Essentials of Economics
Essentials of Economics
4th Edition
ISBN: 9781464186653
Author: Paul Krugman, Robin Wells
Publisher: Worth Publishers
Question
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Chapter 9, Problem 2P
To determine

Concept Introduction:

Cartel: In order to eliminate competition; manufacturers or suppliers, or an association creates a formal agreement to earn profits, by manipulating prices.

Total Revenue: It refers to the total receipts received by selling a given quantity of goods or services; it is also known as the total income of a business or a firm. The formula to calculate the total revenue is:

    Essentials of Economics, Chapter 9, Problem 2P , additional homework tip  1

Here,

  • P is the price of a commodity.
  • Q is the quantity of the commodity.

Marginal Revenue: It refers to the additional revenue gained by producing one additional unit of a product or service. The formula to calculate the marginal revenue is:

    Essentials of Economics, Chapter 9, Problem 2P , additional homework tip  2

Here,

  • Essentials of Economics, Chapter 9, Problem 2P , additional homework tip  3is the change in Total Revenue
  • Essentials of Economics, Chapter 9, Problem 2P , additional homework tip  4is the change in Quantity of that commodity.

Expert Solution & Answer
Check Mark

Explanation of Solution

a. Calculation of total revenue and marginal revenue.

    Price of Olive oil (per gallon)($)(A)Quantity of olive oil demanded (gallon)(B)Change in Quantity(C)Total Revenue($)Essentials of Economics, Chapter 9, Problem 2P , additional homework tip  5Change in Total Revenue(D)Marginal RevenueEssentials of Economics, Chapter 9, Problem 2P , additional homework tip  6
    100 1,000 - 100,000 - -
    90 1,500 500 135,000 35,000 70
    80 2,000 500 160,000 25,000 50
    70 2,500 500 175,000 15,000 30
    60 3,000 500 180,000 5,000 10
    50 3,500 500 175,000 -5,000 -10
    40 4,000 500 160,000 -15,000 -30
    30 4,500 500 135,000 -25,000 -50
    20 5,000 500 100,000 -35,000 -70
    10 5,500 500 55,000 -45,000 -90
  • As the cartel acts like a monopolist, it will maximize profits at a point where the marginal revenue is equal to or more than the marginal cost, which is $40 per gallon.
  • For all gallons up to 2,000 gallons, the marginal revenue is greater than the marginal cost.
  • Therefore, the cartel will produce 2,000 gallons at a per gallon price.
  • As there are two families sharing the market equally, therefore each family will have a revenue ofEssentials of Economics, Chapter 9, Problem 2P , additional homework tip  7

  • The cost of producing 1000 gallons isEssentials of Economics, Chapter 9, Problem 2P , additional homework tip  8

Conclusion:

Thus, each family makes a profit of $40,000Essentials of Economics, Chapter 9, Problem 2P , additional homework tip  9

b. Effect on the price of olive oil and the profit of each family.

  • If the Sopranos family sells 500 more gallons of oil after breaking the cartel agreement, then the total quantity of oil will increase to 2,500 from 2,000. As a result, the price of olive oil will fall to $70 from $80 per gallon.
  • The Sopranos family has earned a revenue of $105,000 Essentials of Economics, Chapter 9, Problem 2P , additional homework tip  10and cost of $60,000Essentials of Economics, Chapter 9, Problem 2P , additional homework tip  11

  • Similarly, Contraltos have earned a revenue of $70,000 Essentials of Economics, Chapter 9, Problem 2P , additional homework tip  12and cost of $40,000Essentials of Economics, Chapter 9, Problem 2P , additional homework tip  13

  • Profit for Sopranos family will be calculated by subtracting the total cost from the total revenue, which is $45,000 Essentials of Economics, Chapter 9, Problem 2P , additional homework tip  14and profit for Contraltos family will be $30,000Essentials of Economics, Chapter 9, Problem 2P , additional homework tip  15

Conclusion:

Thus, the profit for Sopranos family is $45,000 and profit for Contraltos family is $30,000.

c. Profit earned by each family.

  • If the Contraltos also break the cartel agreement and sell 500 more gallons of oil then this will increase to 3,000 from 2,000 gallons.
  • Therefore, the price of an olive oil falls to $60 from $80 per gallon.

Conclusion:

Thus, each family has earned a revenue of $90,000 and cost of $60,000 and hence, the profit is $30,000.

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