Market Structures and Pricing Decisions Applied
Problems
Complete the following two applied problems:
Problem 1:
Robert’s New Way Vacuum Cleaner Company is a newly started small business that produces vacuum
cleaners and belongs to a monopolistically competitive market. Its demand curve for the product is
expressed as Q = 5000 – 25P where Q is the number of vacuum cleaners per year and P is in dollars.
Cost estimation processes have determined that the firm’s cost function is represented by TC = 1500 +
20Q + 0.02Q2.
Show all of your calculations and processes. Describe your answer for each question in complete
sentences, whenever it is necessary.
a. What are the profit-maximizing price and output levels? Explain them and calculate algebraically for
equilibrium P (price) and Q (output). Then, plot the MC (marginal cost), D (demand), and MR
(marginal revenue) curves graphically and illustrate the equilibrium point.
b. How much economic profit do you expect that Robert’s company will make in the first year?
c. Do you expect this economic profit level to continue in subsequent years? Why or why not?
Problem 2:
Greener Grass Company (GGC) competes with its main rival, Better Lawns and Gardens (BLG), in the
supply and installation of in-ground lawn watering systems in the wealthy western suburbs of a major
east-coast city. Last year, GGC’s price for the typical lawn system was $1,900 compared with BLG’s
price of $2,100. GGC installed 9,960 systems, or about 60% of total sales and BLG installed the rest.
(No doubt many additional systems were installed by do-it-yourself homeowners because the parts are
readily available at hardware stores.)
GGC has substantial excess capacity–it could easily install 25,000 systems annually, as it has all the
necessary equipment and can easily hire and train installers. Accordingly, GGC is considering
expansion into the eastern suburbs, where the homeowners are less wealthy. In past years, both GGC
and BLG have installed several hundred systems in the eastern suburbs but generally their sales
efforts are met with the response that the systems are too expensive. GGC has hired you to
recommend a pricing strategy for both the western and eastern suburb markets for this coming season.
You have estimated two distinct demand functions, as follows:
Qw =2100 – 6.25Pgw + 3Pbw + 2100Ag – 1500Ab + 0.2Yw
for the western market and
Qe = 36620 – 25Pge + 7Pbe + 1180Ag – 950Ab + 0.085Ye
for the eastern market, where Q refers to the number of units sold; P refers to price level; A refers to
advertising budgets of the firms (in millions); Y refers to average disposable income levels of the
potential customers; the subscripts w and e refer to the western and eastern markets, respectively; and
the subscripts g and b refer to GGC and BLG, respectively. GGC expects to spend $1.5 million (use Ag
= 1.5) on advertising this coming year and expects BLG to spend $1.2 million (use Ab = 1.2) on
advertising. The average household disposable income is $60,000 in the western suburbs and $30,000
in the eastern suburbs. GGC does not expect BLG to change its price from last year because it has
already distributed its glossy brochures (with the $2,100 price stated) in both suburbs, and its TV
commercial has already been produced. GGC’s cost structure has been estimated as TVC = 750Q +
0.005Q2, where Q represents single lawn watering systems.
Show all of your calculations and processes. Describe your answer for each item below in complete
sentences, whenever it is necessary.
a. Derive the demand curves for GGC’s product in each market.
b. Derive GGC’s marginal revenue (MR) and marginal cost (MC) curves in each market. Show
graphically GGC’s demand, MR, and MC curves for each market.
c. Derive algebraically the quantities that should be produced and sold, and the prices that should be
charged, in each market.
d. Calculate the price elasticities of demand in each market and discuss these in relation to the prices
to be charged in each market.
e. Add a short note to GGC management outlining any reservations and qualifications you may have
concerning your price recommendations.
