Question:

Help with problem regarding profit maximizing price/output combination and economic profits?

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During recent years, MBU, Inc. has enjoyed substantial economic profits derived from patents covering a wide range of inventions and innovations. A recent software product, QuickerBetter has proven especially profitable. Market demand and marginal revenues for this software product are:

P = $5,500 - $0.05*Q

MR = $5,500 - $0.10*Q

Where P is the product price, its quantity sold is Q and MR is the marginal revenue of the product. Fixed costs are zero since the research and development expenses have been fully amortized in previous periods. Average variable costs are constant at $4,500 per unit.

a. Calculate the profit maximizing price/output combination and economic profits if MBU enjoys an effective monopoly on QuickerBetter due to patent protection.

b. Calculate the price/output combination and the total economic profits that would result if competitors offer similar software that makes the QuickerBetter market competitive.

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2 ANSWERS


  1. a) in a monopoly, marginal cost equals marginal revenue

    marginal cost is 4500

    4500=5500-.10Q

    1000=.10Q

    Q=10000

    P=$5000

    b)in a competitive market, P=MC

    P=$4500

    4500=5500-.05Q

    1000=.05Q

    Q=20000


  2. a)

    AVC=4500

    AVC=TC/Q

    TC=AVC*Q

    TC=4500*Q

    Profit maximization condition MR=MC

    MC=(TC)'=(4500*Q)'=4500

    MR=MC

    5500-0.1*Q=4500

    0.1Q=5500-4500=1000

    Q=1000/0.1=10'000

    P=5500-0.05*Q= 5500-0.05* 10000=5500-500=5'000

    Profit=TR-TC

    TR=P*Q=10'000* 5'000=50'000'000

    TC=4500*Q=4500*10'000=45'000'000

    Profit=50'000'000 - 45'000'000=$+5'000'000

    Answer: for monopoly Profit=$+5'000'000 Q=10'000 P=5'000

    b)

    For perfect competition profit=0

    Profit=TR-TC

    TR-TC=0

    TR=TC

    P*Q=4500*Q

    Q*(5500-0.05Q)=4500*Q

    5500-0.05*Q=4500

    0.05*Q=5500-4500=1000

    Q=1000/0.05=20'000

    P=5500-0.05*20'000=5500-1000=$4'500

    Profit=0

    Answer: for perfect competition Profit=0 Q=20'000 P=4'500

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