Question

I got 1 but can't answer 2 and 3.

Barnacle Industries was awarded a patent over 15 years ago for a unique industrial strength cleaner that removes barnacles and other particles from the hulls of ships. Thanks to its monopoly position, Barnacle has earned more than $160 million over the past decade. Its customers—spanning the gamut from cruise lines to freighters—use the product because it reduces their fuel bills. The annual (inverse) demand function for Barnacle’s product is given by P = 380 -0.00009Q, and Barnacle’s cost function is given by C(Q) = 280Q. Thanks to subsidies stemming from an energy bill passed by Congress nearly two decades ago, Barnacle does not have any fixed costs: The federal government essentially pays for the plant and capital equipment required to make this energy-saving product.

Absent this subsidy, Barnacle’s fixed costs would be about $9 million annually. Knowing that the company’s patent will soon expire, Marge, Barnacle’s manager, is concerned that entrants will qualify for the subsidy, enter the market, and produce a perfect substitute at an identical cost. With interest rates at 6 percent, Marge is considering a limit-pricing strategy.

1. What would Barnacle's profits be if Marge pursues a limit-pricing strategy if the subsidy is in place? = $ 0

2. What would Barnacle's profits be if Marge convinces the government to eliminate the subsidy?

3. What would be the profit of a new entrant if the subsidy is eliminated and Barnacle continues to produce the monopoly level of output?

Answer 1

Answer :-

If Barnacle excercisses Limit Pricing:

First lets calculate Profit maximizing price as follows-

P = 320 -0.0005Q and C = 180Q thus MC = dC/dQ = 180

TR = P*Q =320Q -0.0005Q²

MR = dTR/dQ = 320-0.0010Q

Equating MR and MC

320-0.0010Q = 180

Q = 140000 = 140000

And P= 320-0.0005(140000) = $250

And Profit = TR - TC = 140000*250 - 180*140000 = $9800000

And average cost = TC/Q = 180

Thus to excercise limit pricing, the company will charge price below AC that would be $180 or lower to $180.

At this level of price, the firm will not earn any supernormal profit.

If The company convince government to eliminate subsidy, it will have to bear fixed cost as well.

Thus new TC = 180Q + 6000000

New Profit = TR - TC = 180(140000) + 6000000 - 140000*250 = -$3800000

Eliminating subsidy and continuing is more profitable stratgey.