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Consider a market demand curve that can be expressed as P = 300 - 3 Q. Each of the firms currently serving the market has a total cost function of the form C = 40 q so MC = ATC = 40. There are no fixed costs.
a. If the market is served by a (short-run) profit-maximizing monopoly, calculate P*, Q*, and profits for the monopolist. Show work.
b. If the market is instead served by a limit-pricing monopolist, calculate P*, Q*, and profits. Assume that each potential entrant has the total cost curve given by C = 105 q. Show work. If the discount rate is 10%, compute the present value of a stream of profits for 3 years for the limit-pricing monopolist of this question. Do not discount the first year’s profits. Show work.
c. Compared to the three-period limit-pricing strategy from part b, should the monopolist use a short-run profit-maximizing strategy instead if it can maintain its monopoly only for a single period? (After that, let’s assume that entry would force its profits all the way to zero.) Explain.
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Suppose that in the short run capital is fixed and labor is variable. What happens to the firm’s average cost, average variable cost, and marginal cost when the following changes occur?
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