Problem: A manufacturer of electronics products is considering entering the telephone equipment business.
It estimates that if it were to begin making wireless telephones, its short-run cost functions would be as follows:
| Quantity (Thousands) |
Average Variable Cost (AVC) |
Average Total Cost (ATC) |
Marginal Cost (MC) |
| 9 |
$41.10 |
$52.21 |
$30.70 |
| 10 |
$40.00 |
$50.00 |
$30.10 |
| 11 |
$39.10 |
$48.19 |
$30.10 |
| 12 |
$38.40 |
$46.73 |
$30.70 |
| 13 |
$37.90 |
$45.59 |
$31.90 |
| 14 |
$37.60 |
$44.74 |
$33.70 |
| 15 |
$37.50 |
$44.17 |
$36.10 |
| 16 |
$37.60 |
$43.85 |
$39.10 |
| 17 |
$37.90 |
$43.78 |
$42.70 |
| 18 |
$38.40 |
$43.96 |
$46.90 |
| 19 |
$39.10 |
$44.36 |
$51.70 |
| 20 |
$40.00 |
$45.00 |
$57.10 |
Question 1: Suppose the average wholesale price of a wireless phone is currently $50. Do you think this company should enter the market? Explain.
Question 2: Suppose the firm doesn't enter the market and that over time increasing competition causes the price to fall to $35.
Question 3: What impact will this have on the firm's production levels and profits? Explain. What would you advise this firm to do?
Solution Guide:
Please consider the following when you solve this problem:
1. Under perfect competition, price is equal to marginal revenue.
2. Use the marginal rule (MR=MC which under perfect competition is modified to P = MC) to find the profit-maximizing/loss-minimizing quantity, i.e., find the quantity at which the price is closest to marginal cost but is not below it.
3. Total profit = Total Revenue - Total Cost
4. Total cost = ATC times Q
5. Total Revenue = Price times Quantity
6. Total Fixed cost = (ATC-AVC) times Quantity.