Consider an industry in which chief executive officers (CEOs) run firms. There are two types of CEOs: exceptional and average. There is a fixed supply of 100 exceptional CEOs and an unlimited supply of average CEOs. Any individual capable of being a CEO in this industry is willing to work for a salary of $144,000 per year. The long-run total cost of a firm that hires an exceptional CEO at this salary is
TCE= {144 + ½ Q2 , if Q > 0
0, if Q= 0
where Q is annual output in thousands of units and total cost is expressed in thousands of dollars per year. The corresponding long-run marginal cost curve is MCE(Q) = Q, where marginal cost is expressed as dollars per unit. The long-run total cost for a firm that hires an average CEO for $144,000 per year is TCA(Q) = 144 + Q2. The corresponding marginal cost curve is MCA(Q) = 2Q. The market demand curve in this market is D(P) = 7200 - 100P, where P is the market price and D(P) is the market quantity, expressed in thousands of units per year.
a) What is the minimum efficient scale for a firm run by an average CEO? What is the minimum level of long-run average cost for such a firm?
b) What is the long-run equilibrium price in this industry, assuming that it consists of firms with both exceptional and average CEOs?
c) At this price, how much output will a firm with an average CEO produce? How much output will a firm with an exceptional CEO produce?
d) At this price, how much output will be demanded?
e) Using your answers to parts (c) and (d), determine how many firms with average CEOs will be in this industry at a long-run equilibrium.
f ) What is the economic rent attributable to an exceptional CEO?
g) If firms with exceptional CEOs hire them at the reservation wage of $144,000 per year, how much economic profit do these firms make?
h) Assuming that firms bid against each other for the services of exceptional CEOs, what would you expect their salaries to be in a long-run competitive equilibrium?