There are 2 firms to consider here from 2 different industries. A firm in Indust
ID: 1196194 • Letter: T
Question
There are 2 firms to consider here from 2 different industries.
A firm in Industry A has MC of production = $150 and they know from historical experience that their Lerner index is 0.35.
A firm in Industry B has MC of production = $25 and they know from historical experience that their Lerner index is 0.6.
a. Determine the optimal price that both firms should be charging.
b. Articulate which firm is more likely to earn ‘excess profits’ in the long run…and explain why this is your answer using your understanding of the connection between the Lerner index and industry concentration.
Explanation / Answer
Lerner Index = (P-MC)/P
a)
Industry A
0.35 = (P-150)/P
P* = 230.7
Industry B
0.6 = (P-25)/P
P* = 62.50
b)
A lower lerner index is related to elastic demand while a high lerner index is related to inelastic demand
Thus, a high value of lerner index represents market power and high profits.
Thus, Firm B (LI = 0.6) will earn high profits because of high market power
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