Wal-Mart and other movie DVD retailers, including online vendors like amazon.com, employ a two-step pricing policy. During the first six months following a theatrical release, movie DVD buyers are wiling to pay a premium for new releases. Total and marginal revenue relations for a typical newly released movie DVD are given by the following relations:
TR = $28Q - $0.0045Q2
MR = ∂TC/∂Q = $28 - $0.009Q
Total cost (TC) and marginal costs (MC) for production and distribution are:
TC = $4,500+ $3Q + $0.0005Q
MC = ∂TC/∂Q = $3 + $0.001Q
where Q is in thousands of units (DVDs). Because units are in thousands, both total revenues and total costs are in thousand of dollars. Total costs include a normal profit.
A. Use the marginal revenue and marginal cost relations given above to calculate DVD output, price, and economic profits at the profit-maximizing activity level for new releases.
B. After six months, price-sensitive DVD buyers appear willing to pay no more than $6 per DVD. Calculate the equilibrium price-output activity level in this situation. Is this a stable equilibrium?