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Firm A in Industry A has a marginal cost of production equal to $150 and experience has shown Firm A that their Lerner Index is 0
Firm A in Industry A has a marginal cost of production equal to $150 and experience has shown Firm A that their Lerner Index is 0.35.
Firm B in Industry B has a marginal cost of production equal to $25 and historical experience indicates their Lerner index is 0.6.
A. What is the optimal price each firm should charge?
B. Which firm is more likely to earn greater profits in the long run? Why?
Expert Solution
A. Lerner index is calculated as follows
- Lerner index = (price - marginal cost) / price
Applying the formula for firm A, we have:
- 0.35 = (Price - 150) / Price
- Price = 231
Applying the formula for firm B, we have:
- 0.6 = (Price - 25) / Price
- Price = 62.5
B. In the long run, a firm that enjoys a higher market power will earn a larger profit. According to the Lerner index, the higher the index, the more market power a firm enjoys. Since firm B has a higher Lerner index, it has more market power and will enjoy a higher profit in the long run.
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