Solutions to Class questions for Topic10 Monopolistic-Competition

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Solutions to Topic 10: Monopolistic competition

Question 10.1

Of the following characteristics, which one applies exclusively to a monopolistic competitive firm?

                A)           It always earns a profit.

                B)            It produce differentiated product.

                C)            It can sell all it wants to at the market price.

                D)           It has no barriers to entry.

                E)            It has a range of prices it can charge for its output.

The correct answer is (B).

Monopolistic competitive firm competes from each other by differentiating their products so that each firm can have some market power.

Question 10.2

The similarity between monopoly and monopolistic competition is:

(a) There are barriers to entry

(b) They sell differentiated product

(c) There is perfect information

(d) There is long run normal profit

(e) The price is higher than marginal revenue

The correct answer is (e).

For monopoly and monopolistic competition, the demand curve is downward sloping and so marginal revenue curve is below the demand curve.

To sell one more unit the firms need to charge a lower price for all units.

Thus price is larger than marginal revenue for both market structures.

•          Question 10.3

The similarity between perfect competition and monopolistic competition in the long run is:

(a) They both produces at the lowest point of the ATC

(b) They both charge a price equals marginal cost

(c) They both earn normal profit

(d) The number of firms are the same

(e) Firm’s demand curve is horizontal

The correct answer is (c).

There is free entry and exit of firms in perfect competition and monopolistic competition. In the long run

Profits will induce more firms to enter the industry and push down prices

Loss will lead to firms leaving the industry and push up prices

All firms earn zero economic profit in the long run.

Question 10.4

(a) Consider a monopolistic competitive firm selling shoes and make a normal profit.  How can it differentiate its product in order to make economic profit?

(b) If the firm is able to differentiate successfully and earns an economic profit in the short run.  What will happen to this firm in the long run?

a) The firm can differentiate its product by:

(1) Changing the shapes, sizes, cutting, colours of the shoes

(2) Provide quality service and after sales services

(3) Innovate and provide better quality shoes

(4) Produce at a low cost and charge a low price

(5) Advertise vigorously

b) Due to free entry and exit, in the long run more new firms attracted by the profit will enter the industry.

Each new firm produces a differentiated product, thus provides more substitutes in the market and take away existing firms’ customers.

Existing firms demand curve shifts leftwards and becomes flatter until all firms can only break even in the long run.

Question 10.5

1)      What are the effects of advertising in the monopolistic competitive market?

2)      Draw the diagram of a monopolistic competitive firm that is earning an economic profit. Be sure to label all the curves. Indicate the area that equals the firm’s economic profit. Is this a long-run equilibrium? Why or why not?

1)      Advertising increases cost to the firm and hence raises the ATC curve.

It may also create awareness of the firm’s product so that demand and marginal revenue increases and the firm can charge higher price

The firm may earn higher profit in the short run if the effect on price exceeds cost.

In the long run, all firms advertise and thus demand becomes more elastic, price drops until no more profit for each firm.

2. Please draw a downward sloping demand curve, a downward sloping MR curve, a U-shaped ATC curve and a U-shaped MC curve which intersects the ATC curve at the lowest point of ATC curve.

This is a short run equilibrium, not a long run equilibrium. In the long run equilibrium, all firms earn zero profit.

Solutions to Class questions for topic 9: Monopolies

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Solutions for Topic 9: Monopolies

Question 9.1

If the monopolist's demand curve is downward sloping, then the marginal revenue curve is

        A)           horizontal

        B)            vertical

        C)            downward sloping with the same slope

        D)           downward sloping with steeper slope

        E)            downward sloping with more gentle slope

The correct answer is (D).

When demand curve is a downward sloping straight line, the marginal revenue is also a downward sloping straight line, and it is twice the slope of the demand curve.

Question 9.2

For perfectly competitive firm price _____ marginal revenue, and for monopolist price ____ marginal revenue.

        A)           equals; equals

        B)            equals; is greater than

        C)            equals; is less than

        D)           is greater than; equals

        E)            is less than; equals

The correct answer is (B).

For perfect competition, price is fixed for every unit.  The firm will always earn an additional revenue equal to the price when selling one more unit.

For monopoly, price drops for all units when selling one more unit of output.  The firm earns an additional revenue less than the price when selling one more unit

Perfect Competition                                                               Monopoly

Q     P             TR           MR                                         Q             P             TR           MR

1      5              5              5                                              1              5              5              5

2      5              10           5                                              2              4              8              3

3      5              15           5                                              3              3              9              1

Question 9.3

Perfect competition is efficient and monopoly is not because in perfect competition __________ while in monopoly __________.

        A)           P=MC; P>MC

        B)            P=MC; P<MC

        C)            P<MR; P=MR

        D)           P=MR; P=MC

        E)            P=MR; P<MR

The correct answer is (A).

For perfect competition, the optimal output is P = MC, which means allocative efficiency.

For monopoly, the optimal output is MR = MC.  Since P > MR, at the optimal output P > MC, implies allocative inefficiency.

