The market demand curve in the cotton industry in Australia is given by QD = 160
ID: 1156331 • Letter: T
Question
The market demand curve in the cotton industry in Australia is given by QD = 160 - 2P. Suppose this industry is monopoly with a constant marginal cost of $20 per unit.
a) Assume that the monopolist can engage in first-degree price discrimination. Calculate producer surplus and deadweight loss. Demonstrate the results on a graph.
b) Now assume that the monopolist can engage in second-degree price discrimination (instead of first-degree price discrimination). More specifically, it charges $60 for the first 40 units, then $40 for any additional unit. Calculate producer surplus, consumer surplus, and deadweight loss.
c) Now assume that this cotton industry is dominated by a large firm with a constant marginal cost of $40 per unit, and this firm does not practice price discrimination. There also exists a competitive fringe of 25 firms, each of which has a marginal cost given by MC = 50 + 25q, where q is the output of a typical fringe firm. Suppose the market demand curve for cotton is still the same as above. Derive the equation of the supply curve for the competitive fringe, and the equation of the dominant firm’s residual demand curve.
d) Continue from part (c), what is the profit-maximizing quantity of the dominant firm? What is the resulting market price? At this price, how much does the competitive fringe produce, and what is the fringe’s market share? What is the dominant firm’s market share?
Explanation / Answer
Business manages its risk either all together or separately. Enterprise risk management helps business to manage its risk in cohesive manner.
The process of setting ERM framework requires identifying the risk of the firm and developing a consistent method to assess the exposure of the firm’s risk.
Firm wide VaR analysis should be performed. The proper culmination of three risks broadly i.e. Market risk, credit risk and operational risk should be aggregated. The risk aggregation captures the risk interaction between all three risks and helps appropriately determine the risk capital requirements.
ERM framework helps business determine following:
1) Business should be able to define its total acceptable risk and risk tolerance
2) Taking risk into the view the firm should determine its capital buffer that would require to stand against the risk associated with business
3) Capital buffer should be well defined because that plays major role in rating of the firm
4) Desired or targeted firm’s debt rating is achieved when proper mixture of risk and capital is appropriately done
5) Managers at different decentralized nodes should be given incentives for maintaining risk and capital trade off
Economic capital of the firm should be employed to earn appropriate return so that investor’s interest is protected. Firm should avoid to take such projects which multiplies the risk of the firm or bring firm to financial distress.
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