Chapter 10 Solutions to Monopolistic Competition

Chapter 10 Prices, Output, and Strategy: Pure and Monopolistic Competition Solutions to Exercises 1. Pepsi and Coca-Cola bottlers face enormous supplier power from the syrup manufacturers, sell primarily to concentrated grocery store chains, and are constantly presented with many substitute firms who could provide their role in the value chain. Thus, despite high barriers to entry from high capital requirements, high switching costs, and closed distribution channels, their sustainable profitability is lower than Coca-Cola and Pepsi.The latter face almost no supplier power, few close substitutes as perceived by loyal customers, very high barriers to effective entry, low intensity of rivalry from concentrated markets, non-price tactics, and low cost-fixity with fast growing demand especially overseas. 2.

MTV operates in a highly concentrated near-monopoly market where fixed costs are low and hence intensity of rivalry is reduced. MTV also faces little supplier power from numerous nonunique musical groups. The networks, in contrast, face the much greater supplier power of the NFL, NBA and Professional Baseball.MTV has few substitutes whereas the networks now face 150 channels of substitutes for each type of programming. 3. Reduced capital requirements and diminished scale economies will increase the threat of entry and reduce the sustainable industry profitability.

4. By increasing the demand for corn, the price of corn could be expected to rise in the short run. As corn becomes relatively more expensive as a feed grain, wheat and soybeans would be in more demand for feed grain purposes, also resulting in some price increases for these commodities.In the long run, given that there is excess productive agricultural capacity in the U. S. , the price effects could be wiped out by supply increases.

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This may not be resold, copied, or distributed without the prior consent of the publisher. 97 98 Chapter 10/Prices, Output, and Strategy: Pure and Monopolistic Competition 24P = 192 P = $8 QD = 212 ? 20(8) = 52 QS = 20 + 4(8) = 52 b. At P = $6, QD = 212 ? 20(6) = 92; QS = 20 +4(6) = 44 c. At P = $9, QD = 212 ? 0(9) = 32; QS = 20 + 4(9) = 56 d.

20 + 6P = 212 ? 20 P P = $7. 385 QD = 212 ? 20(7. 385) = 64. 3 QS = 20 + 6(7. 385) = 64. 3 e.

20 + 6P = 250 - 19P P = $9. 2 QD = 250 ? 19(9. 2) = 75. 2 QS = 20 + 6(9. 2) = 75.

2 5. a. QD = 212 ? 20P = 20 + 4P = QS 6. a.

Output (units) 0 10 15 20 25 30 35 40 Total Cost $ 0 110 150 180 225 300 385 480 Marginal Cost MC = ? TC/? Q 110/10=11 40/5 = 8 30/5 = 6 45/5 = 9 75/5 =15 85/5 =17 95/5 =19 Average Cost ATC = TC/Q 110/10 = 11 150/15 = 10 180/20 = 9 225/25 = 9 300/30 = 10 385/35 = 11 480/40 = 12 b. P = MR = $17 MC = 17 @ Q = 35 ? = TR ? TC ? 17(35) ? 385 = $210 ? /unit = 210/35 = $6 This edition is intended for use outside of the U. S. only, with content that may be different from the U. S.

Edition. This may not be resold, copied, or distributed without the prior consent of the publisher. Chapter 10/Prices, Output, and Strategy: Pure and Monopolistic Competition c. No, since MC = MR = P > ATC.

Above normal profits are currently being made. 7. Q = 20,000 P = $10 FC = $60,000 VC1 = $120,000 AVC1 = VC1/Q = 120,000/20,000 = $6 ED = ? 2. 0 a. 99 If %? Q = + 10%, then AVC2 = $6 ? .

40 = $5. 60 %? P = -5% %? Q = ED(%?P) = ? 2. 0(? 5) = +10% (i) %? Q = . 10 = (Q2 ? 20,000)/((Q2 + 20,000)/2) Q2 = 22,100 TR1 = P1Q1 = $10(20,000) = $200,000 TR2 ? TR1 = $10,000 (5% increase) (ii) TC1 = FC1 + VC1 = 60,000 + 6(20,000) = $180,000 TC2 = FC2 + VC2 = 60,000 + 5.

