Chapter 13, Problem 1CACQ

a.

To determine

To explain: The level of output which is to be produced by monopolist in order for entrant to face the residual demand curve.

Answer to Problem 1CACQ

The monopolist firm has to produce 16units of output.

Explanation of Solution

It shall be noted that under limit pricing, the horizontal difference between the entrant's residual demand curve $D^R$ and the monopolists demand curve $D^M$ is constant. The incumbent monopoly firm should produce and supply quantity of output equal to this constant and charge a price corresponding to this quantity as followed from the monopolist's demand curve $D^M$ . Doing so, the incumbent monopoly firm is said to be following limit pricing strategy to prevent the entry of new firm. In the given diagram, the horizontal distance between $D^M$ and $D^R$ is 16 units of output. That means, in order to make the entrant firm to face the residual demand curve $D^R$ , the monopolist firm has to produce 16units of output.

Economics Concept Introduction

It shall be noted that under limit pricing, the horizontal difference between the entrant's residual demand curve $D^R$ and the monopolists demand curve $D^M$ is constant.

b.

To determine

To explain: The amounts of profit will the monopolist earn.

Answer to Problem 1CACQ

The amounts of profit will the monopolist earn is $\$320$ .

Explanation of Solution

The profit is,

  $\pi =TR-TC$

Here, the price is $P$ , the average cost is $AC$ , the quantity is $Q$ , the profit is $\pi$ , the total revenue is $TR$ and the total cost is $TC$ .

  $\begin{array}{c}\pi =TR-TC\\ =\left(P\times Q\right)-\left(AC\times Q\right)\end{array}$

Thus, the amounts of profit will the monopolist earn is $\$320$ .

Economics Concept Introduction

The profit is,

  $\pi =TR-TC$

Here, the profit is $\pi$ , the total revenue is $TR$ and the total cost is $TC$ .

c.

To determine

To explain: Whether monopolist profitably deter entry by committing to a different level of output.

Answer to Problem 1CACQ

The monopoly firm could produce & supply output greater than 16 units that will fetch it higher profits and yet deter entry of new firms in the market.

Explanation of Solution

It shall be noted that under the limit pricing strategy, the monopoly firm should produce a minimum of 16 units of output to prevent entry of new firms in the market. The monopoly firm could increase profits by producing a level of output greater than 16 units and yet prevent the entry of new firms. To supply the quantity greater than 16 units, the monopoly firm would charge lower price as demand curve faced by it is downward sloping. A lower price would be large enough for the potential entrant to meet their costs and hence would drive them away from the very thought of entering the market. With lowering price and increasing supply beyond 16 units, the monopoly firm would increase profits but the profit would remain below the profit when it were charging monopoly price. Thus, the monopoly firm could produce & supply output greater than 16 units that will fetch it higher profits and yet deter entry of new firms in the market.

Economics Concept Introduction

To explain: Whether monopolist profitably deter entry by committing to a different level of output.