There are 2firms to consider here from 2 different indusrties. A firm in Indusrt
ID: 1209735 • Letter: T
Question
There are 2firms to consider here from 2 different indusrties. A firm in Indusrty 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 thet their Lerner index is 0.6
c.Determine the optmal price that both firms should be charging.
d.Articulate which firm is more likely to earn 'excess profits' in the ling run... and explain why this is your answer using your understanding of the connection between the Lerner index and industry concentration.
Explanation / Answer
(c) Lerner Index = (P - MC) / P
Industry A: 0.35 = (P - 150) / P
0.35P = P - 150
0.65P = 150
P = 230.77
Industry B: (P - 25) / 0.6 = P
0.6P = P - 25
0.4P = 25
P = 62.5
(d) Optimal mark-up = (P - MC) / P
Industry A: (230.77 - 150) / 150 = 80.77 / 150 = 0.5385, or 53.85%
Industry B: (62.5 - 25) / 25 = 37.5 / 25 = 1.5 or 150%
Since industry B ahs a much higher markup over cost, it is likely to earn long run excess profit.
This is because, elasticity is higher in industry A than in industry B (Since LI = 1 / Price elasticity, we get price elasticity = 1 / LI, therefore industry with lower LI has higher elasticity). This indicates higher market concentration on A than in B, and so a firm in B is likely to earn higher excess profit.
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