Central Crude Oil is a crude oil monopoly in a market. The following table shows the liner demand schedule of this firm which cannot apply price discrimination. The firm's fixed cost is $2000 per month and its marginal cost is a constant of $20 per thousand of cubic feet.
Price (dollar per thousand cubic feet)
180 140 100 60 20
Quantity(thousands of cubic feet per month)
0 20 40 60 80
(a) Draw the demand curve faced by Central Crude Oil and the marginal revenue curve, as well as its marginal cost and average total cost curves.
(b) Is Central Crude Oil a natural monopoly? Why or why not?
(c) What are the firm's profit-maximizing output and price? What is the firm's economic profit per month?
I have already drawn the demand curve and marginal revenue curve, and I have no idea. about ''marginal cost and average total cost curve.'' ''Its marginal cost is a constant of $20 per thousand of cubic feet'' mentioned above confused me a lot.
I really want to know the solutions of question (a),(b),(c).
Thanks for your help!
(a) To draw the demand curve faced by Central Crude Oil, plot the given price and quantity data on a graph. The price is represented on the vertical axis, and the quantity is represented on the horizontal axis. Connect the data points to obtain the demand curve.
Demand Curve:
Price: 180 140 100 60 20
Quantity: 0 20 40 60 80
Next, the marginal revenue curve can be derived from the demand curve. Since Central Crude Oil cannot apply price discrimination, the marginal revenue is equal to the price for each quantity.
Marginal Revenue Curve:
Price: 180 140 100 60 20
For the marginal cost and average total cost curves, we need to calculate the marginal cost and average total cost for each quantity.
Marginal Cost (MC):
Since the marginal cost is given as a constant of $20 per thousand cubic feet, the marginal cost for each quantity is $20.
Marginal Cost Curve:
Marginal Cost: $20 $20 $20 $20 $20
Average Total Cost (ATC):
To find the average total cost for each quantity, we need to calculate the total cost for each quantity and then divide it by the corresponding quantity.
Total Cost (TC):
The total cost for each quantity is the sum of the fixed cost ($2000) and the variable cost (marginal cost multiplied by the quantity).
Total Cost: $2000 + (20 x Q)
Average Total Cost (ATC):
Average Total Cost = Total Cost / Quantity
ATC = (2000 + (20 x Q)) / Q
Average Total Cost Curve:
Plot the ATC values for each quantity on the graph.
(b) Central Crude Oil is a natural monopoly. A natural monopoly occurs when a single firm can produce the entire quantity demanded in the market at a lower average total cost than multiple firms. In this case, the firm's average total cost decreases as the quantity increases, indicating economies of scale. Due to its large scale of production, Central Crude Oil can offer oil at a lower cost compared to any potential competitors. These economies of scale make it more efficient for Central Crude Oil to be the sole supplier in the market.
(c) To determine the firm's profit-maximizing output and price, we need to find the quantity at which marginal revenue equals marginal cost. This is the point where the marginal revenue curve intersects with the marginal cost curve.
Based on the given marginal cost of $20 per thousand cubic feet, the marginal cost curve is a horizontal line at $20.
To find the profit-maximizing output and price:
1. Find the quantity where the marginal revenue curve intersects with the marginal cost curve. This is the profit-maximizing output.
2. Read the corresponding price from the demand curve. This is the profit-maximizing price.
From the given data, it appears that the marginal revenue curve is also a horizontal line at the same price points as the demand curve. As a result, the profit-maximizing output can be determined by finding the quantity at which the marginal revenue equals the marginal cost ($20).
Looking at the table, we can see that at a price of $60, the quantity demanded is 60 thousand cubic feet per month. Therefore, the profit-maximizing output is 60 thousand cubic feet per month.
The corresponding price is $60, which is the profit-maximizing price.
To calculate the firm's economic profit per month, subtract the total cost (including fixed cost) from the total revenue.
Total Cost (TC) = Fixed Cost + (Marginal Cost x Quantity) = $2000 + (20 x 60) = $3200
Total Revenue (TR) = Price x Quantity = $60 x 60 = $3600
Economic Profit = Total Revenue - Total Cost = $3600 - $3200 = $400
Therefore, the firm's economic profit per month is $400.
To answer the questions (a), (b), and (c), let's go step by step:
(a) To draw the demand curve faced by Central Crude Oil, we plot the price and quantity data given in the table. The demand curve will be downward sloping, showing the relationship between the price and the quantity of oil demanded by consumers.
To draw the marginal revenue (MR) curve, we need to observe that in a perfectly competitive market, the marginal revenue is equal to the market price for each unit sold. Since Central Crude Oil is a monopoly, to find the marginal revenue, we need to recognize the relationship between the change in quantity sold and the change in total revenue.
The marginal cost (MC) curve is given in the question as a constant of $20 per thousand cubic feet. This means that the cost of producing each additional thousand cubic feet of oil is constantly $20 throughout.
The average total cost (ATC) curve can be derived by dividing the total cost (fixed cost + variable cost) by the quantity produced. Since the fixed cost is $2000 per month, it remains constant regardless of the quantity produced, so the ATC curve will gradually decrease as the quantity produced increases.
(b) To determine if Central Crude Oil is a natural monopoly, we need to consider the characteristics of a natural monopoly. A natural monopoly occurs when the average total cost curve continually decreases as the quantity produced increases, indicating that one firm can produce the entire output at a lower cost than multiple firms. If there is a natural monopoly, it is more efficient to have a single firm than multiple firms competing.
Looking at the average total cost curve, we can determine if it exhibits a continuous decrease as the quantity produced increases. If this is the case, then Central Crude Oil qualifies as a natural monopoly.
(c) To identify the firm's profit-maximizing output and price, we need to find the point where marginal cost equals marginal revenue. At this point, the firm maximizes its profits.
Additionally, economic profit is calculated as total revenue minus total cost. Total revenue is obtained by multiplying the price by the quantity produced. By subtracting the total cost, which includes both fixed and variable costs, we can determine the economic profit per month.
To provide more specific guidance and explanation, it would be helpful to see the graph you drew for the demand curve and marginal revenue curve.