Suppose that a single firm monopolizes the market for coffee imports from Colombia into the United States. Supposed the firm is called Juan Perez. Juan Perez has production costs characterized by constant returns to scale such that AC=MC=40. The firm faces a market inverse demand curve given by P=160-2Q.

a. Calculate the profit-maximizing price and output for the firm. What is the profit for this firm?

b. Suppose that the government decides to regulate the coffee importing market and orders the monopoly to break. Now we have two firms Juan (firm number 1 if you will) and Perez (firm number 2). These two firms continue to operate with the same cost structure as the monopoly once did, and face the same demand function, except that quantity is now given by the aggregate output of these two firms.

i. Set up the profit function for each of these two firms.

ii. What are the reaction functions resulting from the profit maximizing behavior of these two firms? In a few words explain what these functions represent.

iii. How much will each firm produce in equilibrium?

iv. What will profits be for each firm?

c. The government still does not seem to be happy with the results in this market, so it decides to promote perfect competition, and to do so, it breaks Juan and Perez into lots of little different firms. What will the outcome in terms of price, aggregate output and profits be in this new market?

d. In looking at your answers from a, b and c. Can you see how market efficiency increases as we move towards perfect competition? Please explain.