MECN 430

Homework 3 (Individual)

Winter 2020

1. The marginal cost of catching a ton of shrimp is $1,500. After Hurricane Carmen destroyed
most shrimping boats, Bubba Gump Shrimp Co., run by Forrest Gump and Lt. Dan Taylor,
obtained a monopoly in this market. They plan to sell the shrimp at a price of $2,000 per ton;
they are certain that the price elasticity of demand at this price is –2. Would you advise
Forrest and Dan to increase or decrease the price of shrimp, or have they chosen the optimal
price? Explain.
Yes, I would advise Forrest and Dan to increase the price of shrimp.
The marginal cost of catching a ton of shrimp is $1,500, therefore MC=1,500. The elasticity at a price of
$2,000/ton is -2, therefore we can calculate the MR
MR=P ¿.
Since the Marginal Revenue MR is different than the Marginal Cost MC, the current price is not optimal
to maximize profits. We can estimate the optimal price by making MR = MC:
MR = P(1 – 1/2)=1500 → P=$ 3,000 /ton .
This calculation assumes that the elasticity remains constant around that value of price change. For
small increments of price, it`s a fair assumption, however, in general, we would expect a higher elasticity
for higher prices, making MR > MC for the new price calculated.
Therefore, my recommendation would be to increase price incrementally and calculate, step by step,
the new elasticity and, therefore, the new MR. The goal would be to equalize the MR to MC to find the
new optimal price.
2. In the summer of 2019, the Royal Mint minted a million 50 pence coins commemorating
Brexit, which was supposed to happen on October 31. After that deadline for Brexit was
missed, the initial plan was to melt all the million coins carrying the wrong date. The final
decision was to melt all but 10,000 coins, which would be sold to collectors at £10 each.
The Chancellor of the Exchequer Sajid Javid suggests that melting the coins is costly, and
taxpayers will foot the bill. However, the marginal cost of melting 10,000 coins is negligible,
as is the value of the metal used to produce it.
a. Suppose that the Bank of England’s goal was to maximize profit, and it did so optimally.
Given the zero marginal cost of melting an additional coin, what can be said about the
elasticity of demand for October 31 Brexit memorial coins at the current (optimal) price?
We can calculate the optimal price to maximize profits by making MC = MR:

MC=0. MC=MR=0 → P¿ → 1 – ( ||1 )=0 → ¿−1

b. Assuming the demand is linear, derive the demand curve. In other words, find a and b in
the equation Q=a−bP.
( 1 ) Q=a – bP→(−b)(P/Q)=. For P = 10 and Q = 10,000 we have:
10000
b= =1000.
10
Applying the value of b∈equation ( 1 ):
Q=a – bP →10000=a – 1000∗10 → a=20,000.
Q=20000 – 1000 P
c. Suppose that the Bank of England decided that it would melt all but one coin. Using the
demand curve you derived in (b), find the price at which Bank of England would be able
to sell this coin.
For Q=1 →
1=20000 – 1000 P →1000 P=19999→ P=£ 19.999
d. How would your answer to (a) change if melting each coin produces precious metals in
non-negligible amounts?
Hint: How does this change the marginal cost of selling (rather than melting) a coin?

The melting would bring additional revenue. This would change the Marginal Revenue
calculation. If the bank seeks to maximize profits, it means that the new marginal cost of selling
 a coin is not zero. This would affect the value of the elasticity, making ||>1 since
¿∨¿ P /(P – MC ) and MC is greater than zero.

3. Rogue Creamery, located in Southern Oregon, has capacity to produce 12,000 pounds of
Rogue River Blue cheese annually. In reality, it produces 10,000 pounds, which sells at $30 a
pound. The marginal cost of producing a pound is $10.
a. Assuming that Rogue Creamery prices optimally, what is the elasticity of demand for this
cheese at the current price?
MC=MR
$ 30
MC=$ 10/ pound , P= → 10=30¿
pound
b. Assuming that the demand curve is linear, derive the demand equation.
(1) Q=a – bP
(2) (1) (−b)(P /Q)=¿ .
Applying P=30 , Q=10,000∧¿−1.5 on (1) we have:
10000∗−1.5
b= =500( ¿)
−30
Applying (*) on (0) we have Q=a – bP →10000=a – 500∗30 → a=25,000.
Thus
Q=25000 – 500 P ¿
c. Write down the inverse demand curve (P as a function of Q) and the marginal revenue
curve. Verify that you would get the same optimal price and quantity using the
“MR=MC” principle.
For the equation (**), isolating P we have

P=(−1/500)Q+50 (2)
−1
( 500
There fore PQ= )∗Q +50∗Q 2

dPQ −1 1
=MR=( )∗2 Q+50=50−(
250 )
→ Q
dQ 500
Q
At the optimal price: MC=MR → MC=10=50 – → Q=10,000 ton.
250
 Applying Q=10,000 ton on (**) we get P=$ 30 / pound .

Rogue River Blue won the top prize at World Cheese Awards, the first cheese from the
United States to do so. This brought considerable interest to the products of the
Creamery. Specifically, demand for Rogue River Blue cheese doubled: for any given
price, twice as many people are willing to buy the cheese. To make optimal pricing
decisions after this demand shock, they have retained you as a consultant. They promised
to pay you $1,000 for your services.

d. Find the optimal price in the short run, i.e., before the Creamery has a chance to adjust its
capacity.
After winning the award, we could write the price equation as:

P ’=(−1 /1000)Q+50
For no increasing production, Q=10000 → P ’=$ 40/ton.
For increasing production until capacity, we have Q=12000 → P’=$ 38/ton

e. The CEO of Rogue Creamery proposes a plan, where some facilities that currently
produce other cheeses would be repurposed for production of Rogue River Blue. It would
increase the capacity by 8,000 pounds per year, to 20,000. This would result in $80,000
of foregone profits from the other cheeses per year. Would you approve this idea?
We can write the profit equation to solve this problem. If the expected profit of this endeavor
turns out to be positive, Rogue Creamery should do the new idea.

Π=P ’∗Q – MC∗Q→ Π=¿ [(−1/1000)Q+50 ]Q – 10 Q=(−1/ 1000)Q2 + 40Q .

For Q=12,000ton, we have: ∏=(−1/1000)(12000)2+ 40(12000)=$ 336,000

For Q=20,000ton, we have ∏=(−1/1000)(20000)2+ 40(20000)=$ 400,000 ,an increase of

$ 64,000. However, the additional profit is lower than the foregone profits of this new endeavor
of $80,000. Thus, the expected profitability is negative and Rogue Creamery should not do this
idea.
f. Before you have a chance to present your advice, the CEO comes back with a different
plan. The plan is essentially half of the previous one: it would expand the capacity to
produce Rogue River Blue by 4,000 pounds per year, and cost half as much, i.e. $40,000.
What would your recommendation be now? Would you advocate for the previous plan,
the new one, or would you advise against any expansion?
Π=P ’∗Q – MC∗Q→ Π=¿ [(−1/1000)Q+50 ]Q – 10 Q=(−1/ 1000)Q2 + 40Q .
For Q=16,000ton, we have: ∏=(−1/1000)(16000)2+ 40(16000)=$ 384,000
an increase of $ 48,000 . The additional profit is higher than the foregone profits of this new
endeavor of $40,000. Thus, the expected profitability is positive and Rogue Creamery should do
this idea.