1) Lentz\'s, Incorporated sells paper in a perfectly competitive market at a pri
ID: 451366 • Letter: 1
Question
1) Lentz's, Incorporated sells paper in a perfectly competitive market at a price of $2 per ream. At the profit-maximizing (cost-minimizing) level of output, average total cost is $2.50 per ream and average variable cost is $1.95 per ream. Should the firm continue to operate in the short run? Explain.
2) Suppose the widget industry is perfectly competitive. A monopoly purchases all widget producers in the market. List three ways in which the market outcome under monopoly will differ from the market outcome under perfect competition.
3) Why do existing firms earn smaller profits as new firms enter an industry?
4) Consider the decision tree depicted in Figure 12.4 concerning a collusive agreement between firms owned by Bob and Donna. Each participant has the option of following the terms of the agreement or cheating on the terms of the agreement, but neither knows what the other will do. What is the dominant strategy for Bob? For Donna? Which strategy should player, Bob and Donna, choose to maximize the potential gain? What do you think the outcome of this game will be? Carefully explain your answers.
Explanation / Answer
1. Yes. The profit would be very marginal as the average variable cost itself is $1.95 which is very much close to $2.00 per ream. General market cost is $2.50 as well. So to beat the competition and to penetrate the market , they can use $2.00 per ream for a short run to accelerate through economies of scale ( maximise the quantity of sales).
2.Market coming from monopoly will be a stable seller market as buyers don’t have any advantage by getting the products at lower price. Seller, being the only player the company has the privilege to decide the price of the product. But in market of perfect competition it can become a buyer side market as many players are there so definitely price war would be there. In monopoly market scarcity of goods can happen many times as there is only one player and their strategy remains same But in perfect competition the buyer will rely on different strategy so goods can be surplus in market. Monopoly market is not subjected to change with economic condition while perfect markets are very much sensitive to economic, social and political environment.
3.Its because of in depth analysis of market condition by new player as they want to penetrate the market. So in order to beat the market they will come up with fresh ideas and attractive offers. So customers most probably inclined to new player as they will sell the product at lower prices as introductory offer. Demand will fluctuate as Bullwhip effects will be more because of new players. Surplus goods might get produced without analysing the proper or actual demand. This leads to low profit condition for existing players.
4. Bobs dominant strategy will be Cheat on Agreement. He could able to receive more profit through cheat on agreement ( 16,000 or 4,000).
Both should be on Stand by agreement to maximise the profit ( 10,000 & 10,000).
The outcome of the game will be both will favour to Standy by agreement as there is a win-win situation for both of them and has the maximum profit potential.
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