1: Let the demand for goods produced by firm i be Yi =( a - b)(Pi/P) and let the production costs be cWYi, here a, b and c are constants and where W is the wage.
a) Write down an expression for profits of the firm (revenue minus costs).
b) Use the demand function to substitute for Yi in the expression for profits.
c) Take the derivative of profits with respect to Pi, set it equal to zero, and solve the expression for the price Pi. What factors determine the price that is optimally set by the firm?
d) Consider now a situation when all firms set the same price. Set Pi = P, and solve for the price level. What factors determine the price level? How does the parameter b affect the price level for a given wage? Explain.
e) Suppose that the production function is Y = AN . What is c and what is equation of price level in this case?
2: In what ways can the government policies affect the degree of competition and the mark-up, positively or negatively?