60(22,100) = $183,800 TC2 ? TC1 = $3,800 (approximately 2. 1% increase) (iii) ? 1 = TR1 ? TC1 = $200,000 ? $180,000 = $20,000 ? 2 = TR2 ? TC2 = $210,000 ? 183,800 = $26,200 ? 2 ? ?1 = $6,200 (approximately 31% increase) b. AVC3 = $6 TC3 = 60,000 + 6(22,100) = $192,600 ? 3 ? ?1 = $17,400 ? $20,000 = ? $2,600 (approximately a 13% decrease). 3 = $210,000 ? $192,600 = $17,400 TR2 = $9. 51 ? 22,100 = approx. $210,000 %? P = ?.

05 = (P2 ? 10)/((P2 + 10)/2) P2 = 9. 51 This edition is intended for use outside of the U. S. only, with content that may be different from the U.

S. Edition. This may not be resold, copied, or distributed without the prior consent of the publisher. 100 8. a. Chapter 10/Prices, Output, and Strategy: Pure and Monopolistic Competition TC = 1/3 Q3 ? 15Q2 + 5Q + 24,000 MC = Q2 ? 30Q + 5 P = 1760 ? 12Q TR = 1760Q ? 12Q2 MR = 1760 ? 24Q MC = MR Q2 ? 30Q + 5 = 1760 ? 24Q Q2 ? 6Q ? 1755 = 0 (Q ? 5)(Q + 39) = 0 Q* = 45 units P* = 1760 ? 12(45) = $1220 ? = TR ? TC ? = 1220(45) ? [(1/3)(45)3 ? 15(45)2 + 5(45) + 24,000] ? * = $30,675 P = 1760 ? 12Q Q = 1760/12 ? P/12 dQ/dP = ? 1/12 ED = ? 1/12(1220/45) = ? 2.

26 $24,000 b. c. d. e.

f. Price and output remain the same, but profit declines by $5,000. 9. a.

TC = 6000 + 400Q ? 20 Q2 + Q3 VC = 400Q ? 20Q2 + Q3 AVC = 400 ? 20Q + Q2 dAVC/dQ = ? 20 + 2Q = 0 Q = 10 When Q = 10, AVC is minimized and equals: AVC = 400 ? 20(10) + (10)2 = $300 No, the price of $250 is below the AVC. The firm should not produce in the short run. b.At a price of $300, the firm just covers its variable costs and incurs losses equal to its fixed costs, or $6,000.

At a price of $300, the firm is indifferent with respect to the decision to produce in the short run. This edition is intended for use outside of the U. S. only, with content that may be different from the U. S.

Edition. This may not be resold, copied, or distributed without the prior consent of the publisher. Chapter 10/Prices, Output, and Strategy: Pure and Monopolistic Competition 101 c. At any price above the minimum average variable cost ($300), the firm should produce in the short run. 0. a.

Revenues increase by $150,000 when advertising expenditures increase from $900,000 to $1,000,000. Hence the marginal revenue from an additional dollar spend in advertising is $1. 50. b. Advertising Outlays $500,000 600,000 700,000 800,000 900,000 1,000,000 Sales Revenues $4,000,000 4,500,000 4,900,000 5,200,000 5,450,000 5,600,000 MR/$Advertising $5. 00 4.

00 3. 00 2. 50 1. 50 Hence, assuming that price and marginal cost are constant over the various ranges of advertising outlays, Jordan should spend $900,000 on advertising? he point where MR from advertising equals the price elasticity of demand.

11. Simple clothing such as a golf shirt has distinguishable weight, cut, color, and sewing precision that is detectable at the point of purchase. Therefore, no adverse selection problem; you get what you knowingly pay for in golf shirts. High quality gemstones, on the other hand, are not distinguishable from good fakes, and a general certificate of quality is not worth the paper on which it is printed. Of course, a certificate from Tiffany's provides a "hostage"? i.

e. , a reputational asset that garners repeat customer business.Since this asset will be deteriorated by fraudulent certification of fakes, it credibly commits Tiffany's to deliver what the buyer thinks he or she paid for; therefore little or no adverse selection problem. The quality of travel packages is verifiable only through your own or someone else's experience, especially when dealing with unbranded independent tour operators who enter and exit with ease.

