# Luigi decides to start a new business. In his business, he takes in old vintage VHC discs and remasters them into 4K Blu-ray versions and puts them for sale. This process requires a building and a machine that copies the original VHC disc onto a Blu-ray. The cost to rent a machine is \$20,000 a month and rent for the building is \$30,000 a month.

Problem Set #3

1. Luigi decides to start a new business. In his business, he takes in old vintage VHC discs and remasters them into 4K Blu-ray versions and puts them for sale. This process requires a building and a machine that copies the original VHC disc onto a Blu-ray. The cost to rent a machine is \$20,000 a month and rent for the building is \$30,000 a month. Here is his variable cost information:
(a) What is Luigi’s average variable cost, average fixed cost, average total cost, and marginal cost for each quantity of output? Show using a table.
(b) Luigi realizes the market is tough, i.e., the competition he is facing from other producers is intense. He notices there are hundreds of other producers doing the same business, trying to meet the demand coming from the consumers who eagerly wait for new 4K releases of their most favorite classics. Luigi thinks having free entry in this business (e.g. no special license tax to remaster movies) is a contributor for seeing that many firms operating in the market. Suppose that currently the price of a 4K Blu-ray movie is \$28. What will Luigi’s profit be? Is this the long-run profit level? If not, what will the price of 4K Blu-ray movies be in the long run? (Hint: In the long-run, efficiency is achieved.)
(c) What is Luigi’s break-even price? What is his shut-down price?
(d) Suppose the price of a 4K Blu-ray movie is \$2. Should Luigi worry? What should Luigi do in the short run?
(e) Suppose the price of a 4K Blu-ray is \$7. What is the profit-maximizing quantity of Blu-rays that Luigi should produce? What will his total profit be? Will he produce or shut down in the short run? Will he stay in the industry or exit in the long run?
(f) Suppose instead that the price of 4K Blu-rays is \$20. Now what is the profit-maximizing quantity of Blu-rays that Luigi should produce? What will his total profit be now? Will he produce or shut down in the short run? Will he stay in the industry or exit in the long
run?
(g) Draw Luigi’s marginal cost curve. In your graph, plot the price range from \$0 to \$60 in increments of \$10.
(h) Over what range of prices will Luigi produce no 4K Blu-rays in the short run?
(i) Draw Luigi’s individual supply curve.

2. You have worked for many years in New York City as an entrepreneur. You decide to move to Santa Barbara for its sunny and mild weather, and the beautiful ocean. You consider opening up a pizza shop, a juice bar, or a dry cleaner around the area. In order to decide on which business to invest, you decide to conduct a market analysis. You start from analyzing the market for dry cleaning in Santa Barbara, Goleta, and Carpinteria. You collect data on the dry cleaners currently operating in the market and find how much they charge for dry cleaning a men’s shirt.
(a) First you want to identify in which city the dry cleaners can charge the highest prices. For this, you decide to calculate the average price of dry cleaning a shirt in each city. What is the average price in each city? (Hint: An average is calculated by summing each values and dividing by the total number of values.)
(b) You notice the prices are high enough that firms can make positive profit in the short run. Draw a typical cost diagram showing marginal cost and average total cost curves for a specific store you are interested in buying: King’s Cleaners which is located in Goleta.
Show the short-run equilibrium production level and shade the area that corresponds to the profit made by King’s Cleaners.
(c) Assume \$2.25 is the short-run equilibrium price in Goleta. Draw a typical short-run demand and supply curve for the market in Goleta. Label the equilibrium point.
(d) Congratulations! You have just purchased King’s Cleaners and enjoyed a year with positive profits. During this year, potential investors took notice in the profits in the Goleta area.
You have learned that an entrepreneur opened up a new dry cleaner called Can’t Touch This Cleaners. It charges \$1.95 per shirt. What is the new average price of dry cleaning a shirt in Goleta now? Illustrate the effect of entry on the average Goleta price by a shift of the short-run supply curve, the demand curve, or both. (Hint: To find the new market equilibrium price, you should calculate the new average price with Can’t Touch This Cleaners in the market.)
(e) Assume that your dry cleaner store now charges the new average price and just breaks even (that is, makes zero economic profit) at this price. Show the likely effect of the entry on your diagram in part b.
(f) After many years operating with zero profits (although zero economic profit covers your opportunity cost of \$1 million a year operating a pizza shop!) you notice that long-run going prices in Goleta are somewhat higher than the long-run prices in Santa Barbara. What does this average difference in prices between Goleta and Santa Barbara imply about costs
in the two cities?
3. Sunshine Records discovers a very talented band: the Strawberries. Assume that producing an album does not have any fixed costs. However Sunshine Records has to pay the band a flat \$6 fee per album sold. Assume that Sunshine Records is a monopolist. Its marketing division finds the demand schedule for the album as shown in the following table.

(a) Calculate the total revenue and the marginal revenue per album for Sunshine Records.
(Hint: You can use the table above and create two new columns for total revenue and marginal revenue.)
(b) The marginal cost of producing each album is constant at \$6. To maximize profit, what level of output should Download Records choose, and which price should it charge for each album?
(c) The Strawberries renegotiates their contract and will be paid a higher royalty per album.
So the marginal cost rises to be constant at \$14. To maximize profit, what level of output should Sunshine Records now choose, and which price should it charge for each album?
4. Here is a diagram for a Monopolist’s MC and MR curve, along with the demand curve the Monopolist faces from the consumers. Use the letters on the diagram to answer the following.
(a) If the industry was perfectly competitive, what would the price have been? How many units would have been produced?
(b) However the industry is not perfectly competitive, in fact there is only one producer. What quantity will the monopolist produce? What price will it charge?