Question

1. Suppose two of the parts Company X produces are Widgets and Gadgets. Each has a marginal cost of $50. Widgets has a price elasticity of 2 and Gadgets has a price elasticity of 4, both in absolute value terms. Compute the profit maximizing prices of both Widgets and Gadgets, and show your work.

2. (8 points) If the Widgets Market experiences entry of competitors,

1. would you predict any change in price elasticity of Widgets? If so, in which direction, and why?

2. would you expect Company X to increase or lower prices for Widgets? Why?

c. (4 points) Company X plans to invest in lean production methods that are anticipated to improve labor productivity. What impact would this likely have on marginal cost? What impact would this likely have on pricing? Explain.

Answer 1

Price of widget:-

MC/1-1/e

50/1-1/2

=50/0.5

=100

Price of Gadgets:-

50/1-1/4

50/0.75

=66.7

i) Yes, demand curve will shift to right because of price reduction.

Entry of many new firms causes the market supply curve to shift to the right. As the supply curve shifts to the right, the market price starts decreasing, and with that, economic profits fall for new and existing firms. As long as there are still profits in the market  entry will continue to shift supply to the right.

c) An improvememt in labour productivity will cause an increase in both price and marginal cost.