Also, since high school or college graduation happens only once, companies arranging tour packages specifically designed for this purpose will be less concerned about inducing repeat customer business.Therefore, buyers expect a major adverse selection problem, and low quality products predominate in the competitive marketplace. Of course, the same is true of unbranded mail-order auto parts, although at least in that case the seller is generally interested in repeat customer business. 12. In the absence of warranties, money-back guarantees, or other third-party enforceable contracts, the key to the exchange of high quality experience goods is always some sort of self-enforcing reliance relationship.

This first requires the possibility of repeat purchase transactions, such as tire replacement decisions.It often then involves reputational investments in brand names, nonredeployable retail displays or store locations by the seller and the payment of present and future This edition is intended for use outside of the U. S. only, with content that may be different from the U. S.

Edition. This may not be resold, copied, or distributed without the prior consent of the publisher. 102 Chapter 10/Prices, Output, and Strategy: Pure and Monopolistic Competition price premiums by the buyer. Such "hostage" arrangements can support the exchange of high quality experience goods. 3. The lag in the dissemination of information about the notorious firm increases the seller's profit from fraud in the southwest cell of Table 11.

1. That is, the lag creates two additional discounted profit terms on the right hand side of equation 11. 1. And the rising interest rate decreases the present value of future profits from non-fraudulent, reliable behavior. Both factors increase the likelihood of fraudulent delivery of low quality products at high prices and therefore the buyers are less likely to offer high prices. 4.

The presence of complemetor companies (the ISPs) who add value to movie production house releases of DVDs is suggestive of a network effect. Until HDTV moves through an inflection point at 30% or more penetration in U. S. households, no such network effect can be expected for HDTV. Solution to Case Exercise: HP and Dell Personal Computers 1.

Apple faces ever-lower barriers to entry today with direct-to-the-consumer sales and low minimum efficient scale at companies like Dell. 2.Component manufacturers like Intel appropriate most of the value in this value chain as unique component suppliers. 3. Intensity of rivalry is high in PCs because a) fragmented industry, b) price competition is the focus of tactics, c) fixed costs are high relative to minuscule variable costs, and d) growth rates of demand are slowing. Solution to Case Exercise: Saving Sony Music 1.

Napster and Kazaa are suppliers of competing technology to Sony’s customers who acquire the end product, musical entertainment by Sony artists without purchasing Sony CDs.Therefore, Napster and Kazaa do not pose a threat of substitute products. Instead, they enhance buyer power by creating the threat of shared files (pirated music) that markedly reduces what Sony can charge. Lower sustainable profitability in the music industry must now be based on $0. 25 license fees for R-distributed songs. 2.

Dell harnessed the power of the Internet to deliver made-to-order product through a virtual supply chain. Sony’s distribution channel in selling physical CDs was disrupted to file sharing of pirated music.This edition is intended for use outside of the U. S. only, with content that may be different from the U. S.

Edition. This may not be resold, copied, or distributed without the prior consent of the publisher. Chapter 10/Prices, Output, and Strategy: Pure and Monopolistic Competition 103 3. Sony has unique relationships with recording artists and music production studios, marketing expertise, and a label with substantial brand equity. Future business models for Sony should address the elements of Figure 10.

1, especially the components in the center column.Clearly, one key to future success for Sony is the Internet-based distribution of licensed music, equipped with security features that prevent files sharing. 4. Most likely, Sony will adopt an information technology strategy. Its strategic focus may be quite broad, pioneering Internet-based licensing solutions for a variety of entertainment and media companies. This edition is intended for use outside of the U.

S. only, with content that may be different from the U. S. Edition. This may not be resold, copied, or distributed without the prior consent of the publisher.