Assignment 1: Insurance Agents Receive A Commission On The P ✓ Solved

Assignment1 Insurance Agents Receive A Commission On The Policies Th

1. Insurance agents receive a commission on the policies they sell. Many states regulate the rates that can be charged for insurance. Would higher or lower rates increase the incomes of agents? Explain, distinguishing between the short-run and the long-run.

2. During a coffee-room debate among several young MBAs who recently graduated, one of the young executives flatly stated, “The most this company can lose on its Brazilian division is the amount it invested (its fixed costs).” Not everyone agreed with this statement. In what sense is this statement correct? Under what circumstances could it be false? Explain.

3. Even if firms in a monopolistically competitive market collude successfully and fix price, economic profit will still be competed away if there is unrestricted entry. Explain. Will price be higher or lower under such an agreement in long-run equilibrium than would be the case if firms didn’t collude? Explain.

4. Antitrust authorities at the Federal Trade Commission are reviewing your company’s recent merger with a rival firm. The FTC is concerned that the merger of the two rival firms in the same market will increase market power. A hearing is scheduled for your company to present arguments that your firm has not increased its market power through the merger. Can you do this? How? What evidence might you bring to the hearing?

5. Dr. Leona Williams, a well-known plastic surgeon, has a reputation for being one of the best surgeons for reconstructive nose surgery. Dr. Williams enjoys a rather substantial degree of market power in this market. She has estimated demand for her work to be: where Q is the number of nose operations performed monthly and P is the price of a nose operation.

a. What is the inverse demand function for Dr. Williams’ services?

b. What is the marginal revenue function? The average variable cost function for reconstructive nose surgery is estimated to be: where AVC is the average variable cost (measured in dollars), and Q is the number of operations per month. The doctor’s fixed cost per month is $8,000.

c. If the doctor wishes to maximize her profit, how many nose operations should she perform each month?

d. What price should Dr. Williams charge to perform a nose operation?

e. How much profit does she earn each month?

Sample Paper For Above instruction

In the diverse landscape of insurance and healthcare industries, understanding the implications of market regulation, firm behavior, and managerial decisions is crucial. This paper explores several interconnected economic concepts ranging from the impact of rate regulation on insurance agents’ incomes to strategic behavior in monopolistic markets and economic power within healthcare services. Through critical analysis, it aims to elucidate the short-term and long-term effects, the nuances of market power, and optimal managerial strategies under different market conditions.

Influence of Insurance Rate Regulation on Agent Income

Insurance agents earn commissions based on the policies they sell, which are typically regulated by state authorities to prevent consumer exploitation. The regulation of insurance rates can significantly influence the income of these agents. In the short run, higher regulated rates (or premiums) generally lead to increased commission incomes for agents because commission earnings are directly tied to the policy premiums sold. For example, if regulation caps the premium at a higher rate, agents will earn more per policy. Conversely, lower regulation caps or stricter controls might suppress premium levels, subsequently reducing agent commissions in the short run.

However, the long-term effects are more nuanced. If rates are set too high in the regulatory framework, it may lead to a reduction in policy sales as consumers seek alternatives or reduce coverage due to affordability issues. This decline could ultimately diminish agents’ long-term earning potential. Conversely, if rates are competitively regulated, maintaining a balance that supports policy sales while ensuring fair compensation, agents’ incomes might stabilize or even grow alongside market growth. Therefore, both the short-term increase in rates and the long-term market responses determine agents’ earnings trajectories.

Valuation of Fixed Costs in Business Loss Assessment

The statement that “the most this company can lose on its Brazilian division is the amount it invested” underscores a fundamental principle in economics concerning fixed costs and potential losses. From an accounting perspective, the fixed costs—the initial investments—are sunk in the short term, and the company's potential losses are limited to the variable costs and the initial investment if the business ceases operations. This principle is correct in the sense that once fixed costs are paid, the maximum loss is typically the total initial investment, assuming no salvage value or recoverable assets.

However, this statement could be false if the division continues to generate revenues exceeding variable costs, thereby covering fixed costs and contributing to fixed cost recovery. In such circumstances, the division is not necessarily a loss-maker in the short run, and shutting it down might lead to losses greater than the initial fixed costs. Additionally, if variable costs change or if unforeseen expenses occur, the actual potential loss could differ. Thus, the statement holds under certain conditions but is situationally dependent on the division’s operational performance and market conditions.

Price Collusion and Entry Effects in Monopoly-like Markets

In monopolistically competitive markets, firms often face the challenge of maintaining economic profits in the face of potential entry by new competitors. Even if existing firms collude to fix prices successfully, the presence of free and unrestricted entry acts as a competitive force that erodes profits over time. When firms collude to set prices above marginal cost, new entrants are incentivized to enter if they observe the possibility of earning profits, leading to increased competition, reduced prices, and diminishing profits until only normal profits remain in the long run.

Regarding the price under collusion, if the cartel successfully sustains its agreement, prices initially will be higher than in a competitive market. However, in the long run, if the entry barrier is low, the collusive price may not be sustained because the threat of new entrants will depress prices toward the competitive level. Consequently, despite short-term higher prices from collusion, long-term equilibrium prices tend to be close to the competitive level unless significant entry barriers exist.

Market Power Post-Merger and Antitrust Considerations

The concern of the Federal Trade Commission regarding a merger hinges on the potential increase in market power, which could lead to higher prices and reduced consumer choice. To argue that a merger has not increased market power, the company can present evidence such as pre- and post-merger market shares, existing competitive pressures, and the presence of alternative suppliers or substitutes. Demonstrating that the merger does not significantly reduce competition involves analyzing whether the merged entity would still face competitive constraints from other firms or substitute products.

Evidence such as unchanged or increased market competitiveness, significant customer or supplier bargaining power, and low market concentration ratios can support the argument that market power has not increased. Additionally, providing data on how the merger benefits consumers or promotes efficiency can also be persuasive in countering antitrust concerns.

Market Power and Demand Estimation in Medical Services

Dr. Leona Williams’ market power stems from her reputation and unique skills in reconstructive nose surgery. Her demand estimation function helps understand her pricing and output decisions. The inverse demand function relates the price directly to the quantity demanded, implying that as she performs more operations, the price she can charge per operation decreases—reflecting a downward-sloping demand curve.

Using estimated demand, the inverse function can be derived by algebraic manipulation, and the marginal revenue function can be obtained by differentiating total revenue with respect to quantity. To maximize profit, Dr. Williams should equate marginal revenue to marginal cost (including variable costs and fixed costs). Considering her variable cost function and fixed costs, her optimal output can be calculated. The corresponding price for this output is found by plugging the optimal quantity into the inverse demand function, and profit calculations follow standard profit-margin procedures.

Overall, these analytical techniques demonstrate how market power, cost structures, and demand elasticity influence strategic decisions in healthcare markets, emphasizing the importance of economic principles in medical and business decision-making.

References

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