Question

producer of good Q signs an attractive contract with Walmart, such that Walmart will purchase any amount of good Q up to a maximum of 1 million units at price P1 = $100 per unit. The producer of good Q can also sell any number of units in the open market at the “market price” of P2 = $70 per unit. The producer of good Q has marginal cost that increases as more is produced. Assume that the producer of good Q is better off producing than shutting down. There are three possibilities for the profit maximum, depending on the character of the seller’s costs. Either the firm will produce: (i) Q* < 1 million; (ii) Q* = 1 million; or (iii) Q* > 1 million. The question is to clarify the circumstances under which each of the three possibilities would be profit maximizing. (Drawing the right graph(s) with associated explanation is one nice way to answer this question.)

Answer 1