HELLENIC OPEN UNIVERSITY

SCHOOL OF SOCIAL SCIENCES

MASTERS DEGREE PROGRAMME IN BUSINESS ADMINISTRATION
Module: MBA50
Academic Year: 2014-15
1st Written Assignment (WA1)

Question 1
Chapter 4: Theory of Production and Costs
In the city of Chania the market of taxi services is competitive with block entry. Any individual can
provide taxi service as long as his cab and his driving skills satisfy certain safety standards. The
marginal cost of a taxi ride is MC = 5 euros whereas each cab has a capacity of 20 trips per day. The
demand function for taxi services (i.e., trips per day) in the city is given by Q0 = 1,200 20 p . Using
these, please answer the following (Hint: assume that all drivers operate at full capacity 20 trips per day
for 365 days per year):

a. Find the equilibrium price per trip, the supply of trips per dayand how many taxicabs will be in
the city. (Mark: 0.6)
b. Suddenly the City Council introduced a licensing scheme for each one of the existing taxicabs
(each owner is entitled with a license for his cab). At the same time the demand for taxi services
changed to Q1 = 1,220 20 p . What would be the new equilibrium price per trip and the profits
per day for the owners (Mark: 0.6)
c. If there is a free entry in the market of taxi operators what is the equilibrium rental price (i.e.,
the amount that makes a taxi driver indifferent between working his cab or renting it to

someone
else) for a license for a year (Hint: assume that the number of licenses remains the
same.)? (Mark: 0.65)
d. Suppose that the City Council wants to bring the price to its initial equilibrium value. How
many licenses would this take? (Mark: 0.65)

Indicative Answer
a. In the taxi services barriers to entry dont imply monopoly as they do not give to taxi drivers the
ability to charge a price above the competitive level. At equilibrium it holds p = MC so price
would be 5 euros per trip. The number of trips per day is obtained from
Q0 = 1,200 20 p = 1,200 20 5 = 1,100 . Since each driver supplies 20 trips per day there are
1,100
= 55 taxis in the city.

20
b. Since the supply of trips per day remained unchanged the new equilibrium price is given from:
Q1 = S 1,220 20 p = 1,100 120 = 20 p p = 6 . The profits per trip for the owner are
t = p MC t = 6 5 = 1 euro. Accordingly, the profits per day are d = 20 t = 20 euros.
c. The annual equilibrium rental price for a license would be equal with the profits earned by the
taxi owner per year. Using (b) annual profits for taxi owners would be y = 365 d = 7,300
euros.

HELLENIC OPEN UNIVERSITY

SCHOOL OF SOCIAL SCIENCES
MASTERS DEGREE PROGRAMME IN BUSINESS ADMINISTRATION
d. The number of trips per day assuming the initial equilibrium price would be Q1 = 1,220 20 p
Q1 = 1,220 20 5 Q1 = 1,120 . Hence, in order to maintain the same price under the new
1,120
demand conditions requires
= 56 taxicabs in the city.
20

Question 2
Chapter 3: Demand and Supply Shifters

You read the following article in the financial pages of your newspaper:
In 2010 the market price for a nutrient crop was 5 per bushel and 4 million bushels were sold. In
2011 there was a scare over the possibility of the crop in question being contaminated? The price
dropped to 4.5 and 2.5 million bushels were sold. In 2012 the scare was over as the media reported
that the initial reports about the contamination were a hoax. However, flooding in areas producing the
crop in question has destroyed a significant proportion of the crops production. The market price
increased to 8 per bushel and 3.5 million bushels were sold.
Find the linear demand (Mark 1.25) and supply curves (Mark 1.25) for the year 2010 which are
consistent with the above information (Hint: as result of the contamination threat being a hoax the
demand curve in 2012 reassumes its 2010 position. We also talk about normal goods.)
Indicative Answer

The contamination scare shifts the demand curve to the left. It is this shift that allows us to calculate the
slope of the supply curve, provided that the latter has not shifted. The unknown linear supply should be
of the form QS = a + bP . Two points on the supply curve are (4,5) and (2.5,4.5). The first refers to
2010 quantity and price, respectively, and the second to the corresponding 2011 ones. Hence,
QS 2.5 4 1.5
b=
=
=
= 3 . The demand curve in 2012 reassumes its 2010 position. This implies
P
4.5 5 0.5

that one point of the demand curve should be (4,5). In 2012 the flooding has caused the supply curve
to shift to the left. This allows us to calculate the slope of the demand curve equation. In 2012 the price
is 8 and the quantity 3.5 million bushels. So another point on the demand curve should be (3.5,8). The
QD 3.5 4
0.5
demand curve equation should be of the form QD = c dP . Therefore, d =
=
=
P
8 5
3
1
1
= So far we found that QS = a + 3P and QD = c P . We then need to identify parameters a and
6
6
c. Taking the supply equation first, this
should
be
satisfied by two quantity-price combinations:

Q
(2.5,4.5) and (4,5). Therefore, a = 2.5 3X 4.5 = 4 3X5 = 11 and
S(2010) = 11+ 3P . Turning to the
demand equation,this should be satisfied by the following quantity-price combinations: (4,5) and

1
1
29
29 1
(3.5,8). So, it holds, b = 4 + X5 = 3.5 + X8 =
and QD(2010) =
P . All the above changes are
6
6
6
6 6

depicted in the following graph:

HELLENIC OPEN UNIVERSITY

SCHOOL OF SOCIAL SCIENCES
MASTERS DEGREE PROGRAMME IN BUSINESS ADMINISTRATION

Question 3
Chapter 5: Market Structure
James Harden is the owner of a metal producing firm that is an unregulated monopoly. The marketing
and production departments, after considerable experimentation and research, has informed him that
the demand curve faced by the firm is given by Q = 50 p . They also suggest two alternative
technologies to produce firms final product: (i) the existing one which implies the following cost
function TC = 4Q2 +10Q + 400 and, (ii) a recently developed technology with the following cost
structure: TC = Q2 +10Q + 50 . Please answer the following for both cost scenarios:

a. How much will the firm produce to maximize its profits? (Mark: 0.6)
b. What price will it charge? (Mark: 0.6)

c. What is the firms profit at this price and quantity? (Mark: 0.65)

d. Will it continue to operate at that level of profit? Explain why or why not. (Mark: 0.65)
Indicative Answer
The inverse demand curve is p = 50 Q, total revenue is TR = 50Q Q2 and marginal revenue is
MR = 50 2Q . In both cases monopolist maximizes profits at MR=MC.
(i) First Case: TC = 4Q2 +10Q + 400

TC
a. The marginal cost is MC =
= 8Q +10 . In equilibrium it should holds that MR = MC
Q
50 2Q = 8Q +10 Q = 4
b. Using the inverse demand function the equilibrium price is p = 50 4 = 46 euros.

HELLENIC OPEN UNIVERSITY

SCHOOL OF SOCIAL SCIENCES
MASTERS DEGREE PROGRAMME IN BUSINESS ADMINISTRATION
c. Therefore profits are = pQ TC = 46 4 ( 4 4 2 +10 4 + 400) = 320 euros.
d. Profits are negative and thus the monopolist might want to shut down his operation, that is, to
produce Q=0. However, in this case he will still incur a fixed cost of 400 euros. Since this loss
is greater than
the loss suffered from operation (-320 euros) he will not shut down his business.
(ii) Second Case: TC = Q2 +10Q + 50
a. Firms marginal cost is MC =

TC
= 2Q +10 . Again it should holds that MR = MC
Q

50 2Q = 2Q +10 Q = 10

b. Using the inverse demand function p = 50 10 = 40 euros.

2

c. Profits are given by

= pQ TC = 40 10 (10 +10 10 + 50) = 150 euros.
d. Yes since profits are positive.

Question 4
Chapter 4: Cournot Oligopoly

The international market of microchips is dominated by two firms, one based in the US and another
based in Japan. The two firms compete la Cournot, and for simplicity, assume they are the only firms
in the market. The international demand for microchips is
, where
is the
total quantity, and the price of microchips expressed in $US. The two companies buy resources from
their respective country. The marginal cost of the US company is $US 60; the marginal cost of the
Japanese company is also $US 60.
a. Find the reaction functions of the two competitors and draw them on a single diagram. (Mark:
1.0)
b. Find the two firms quantities, the market price and their profits in equilibrium (Mark: 0.9)
c. An important drop of the Japanese labor costs, reduces the marginal cost of the Japanese firm to
$US per unit. The marginal cost of the American firm remains $US 60 per unit of
output. Repeat a) and b) above. On your diagram indicate the new position of the Japanese
firms reaction function. (Mark: 0.4)
d. Calculate the market share of the Japanese firm in the new equilibrium and compare that firms
market share before the change of the marginal cost. What is your conclusion about the relation
between cost advantage and market share? (Mark: 0.2)
Indicative Answer
a. The reaction function of the American firm is
,

(1)

and since the two firms have the same marginal cost the reaction function of the Japanese firm
in $US is exactly similar to that of the American firm (symmetric Cournot).

HELLENIC OPEN UNIVERSITY

SCHOOL OF SOCIAL SCIENCES
MASTERS DEGREE PROGRAMME IN BUSINESS ADMINISTRATION
b. Straightforward calculation show

, and the profits of the two

firms
. (The equilibrium is obtained after solving a system of two
equationsequation (1) and its symmetric expression for the Japanese firmin two unknowns.
Symmetry, however, offers an easy way to do it: since we know that in equilibrium both firms
produce the same amount
, we can replace in (1) both
, by
and solve.
This is a shortcut not available in asymmetric cases (i.e., where firms have different marginal
cost) like case c. below)
c. After the change, the reaction function of the American firm remains unaffected, while that of
the Japanese firm becomes:
.

(2)

Compared to the previous case it has moved outwards since its intercept has increased (from 10
to 11.5). The aforementioned shortcut cannot be used in this case, therefore we must
C
C
= 5.67 , q! CJa = 8.67 , P! C = 71.33 , US
= 64.18 , and
simultaneously solve (1) and (2) to obtain q!US
C
! Ja
= 150.22
d. From the above we see that if a firms MC is reduced while the other firms MC remains
constant, the former expands while the second contracts its output relative to the symmetric
q! C
8.67
case. The market share of the Japanese firm is now C Ja C =
= 0.605 . From 50%q!US + q! Ja 5.67 + 8.67
50% when no firm had cost advantage, when Japan became cheaper, market shares turned to be
(approximately) 40%-60%. Hence, the firm that has cost advantage obtains a greater market
share in equilibrium than its rival.
The situation is depicted on the following diagram where the red line represents the reaction
function of the American firm, and the blue and magenta lines represent the reaction function of
the Japanese firm, before and after the change in its cost, respectively.

HELLENIC OPEN UNIVERSITY

SCHOOL OF SOCIAL SCIENCES
MASTERS DEGREE PROGRAMME IN BUSINESS ADMINISTRATION

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