Chapter 7 presents several formulas for calculation of various short-term and long-term cost measures pertaining to the production process and the industry structures of perfect competition, monopoly, and monopolistic competition. These formulas, together with some basic data, allow us to solve numerical problems involving decisions that aim to achieve some managerial objective. Further, in chapter 9, we learned that monopolies have something called market power, and that it is because of this market power and the efficiency losses it generates, that governments often seek to regulate monopolies. Although both competitive firms and monopolies share many similarities with respect to the cost curves that determine how each makes output and pricing decisions, monopolies follow a slightly different list of steps in making their output and pricing decision.

Monopolies generate deadweight losses. The most intuitive definition of deadweight losses is offered in chapter 3, on page 72, where deadweight losses are likened to "money thrown away that benefits no one." More technically, it is the "loss in social surplus that occurs when the economy produces at an inefficient quantity."

Instructions

Problem 1

TheEl Dorado Staris the only newspaper in El Dorado, New Mexico. Certainly, theStarcompete withThe Wall Street Journal,USA Today, and theNew York Timesfor national news reporting, but theStaroffers readers stories of local interest, such as local news, weather, high-school sporting events, and so on. The El Dorado Star faces the demand and cost schedules shown in the spreadsheet that follows:

(1)

Number of newspapers per day (Q)

(2)

Price (P)

(3)

Total cost per day (TC)

00$2,0001,000$1.502,1002,0001.252,2003,0001.002,3604,0000.802,5205,0000.702,7006,0000.602,8907,0000.553,0908,0000.453,3109,0000.403,550

a. Create a spreadsheet using Microsoft Excel (or any other spreadsheet software) that matches the one above by entering the output, price, and cost data given.

b. Use the appropriate formulas to create three new columns (4, 5, and 6) in your spreadsheet for total revenue (TR), marginal revenue (MR), and marginal cost (MC), respectively. [Computation check: AT Q = 3,000, MR = $0.50 and MC = $0.16]. What price should the manager of theEl Dorado Starcharge? How many papers should be sold daily to maximize profit?

c. At the price and output level you answered in partb, is theEl Dorado Starmaking the greatest possible amount of total revenue? Is this what you expected? Explain why or why not.

d. Use the appropriate formulas to create two new columns (6 and 7) for total profit and profit margin. What is the maximum profit the El Dorado Star can earn? What is the maximum possible profit margin? Are profit and profit margin maximized at the same point on demand?

e. What is the total fixed cost fo theEl Dorado Star? Create a new spreadsheet in which total fixed cost increases to $5,000. what price should the manager charge? How many papers should be sold in the short run? What should the owners of theStardo in the long run?

Problem 2

Mirk Labs is a British pharmaceutical company that currently enjoys a patent monopoly in Europe, Canada, and the United States on Zatab (pronouncedzay-tab), an allergy medication. The global demand for Zatab is

Qd = 15.0 - 0.2P

where Qd is annual quantity demanded (in millions of units) of Zatab, and P is the wholesale price of Zatab per unit. A decade ago, Mirk Labs incurred a $60 million in research and development costs for Zatab. Current production costs for Zatab are constant and equal to $5 per unit.

a. What wholesale price will Mirk Labs set? How much Zatab will it produce and sell annually? How much annual profit does the firm make on Zatab?

b. The patent on Zatab expires next month, and dozens of pharmaceutical firms are prepared to enter the market with identical generic versions of Zatab. What price and quantity will result once the patent expires and competition emerges in this market? How much consumer surplus annually will allergy sufferers who take Zatab gain?

c. Calculate the annual deadweight loss to society due to the drug firm's market power in Zatab. What exactly does this deadweight loss represent?

d. Given your answer to partc, would it be helpful to society for competition authorities in Europe, Canada, and the United States to limit entry of generic drugs to just five years for new drugs? Why or why not?

Hint: Use the graph below as inspiration for this problem. Note that the graph below is only an example. All the values in the graph are hypothetical and in no way related to this problem.