Friday, 29 July 2011
Thursday, 28 July 2011
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.
Wednesday, 27 July 2011
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.
Thursday, 21 July 2011
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.
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