: Q1. (page 497)

Suppose all firms in a monopolistically competitive industry were merged into one large firm. Would that new firm produce as many different brands? Would it produce only a single brand? Explain.

Short Answer

Expert verified

Yes, after the merger, many different brands will earn more profits from different customers.

Step by step solution

01

Step 1. Explanation

The competitive monopolist firms produce differentiated products. Each firm in this market spends on selling costs, i.e., advertisement to make their product known to everyone. After the merger, there will be one firm managing the different brands of the different firms, or there will be coordination issues.

The decision to produce different brands is to take advantage of the loyal customers. A single brand will not be able to cater to the different tastes and preferences of the customers. Continuing with various brands will increase the market size for the single firm. The single firm acting as a monopolist will have the power to control the prices. This price discrimination would result in higher profits for the firm. Thus, the monopolist can earn more profit by selling different brands and also by discriminating the price.

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Most popular questions from this chapter

A monopolist can produce at a constant average (and marginal) cost of AC = MC = \(5. It faces a market demand curve given by Q = 53 - P.

  1. Calculate the profit-maximizing price and quantity for this monopolist. Also calculate its profits.
  2. Suppose a second firm enters the market. Let Q1 be the output of the first firm and Q2 be the output of the second. Market demand is now given by

Q1 + Q2 = 53 - P

Assuming that this second firm has the same costs as the first, write the profits of each firm as functions of Q1 and Q2.

c. Suppose (as in the Cournot model) that each firm chooses its profit maximizing level of output on the assumption that its competitor’s output is fixed. Find each firm’s “reaction curve” (i.e., the rule that gives its desired output in terms of its competitor’s output).

d. Calculate the Cournot equilibrium (i.e., the values of Q1 and Q2 for which each firm is doing as well as it can given its competitor’s output). What are the resulting market price and profits of each firm?

e. Suppose there are N firms in the industry, all with the same constant marginal cost, MC = \)5. Find the Cournot equilibrium. How much will each firm produce, what will be the market price, and how much profit will each firm earn? Also, show that as N becomes large, the market price approaches the price that would prevail under perfect competition.

A lemon-growing cartel consists of four orchards. Their total cost functions are

TC1 = 20 + 5Q12

TC2 = 25 + 3Q22

TC3 = 15 + 4Q32

TC4 = 20 + 6Q42

TC is in hundreds of dollars, and Q is in cartons per month picked and shipped.

  1. Tabulate total, average, and marginal costs for each firm for output levels between 1 and 5 cartons per month (i.e., for 1, 2, 3, 4, and 5 cartons).
  2. If the cartel decided to ship 10 cartons per month and set a price of $25 per carton, how should output be allocated among the firms?
  3. At this shipping level, which firm has the most incentive to cheat? Does any firm not have an incentive to cheat?

Suppose the airline industry consisted of only two firms: American and Texas Air Corp. Let the two firms have identical cost functions, C(q) = 40q. Assume that the demand curve for the industry is given by P = 100 - Q and that each firm expects the other to behave as a Cournot competitor.

  1. Calculate the Cournot-Nash equilibrium for each firm, assuming that each chooses the output level that maximizes its profits when taking its rival’s output as given. What are the profits of each firm?
  2. What would be the equilibrium quantity if Texas Air had constant marginal and average costs of \(25 and American had constant marginal and average costs of \)40?
  3. Assuming that both firms have the original cost function, C(q) = 40q, how much should Texas Air be willing to invest to lower its marginal cost from 40 to 25, assuming that American will not follow suit? How much should American be willing to spend to reduce its marginal cost to 25, assuming that Texas Air will have marginal costs of 25 regardless of American’s actions?

Suppose the market for tennis shoes has one dominant firm and five fringe firms. The market demand is Q = 400 - 2 P. The dominant firm has a constant marginal cost of 20. The fringe firms each have a marginal cost of MC = 20 + 5q.

a. Verify that the total supply curve for the five fringe firms is Qf = P - 20.

b. Find the dominant firm’s demand curve.

c. Find the profit-maximizing quantity produced and the price charged by the dominant firm, and the quantity produced and the price charged by each of the fringe firms.

d. Suppose there are 10 fringe firms instead of five. How does this change your results?

e. Suppose there continue to be five fringe firms but that each manages to reduce its marginal cost to MC = 20 + 2q. How does this change your results?

This exercise is a continuation of Exercise 3. We return to two firms with the same constant average and marginal cost, AC = MC = 5, facing the market demand curve Q1 + Q2 = 53 - P. Now we will use the Stackelberg model to analyze what will happen if one of the firms makes its output decision before the other.

  1. Suppose Firm 1 is the Stackelberg leader (i.e., makes its output decisions before Firm 2). Find the reaction curves that tell each firm how much to produce in terms of the output of its competitor.
  2. How much will each firm produce, and what will its profit be?
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