AutoCorp faces a demand of P = $30,000 ? 5 Q for its primary line of sporty mini-cars in Little Rock. The marginal cost of producing the car is $8,000. Discuss the implications of selling the new mini-car through its own dealership or through the local dealer: MiniMart.
What will be an ideal response?
Selling through the local dealer could result in a double markup problem, where both AutoCorp and MiniMart charge monopolistic mark ups. The end result is a higher price, lower volume, and lower aggregate profit than with a single monopolistic mark up. If AutoCorp transfers at marginal cost to its own dealership, a single monopolistic markup will occur. (1) Selling within AutoCorp dealership: Maximize profit by MR = MC. This requires 30,000 ? 10Q = 8,000, or Q = 2,200. To sell this, the dealership should set P = 30,000 ? 5(2,200) = $19,000. (2) Selling to MiniMart: MiniMart's derived demand is $30,000 ?10Q. Therefore, AutoCorp faces MR of selling to MiniMart of 30,000 ? 20Q. Maximizing profit would require 30,000 ? 20Q = 8,000 or Q = 1,100. The wholesale price to MiniMart would accordingly be P = 30,000 ? 10(1,100) = $19,000. MiniMart, facing a retail demand of 30,000 ? 5Q, will charge P = 30,000 ? 5(1,100) = $24,500, significantly higher than AutoCorp's own dealership price of $19,000.
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