Homework about Breakeven Cost and Prefect Competition

1. Three graduate business students are considering operating a fruit smoothie stand in the Harbor
Springs, Michigan, resort area during their summer break. This is an alternative to summer
employment with a local firm, where they would each earn $6,000 over the three-month
summer period. A fully equipped facility can be leased at a cost of $8,000 for the summer.
Additional projected costs are $1,000 for insurance and $3.20 per unit for materials and
supplies. Their fruit smoothies would be priced at $5 per unit.

a) What is the cost function for this business?

b) What is the economic breakeven number of units for this operation? (Assume a $5 price and
ignore interest costs associated with the timing of lease payments.)

2. Assume a perfect competitive market and a total cost given by: TC= 361,250 + 5q = 0.0002q2
In addition, assume a marginal cost MC= 5+0.0004Q

a) Estimate quantity and price of equilibrium

b) Estimate total profits made by the company in the short run
c) Explain in detail how are going to be the profits in the long run

3. Short-run Firm Supply. Florida is the biggest sugar-producing state, but Michigan and
Minnesota are home to thousands of sugar beet growers. Sugar prices in the United States
average about 20¢ per pound, or more than double the world-wide average of less than 10¢ per
pound given import quotas that restrict imports to about 15% of the U.S. market. Still, the
industry is perfectly competitive for U.S. growers who take the market price of 20¢ as fixed.
Thus, P = MR = 20¢ in the U.S. sugar market. Assume that a typical sugar grower has fixed
costs of $30,000 per year. Total variable cost (TVC), total cost (TC), and marginal cost (MC)
relations are:

TVC = $15,000 + $0.02Q + $0.00000018Q2

TC = $45,000 + $0.02Q + $0.00000018Q2

MC =  TC/  Q = $0.02 + $0.00000036Q

where Q is pounds of sugar, total costs include a normal profit.

a) Using the firm’s marginal cost curve, calculate the profit-maximizing short-run supply
curve for a typical grower.

b) Calculate the average variable cost curve for a typical grower, and verify that average
variable costs are less than price at this optimal activity level.

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4. Short-run Market Supply. New England Textiles, Inc., is a medium-sized manufacturer of blue
denim that sells in a perfectly competitive market. Given $25,000 in fixed costs, the total cost
function for this product is described by:

TC = $25,000 + $1Q + $0.000008Q2

MC = ∂TC/∂Q = $1 + $0.000016Q

where Q is square yards of blue denim produced per month. Assume that MC > AVC at every
point along the firm’s marginal cost curve, and that total costs include a normal profit.

a) Derive the firm's supply curve, expressing quantity as a function of price.

b) Derive the market supply curve if New England Textiles is one of 500 competitors.

c) Calculate market supply per month at a market price of $2 per square yard.

5. Dynamic Competitive Equilibrium. Wal-Mart and other movie DVD retailers, including online
vendors like amazon.com, employ a two-step pricing policy. During the first six months
following a theatrical release, movie DVD buyers are willing to pay a premium for new
releases. Total and marginal revenue relations for a typical newly released movie DVD are
given by the following relations:

TR = $28Q - $0.0045Q2

MR = ∂TC/∂Q = $28 - $0.009Q

Total cost (TC) and marginal costs (MC) for production and distribution are:

TC = $4,500+ $3Q + $0.0005Q2

MC = ∂TC/∂Q = $3 + $0.001Q

where Q is in thousands of units (DVDs). Because units are in thousands, both total revenues
and total costs are in thousands of dollars. Total costs include a normal profit.

a) Use the marginal revenue and marginal cost relations given above to calculate DVD output,
price, and economic profits at the profit-maximizing activity level for new releases.

b) After six months, price-sensitive DVD buyers appear willing to pay no more than $6 per
DVD. Calculate the equilibrium price-output activity level in this situation. Is this a stable
equilibrium?

6. Read the following paper and make a 2 pages summary. Paper: Stigler, G. J. (1957). Perfect
competition, historically contemplated. Journal of political economy, 65(1), 1-17.
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