Question 9.4

(a) Explain why a firm that practices price discrimination tend to earn a higher profit than one that charge a single price.

(b) If the demand for residential phone line is elastic while the demand for commercial phone line is inelastic, what should the telecommunication firm do to its pricing in order to maximize profit?

(a) Different consumers have different willingness to pay.  If the firm charge a single price to all customers, some consumers may actually be willing to pay more and hence they enjoy consumer surplus.  With price discrimination, the firm can charge a higher price to those who are willing to pay more, hence profit can be increased.

(b) The firm should charge a higher price for commercial phone and a lower price for residential phone in order to maximize profit.

Question 9.5

(1) Can a monopoly incur losses?

(2) Is the monopoly always inefficient compared to perfect competition?

(1) A monopoly need not always earn economic profit.  Economic profit occurs when P > ATC but some monopolists may encounter price control such that they operate at a loss.  They need the government subsidy to remain operational.

(2) A natural monopoly can be more efficient than perfect competition when there are economies of scale to exploit.  Also a monopolist that practice perfect price discrimination is as efficient as perfect competition.

Solutions to class questions topic 8 - Perfect competition

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Solutions for Topic 8 - Perfect Competition

 Question 8.1

Suppose a perfectly competitive firm collects total revenues of $1000 when it produces 200 units; the marginal costs of producing 200 units is $5.  The firm should

            A)         expand production because price is greater than marginal costs.

            B)         contract production because price is greater than marginal costs.

            C)         expand production because price is less than marginal costs.

            D)         contract production because price is less than marginal costs.

            E)         leave production unchanged because price equals marginal costs.

The correct answer is (E)

For perfect competition, the optimal output occurs where MR (= P) = MC.

Total revenue of 200 units of output is $1000 means the price of product is $1000/200 = $5.

Since marginal cost of 200 unit is $5, the condition MR (= P) = MC is fulfilled.

Question 8.2

In the short run, if a firm chooses to operate and produce output, it must be the case that

      A)         it earns a profit.

      B)         total revenues are greater than or equal to the total cost of fixed and variable factors of production.

      C)         total revenues are greater than or equal to the cost of fixed factors of production.

      D)         total revenues are greater than or equal to the cost of variable factors of production.

      E)         it avoids a loss.

The correct answer is (D).

In the short run, a perfectly competitive may earn a profit, break even or incur a loss.

If it incurs a loss, it will stay in the industry TR > TVC or P > AVC

If TR < TVC or P < AVC, it will shut down in the short run.

In the long run, the firm will only remains if it can at least break even.  That is, TR = TC or P = ATC

Question 8.3

If all firms in a perfectly competitive industry are experiencing economic losses, then 

      A)         some firms will enter the industry, seeking new opportunities.

      B)         all firms will increase their prices, until economic profits occurs.

      C)         all firms will continue in the industry, hoping for better times.

      D)         some firms will exit the industry, until no economic losses occur for remaining firms.

      E)         all firms will exit the industry, until economic profits are positive.

The correct answer is (D).

If all firms are making losses, then in the long run some firms which cannot withstand the loss will exit the industry.

Industry supply decreases, price increases, losses of existing firms become smaller until all existing firms earn normal profit (zero economic profit).

Question 8.4

(1) A profit maximizing perfectly competitive firm must decide on both price and quantity of output.  Do you agree?  Explain.

(2) In the long run a perfectly competitive firm can only earns normal profit.  Do you agree?  Explain.

Solution 8.4

(1) The statement is not valid.  Firms have no control over the price in perfect competition.  They only decides on the output and the optimal output is P = MR = MC.

(2) The statement is valid.  There is free entry and exit of firms under perfect competition.  If firms are making profits then new firms will enter until no more profit to be made.  If firms are incurring losses then existing firms will exit the industry until all remaining firms incur no losses.

Question 8.5

If a single firm, belonging to a perfectly competitive industry in long run equilibrium, discovers a significant cost saving methodology, then what will happen to this firm in the short run and in the long run?

Solution:

In the short run, this firm will make positive economic profit since the cost is lower.

But in the long run, new firms will enter the industry with the same cost savings technique (due to perfect information).  With supply increases, price will drop until this firm can only earn normal profit.

Solutions to Class questions done in lesson 7: Outputs and costs

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Solutions for Topic 7: Outputs and Costs

Question 7.1

Suppose 40 employee-hours can produce 80 units of output.  Assuming the law of diminishing marginal returns is present, to produce 160 units of output will require

      A)        an additional 40 employee-hours.

      B)        a total of 80 or less employee-hours.

      C)        less than 40 additional employee-hours.

      D)        a total of 81 or more employee-hours.

      E)        a total of 80 employee-hours.

The correct answer is (D).

Diminishing returns means the workers are less productive due to insufficient physical capital.

Since 40 hours is needed to produce the first 80 units of output, it will take more than 40 hours to produce another 80 units of output to reach 160 units

Question 7.2

If the firm spends $200 to produce 17 units of output and spends $455 to produce 34 units, then the marginal cost of increasing production from 17 to 34 units is

      (A)       $13.38.

