Chapter 15. Chapter 15

Step 1

Work It Out
Chapter 15
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You must read each slide, and complete any questions on the slide, in sequence.

Question

Consider the following demand schedule for Rainbow Looms. Assume that the marginal cost of producing a Rainbow Loom is a constant $2.50. Note that when marginal cost is constant, average cost is constant. Fixed costs are assumed to be zero.

A table with seven rows and two columns. The column headers are Price in dollars per Rainbow loom and Quantity demanded (Rainbow looms). The values in the second row are 17.50 dollars, 0. The values in the third row are 15 dollars, 12. The values in the fourth row are 12.50 dollars, 24. The values in the fifth row are 10 dollars, 36. The values in the sixth row are 7.5 dollars, 48. The values in the seventh row are 5 dollars, 60.

rQjDkAvG+7AMmzcZBNWubVWXTw0= Rainbow Looms would be produced under a Rainbow Loom monopoly.

2:17
Correct! The columns in the below table were calculated using the following formulas: Total revenue (TR) = P × Q and Marginal Revenue (MR) = ∆TR/∆Q. Profit increases from additional sales as long as MR > MC. From the table, this occurs at a quantity of 36, which is where profit would be maximized. Beyond 36 units, where MR < MC, profit would decline as seen in the "Change in Profit" column.

A table with seven rows and six columns. The column headers are Price in dollars per Rainbow loom, Quantity demanded (Rainbow looms), total revenue, marginal revenue, marginal cost, and change in profit. The values in the second row and the first, second and third columns are 17.50 dollars, 0, 0 dollars. Other cells in this row are empty. The values in the third row are 15 dollars, 12, 180 dollars, 15 dollars, 2.5 dollars, 12.5 dollars. The values in the fourth row are 12.50 dollars, 24, 300 dollars, 10 dollars, 2.5 dollars, 7.5 dollars. The values in the fifth row are 10 dollars, 36, 360 dollars, 5 dollars, 2.5 dollars, 2.5 dollars. This row is highlighted in yellow. The values in the sixth row are 7.5 dollars, 48, 360 dollars, 0 dollars, 2.5 dollars, minus 2.5 dollars. The values in the seventh row are 5 dollars, 60, 300 dollars, minus 5 dollars, 2.5 dollars, minus 7.5 dollars.
Sorry! Think about whether the quantity that you chose maximizes profit. To review how to determine the output that will maximize profit, please see the section “Cartels?"

Step 2

Question

If instead of a monopoly, a two-firm cartel controlled the Rainbow Loom market, each firm would want to produce bYQZi5Zmol1+FelNn8CeQDoRQMQ7dIPbi9asF1ECInNr2jgk Rainbow Looms in order to maximize industry profits.

Correct! If there is a two-firm cartel, they will attempt to act as a monopoly. In Question 1, we determined that the monopoly production level would be 36, so each member of the cartel would produce 18, or half the monopoly amount.
Sorry! Consider how the cartel would behave given that it is made up of the only two firms in the industry. To review how to determine the output that will maximize profit, please see the section “Cartels?”

Step 3

Question

It HiZqQd5Ha5flu2vmJsHnigNuJq59GO7Eaux5OQ== possible for one of the two firms in the cartel to earn higher profits by producing more than the industry profit-maximizing quantity calculated in Question 2.

3:43
Correct! If there is a two-firm cartel, one could attempt to cheat and produce more than the cartel amount of 18 per firm. Say that 1 firm cheats and produces 12 additional units so that total production is now 48. From the table, we can see that this would push the price down to $7.50. Prior to the firm cheating, each firm produced 18 units and total revenue was $360, so each firm's total revenue equaled $180. After the firm cheats, the total revenue for the cheating firm will be $225 ($7.50 × 30) with total costs of $75 ($2.50 × 30), leading to profits of $150 ($225 − $75). The firm that does not cheat earns total revenue of $135 ($7.50 × 18) with total costs of $45 ($2.50 × 18), leading to profits of $90 ($135 − $45). Thus the cheating firm's profit will rise and the non-cheating firm's profit will fall.

A table with seven rows and five columns. The column headers are Price in dollars per Rainbow loom, Quantity demanded (Rainbow looms), total revenue (the product of P and Q), total cost (the product of 2.50 dollars and Q), and profit. The values in the second row are 17.50 dollars, 0, 0 dollars, 0 dollars, 0 dollars. The values in the third row are 15 dollars, 12, 180 dollars, 30 dollars, 150 dollars. The values in the fourth row are 12.50 dollars, 24, 300 dollars, 60 dollars, 240 dollars. The values in the fifth row are 10 dollars, 36, 360 dollars, 90 dollars, 270 dollars. The values in the sixth row are 7.5 dollars, 48, 360 dollars, 120 dollars, 240 dollars. This row is highlighted in yellow. The values in the seventh row are 5 dollars, 60, 300 dollars, 150 dollars, 150 dollars.
Sorry! Think about whether there is an incentive to cheat on the industry profit maximizing level of production determined in Question 2. To review please see the section on "The Incentive to Cheat.”