ECON 2210 Chapter Notes - Chapter 10: Fixed Cost, Expenditure Function, Chulalongkorn University
1
Chulalongkorn University: BBA International Program, Faculty of Commerce and
Accountancy
2900111 (Section 1) Chairat Aemkulwat
Economics I: Microeconomics Spring 2015
Solution to Selected Questions: CHAPTER 10
MARKET POWER: MONOPOLY AND MONOPSONY
2. Caterpillar Tractor, one of the largest producers of farm machinery in the world,
has hired you to advise it on pricing policy. One of the things the company would
like to know is how much a 5-percent increase in price is likely to reduce sales. What
would you need to know to help the company with this problem? Explain why these
facts are important.
As a large producer of farm equipment, Caterpillar Tractor has some market power
and should consider the entire demand curve when choosing prices for its products.
As their advisor, you should focus on the determination of the elasticity of demand
for the company’s tractors. There are at least four important factors to be
considered. First, how similar are the products offered by Caterpillar’s competitors?
If they are close substitutes, a small increase in price could induce customers to
switch to the competition. Second, how will Caterpillar’s competitors respond to a
price increase? If the other firms are likely to match Caterpillar’s increase,
Caterpillar’s sales will not fall nearly as much as they would were the other firms
not to match the price increase. Third, what is the age of the existing stock of
tractors? With an older population of tractors, farmers will want to replace their
aging stock, and their demands will be less elastic. In this case, a 5 percent price
increase induces a smaller drop in sales than would occur with a younger stock of
tractors that are not in need of replacement. Finally, because farm tractors are a
capital input in agricultural production, what is the expected profitability of the
agricultural sector? If farm incomes are expected to fall, an increase in tractor
prices would cause a greater decline in sales than would occur if farm incomes were
high.
4. A firm faces the following average revenue (demand) curve:
P = 120 – 0.02Q
where Q is weekly production and P is price, measured in cents per unit. The firm’s cost
function is given by C = 60Q + 25,000. Assume that the firm maximizes profits.
a. What is the level of production, price, and total profit per week?
The profit-maximizing output is found by setting marginal revenue equal to
marginal cost. Given a linear demand curve in inverse form, P = 120 – 0.02Q, we
know that the marginal revenue curve has the same intercept and twice the slope
of the demand curve. Thus, the marginal revenue curve for the firm is MR = 120 –
0.04Q. Marginal cost is the slope of the total cost curve. The slope of TC = 60Q +
25,000 is 60, so MC equals 60. Setting MR = MC to determine the profit-
maximizing quantity:
120 – 0.04Q = 60, or
Q = 1500.
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Document Summary
Chulalongkorn university: bba international program, faculty of commerce and. Market power: monopoly and monopsony: caterpillar tractor, one of the largest producers of farm machinery in the world, has hired you to advise it on pricing policy. One of the things the company would like to know is how much a 5-percent increase in price is likely to reduce sales. As a large producer of farm equipment, caterpillar tractor has some market power and should consider the entire demand curve when choosing prices for its products. As their advisor, you should focus on the determination of the elasticity of demand for the company"s tractors. There are at least four important factors to be considered. If they are close substitutes, a small increase in price could induce customers to switch to the competition. If the other firms are likely to match caterpillar"s increase,
