Question 1
Tobacco King is a monopolist in the cigarette market in the Nicotiana Republic, where the Singapore dollar is used as the official currency. The firm has a constant marginal cost of $2.00 per pack. The fixed cost of the firm is $50 million. The firm’s demand curve can be expressed as P = 8 – 0.04Q, where Q is the quantity demanded (in millions of packs) and P is the price per pack (in $).
In a table showing Tobacco King’s demand schedule, total revenue, average revenue, and marginal revenue for prices $2, $4, $6, and $8.
Based on the table created in your answer to part (a), show Tobacco King’s average revenue and marginal revenue curves on a graph. Comment on why the MR curve lies below the AR curve in 100 words or less.
Add the marginal cost curve to the graph drawn in part (b). Find the price and quantity combination of cigarette packets at which Tobacco King will maximize its profit.
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Question 2
The drainage of waste products from the chemical factory, Ultra Chemicals, situated along the banks of the Misty River has led to the formation of a dead zone in the river that cannot support aquatic life.
Without any government intervention, will Ultra Chemicals produce a socially optimal quantity? Why or why not?
Does Ultra Chemicals impose a deadweight loss on society? Explain in 100 words or less. Use your diagram to show the deadweight loss to society.
How can a government intervene to improve upon the outcome from society’s point of view? Explain in 100 words or less. A diagram is not needed.
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Question 3
Two home-improvement stores (Great Home and Super Home) in a growing urban area are interested in expanding their market share. Both are interested in expanding the size of their store and parking lot to accommodate potential growth in their customer base. Two possible actions for both firms are: ‘increase the size of the store and parking lot’ and ‘do not increase the size of the store and parking lot’. Payoffs are defined in terms of an increase in annual profits of $million. The following table describes the payoffs for both firms to alternative actions taken by each of them. Note, Great Home’s payoffs are given first and Super Home’s payoffs are given second.
Let’s say, each store is pursuing its own best interest. What will be a rational (or dominant) strategy for Super Home to follow? Explain in 3-4 sentences. What will be a rational (or dominant) strategy for Great Home to follow? Explain in 3-4 sentences.
What will be the annual profit growth for each store, if they both follow their dominant strategy? Define Nash Equilibrium and identify the Nash Equilibrium in the table above.
Suppose the owners of Super Home and Great Home meet for a friendly game of golf one afternoon and happen to discuss a strategy to optimize profit. What should the joint strategy be they should both agree to? What will annual profit growth be for each store under this agreement?