MARKETS WITH MARKET POWER - Tufts University

Quantity of Output
(Demanded)
Selling Price
($)
Total Revenue
($)
Marginal Revenue
($)
1 17 17 17
2 14 28 11
3 11 33 5
4 8 32 -1
5 5 25 -7
c) The selling price of $8 cannot be profit maximizing because the marginal revenue is
negative – Braeburn decreases its revenue by producing and selling the fourth book.
d) See the graph above for the horizontal marginal cost curve.
e) Profit maximization occurs where marginal revenue equals marginal cost. In the graph
above, this occurs at a production level of three books and a price of $11.
f) At a price of $8, Braeburn would sell four books for a total revenue of $32. Total cost
would be $20 (4*$5) and profits would be $12. At the profit maximizing price of $11,
Braeburn’s revenues are $33, their costs are $15, and their profits are $18.
2. a) Firm 1 will make high (additional) profit; Firm 2 will make no (additional) profit--as
shown in the upper right cell in the payoff matrix.
b) The worst that can happen to Firm 1 if it opens a new outlet is that it could make moderate
profit. If it doesn’t open one, the worst that can happen is that it could make no profit. So it
will open the new outlet.
c) The outcome will be that each firm will open a new outlet. The end result will be that each
firm will make a moderate profit.
d) This situation is not like the prisoner’s dilemma because the firms could not both clearly
achieve a better outcome through cooperation.
e) Given the potential to open outlets in multiple towns, the firms do have potential gains
through collusion. Suppose there are two potential towns. If both firms open an outlet in
each town, each firm will make only a moderate profit in each town. However, if one firm
opens an exclusive outlet in one town and the other firm opens an exclusive outlet in the
other town, each firm would make a high profit. Thus (if “high” is greater than two
“moderates”) an agreement that gives each firm exclusive access to each town has the
potential to benefit both firms.
3. The correct matches are a-2, b-5, c-1, d-7, e-4, f-6, g-3.
Extensions
1. Discussion of “Competition and Concentration” (suitable for lecture preparation or handout).
(1 page)
2. Extra numerical example of Monopoly. NOTE: Table 1 refers only to material covered in the
text, but uses the notation “Δ” for “change in.” Table 2 includes material (average variable costs
and average total costs) covered in the appendix, and also includes average fixed costs (not
Chapter 12 − Markets with Power 9