ECO402 Assignment No. 2 full solution Fall 2011 January 2012

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ECO402 Assignment No. 2

Assignment:

The Case:

Urea is used as a fertilizer in cultivation of agricultural products. In Pakistan there are very few industrial plants for the production of urea. Energy shortage has badly affected the production of these industrial plants. This situation has increased the price of urea. To provide incentives to farmers, government has decided to control the price by setting price Rs.2500 per bag. Demand and cost functions of urea industry are given below:

P = 6000-4Q

TC = 500,000 + Q2

Where Q is quantity of urea, P is price being paid by the farmers and TC is total cost which is borne by urea industry.

Requirements:

Considering the above scenario, answer the questions stated below:

A. What price would be charged and what quantity would be supplied by the urea industry in order to maximize its profit.

B. What would be the maximum profit that can be earned by the urea industry?

C. How much profit urea industry will earn after imposition of the new price by the Government?

D. Being a student of Economics, suggest what production decision urea industry should take in the short run as a result of imposition of price by the government. (Marks = 5+5+3+2)
SOLUTION:

Assignment:

The Case:

Urea is used as a fertilizer in cultivation of agricultural products. In Pakistan there are very few industrial plants for the production of urea. Energy shortage has badly affected the production of these industrial plants. This situation has increased the price of urea. To provide incentives to farmers, government has decided to control the price by setting price Rs.2500 per bag. Demand and cost functions of urea industry are given below:

P = 6000-4Q

TC = 500,000 + Q2

Where Q is quantity of urea, P is price being paid by the farmers and TC is total cost which is borne by urea industry.

Requirements:

Considering the above scenario, answer the questions stated below:

A. What price would be charged and what quantity would be supplied by the urea industry in order to maximize its profit.



Solution:

P = 6000-4Q

TC = 500,000 + Q2

Setting Price per Bag = Rs.2500

So,

P = 6000 – 4Q

2500 = 6000 – 4Q

4Q = 6000 / 2500

4Q = 2.4

Q = 4 / 2.4

Q = 1.66

TC = 500,000 + Q2

TC = 500,000 + (1.66) 2

TC = 500,000 + 2.7556

TC= 500002.7556

i. Price which is denoted by P Is 2500/bag

ii. Quantity which is Q is 1.66



B. What would be the maximum profit that can be earned by the urea industry?

Solution:

B.

TC = 500,000 + Q2

TC = 500,000 + (1.66) 2

TC = 500,000 + 2.7556

TC= 500002.7556

SO, 500002.7556 is the maximizing profit.

C. How much profit urea industry will earn after imposition of the new price by the Government?



Solution:

C. 2.7556 is the profit.



D. Being a student of Economics, suggest what production decision urea industry should take in the short run as a result of imposition of price by the government.

Solution:

D. They have to increase the production and increase the cost of the product as government increases the cost of urea per bag .In the short run the equilibrium market price is determined by the interaction between market demand and market supply. A firm maximize profits when marginal revenue = marginal cost. Some firms may be experiencing sub-normal profits because their average total costs exceed the current market price. Other firms may be making normal profits where total revenue equals total cost