      (B)       $15.

      (C)       $7.50.

      (D)       $11.76.

      (E)       impossible to calculate due to a lack of information.

The correct answer is (B).

Marginal cost is change in total cost divided by change in output

Change in total cost is $455 - $200 = $255

Change in output is 34 units – 17 units = 17 units

So MC = $255/17 = $15

Question 7.3

Economies of scale exist when

      A)        constant returns to scale are present.

      B)        input prices are falling.

      C)        average costs fall as the scale of production grows.

      D)        a 10% increase in all inputs causes a 9% increase in output.

      E)        firms become extremely large.

The correct answer is (c).

Economies of scale means when the scale of production increases, total output increases by more than total cost due to efficiency in using resources

Thus the average total cost decreases. Refer to the Long Run AC curve

Question 7.4

Suppose, a firm has $1500 of variable costs and $500 of fixed cost when it produces 500 units of output and sells them for $5 per unit.

(1) Calculate the average fixed cost, average variable cost and average total cost at this output level.

(2) Is this firm making a profit or incurring a loss at this output?

Total fixed cost (TFC) = $500, Total variable cost (TVC) = $1500, Total output (Q) = 500 units

(1) AFC = TFC/Q = $500/500 = $1

AVC = TVC/Q = $1500/500 = $3

ATC = AFC + AVC = $4

(2) Total revenue = $5 X 500 = $2500

Total cost = $500 + $1500 = $2000

The firm is making a profit of $500

Question 7.5

•          Complete the following table and explain the relationship between marginal cost and average total cost.

Q	TVC	TC	MC	AFC	AVC	ATC
0	0	60	-	-	-	-
1	80	140	80	60	80	140
2	120	180	40	30	60	90
3	140	200	20	20	46.67	66.67
4	200	260	60	15	50	65
5	300	360	100	12	60	72
6	500	560	200	10	83.33	93.33

Solutions for class questions in Lesson 6 on Preferences, possibilities and choice

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Solutions for Topic 6: Possibilities, Preference and Choice

Question 6.1

Anna earns $150 a week and she consumes fish and shrimp. The price of fish is $3 a pound and the price of shrimp is $5 a pound. Anna can therefore buy a maximum of _____ pounds of fish or a maximum of _____ pounds of shrimp.

(A) 30, 50 

(B)  50, 30

(C)  15, 30

(D)  30,15

(E)  50,15

Solution 6.1

The correct answer is (B).

Out of $150, he can buy a maximum of $150/$3 = 50 pounds of fish, or a maximum of $150/$5 = 30 pounds of shrimps.

Question 6.2

The quantity of Revlon nail polish demanded by Jen decreased after the price of Revlon nail polish increased. Jen decides to find a cheaper brand of nail polish. This is called

      A)        substitution effect of a price change

      B)        increase in buyer's reservation price

      C)        income effect of a price change

      D)        shift in the supply curve

      E)        decrease in buyer's reservation price

Solution 6.2

The correct answer is (A)

When a consumer switch to a cheaper substitute due to a higher price of the original product, this reflects the substitution effect of a price change

Question 6.3

Units               Total Utility of Food             Total utility of rooms

1                      75                                            480

2                      135                                          720

3                      180                                          960

4                      210                                          1120

Refer to the table above.  If the price of Food is $5 and the price of Rooms is $80, then the best spending consumption implies _____ units of Food and ______ Rooms will be purchased.

(A)  4;3

(B)  3;4

(C)  4;4

(D)  3;3

(E)  4;1

Solution 6.3

The correct answer is (E).

We need to calculate the MU/P for both products.

The optimal consumption combination occurs when (MU/P)_Food = (MU/P)_Room.

From the table, the best combination is 4 units of food and 1 unit of room

Note that if information on income is available, then this combination should also exhaust the income.

Units                     MU/P food                  MU/P rooms

1                            15                                            6

2                            12                                            3

3                            9                                              3

4                            6                                              2

Question 6.4

(a) Explain why the best affordable point is the point at which the budget line touches the highest attainable indifference curve.

(b) What happen when the consumer has a higher income and one of the product is an inferior good?

Solution 6.4

(a)  At the tangency point of an indifference curve with the budget line, the consumer gets the highest total utility given his budget constraint, and hence the point is the optimal consumption point. Draw a diagram like slide 22

(b)  With a higher income, the budget line shifts outwards in a parallel manner.

Assume that X is inferior and Y is normal.  The final equilibrium must indicate a smaller quantity of Y demanded and a larger X demanded. Draw a diagram like slide 27 showing the shift out of the curve.

Question 6.5

Consider two products, A and B.  Represent A on the Y axis and B on the X axis and establish the best affordable point.  What happen to the best affordable point when the price of B increases and B is a normal good?

Solution 6.5

With a higher price of B, the budget line becomes steeper. Consumption of B decreases. Draw a diagram like slide 25, but with prices rising (not falling like in the slide!)