I need to solve this, and have no idea how to do it. Thanks in advance for your help!!
Entry and Technological Change
Let’s assume that the monthly demand curve for bread is given by
P = 15 -
Suppose the two main costs involved in this business are (1) a fixed cost of leasing baking
equipment, and (2) variable costs related to raw materials — flour, yeast, water, etc.
Let the fixed cost of leasing baking equipment be $8000 per month. Let the marginal cost of
producing a loaf of bread be $1. (Assume that all firms in this market lease all their equipment
on a month-to-month basis.)
(a) Suppose there are two firms in this market. Compute equilibrium quantities and profits
for each firm, and the equilibrium market price. Hint: Start with thinking about the
number of loaves a firm will sell in a month — this quantity must be where its marginal
revenue is equal to its marginal cost. But notice that firm 1’s marginal revenue will
depend on firm 2’s quantity choice, and vice versa. To construct a spreadsheet, start by
constructing a formula for firm 1’s marginal revenue as a function of its quantity choice
and firm 2’s quantity choice. If firm 1 is making 1000 loaves and firm 2 is also making 1000
loaves, then firm 1’s marginal revenue is how its revenue changes if it increases quantity
by one, assuming firm 2 keeps its quantity at 1000. Do the same firm firm 2, and then
use Solver to find quantities where MR = MC for both firms.
(b) Should a third bread firm enter?
(c) A fourth firm? A fifth? Compute the equilibrium number of bread-baking firms in this
market, the equilibrium price of a loaf, and the number of loaves baked by each firm in a
(d) Suppose the price of leasing bread equipment falls to $7,000 per month. Compute the
equilibrum number of bread-baking firms in this market, the equilibrium price of a loaf,
and the number of loaves baked by each firm in a month. Compare the price of bread to
your answer in (c) — do fixed costs affect prices? If so, how and why?
(e) Return to the assumption that the monthly price to lease bread equipment is $8,000, and
suppose the current market equilibrium is the same as what you computed in (c). A Bread
Institute scientist develops a new method — which he calls the “Inbreadible!” technique
— for baking bread. The good news is that the Inbreadible! method makes much more
effective use of bread ingredients — the marginal cost of producing a loaf of bread drops
to 10 cents when using the new technique. The bad news is that the Inbreadible! method
requires a lot of new bread-making equipment — the monthly leasing cost for Inbreadible!
equipment is currently around $18,000. The scientist is hard at work trying to improve
his method to reduce this large fixed cost.
The scientist hires you to help with market planning. His main question is this: “How
low do my fixed costs need to be before I am certain that I’ll be able to enter this market
(f) Suppose the scientist succeeds at reducing the Inbreadible! fixed cost to $14,000. Should
he enter? (The right answer is “maybe.” Your job is to explain why.)