Competition

Question 1

What is perfect competition?

Answer 1

When there are a large number of buyers and sellers, selling homogenous products, who have no barriers to exit/entry. None of the producers are larger than the market and consumers/producers have perfect knowledge about the market. The companies are all price takers.

Question 2

For price takers in perfect competition, is demand elastic or inelastic?

Answer 2

Perfectly elastic at the prevailing market price - can sell as many or as few units as it likes at that price, without having to lower the price to sell more.

Question 3

If price takers in perfect competition, what do their prevailing market prices also show?

Answer 3

Their marginal and average revenue - they are the same as the current market prevailing price.

Question 4

Total profits = ?

Answer 4

Profit per unit x the number of units sold

Question 5

Why are Average Costs and Normal Profits synonymous in a competition context?

Answer 5

Because Average Costs are the amount you typically spend, while normal profits are this amount that keeps your company in production (i.e. the amount you typically spend)

Question 6

What are economic profits?

Answer 6

Above normal profits (the minimum return on capital to stay in business)

Question 7

In a perfect competition, what is the breakeven point?

Answer 7

P = AC = ATC = MC = AC

Question 8

What are losses?

Answer 8

When the revenue per unit is below the average cost of production (when the market price is not sufficient to cover total costs)

Question 9

How can firms avoid being shut down?

Answer 9

Alter their variable costs

Question 10

What is the shut down price equal to?

Answer 10

The minimum average variable cost (AVC) (i.e. if the revenue it gets from producing is less than the variable cost of production) - if TR

Question 11

If P > AC…

Answer 11

Then the firm will continue to produce at a profit

Question 12

If P > AVC…

Answer 12

Then the firm will continue to produce in the short run

Question 13

If P

Answer 13

The firm shuts down

Question 14

Where on a marginal cost graph should production occur?

Answer 14

At the maximisation point (when the line is curving upwards), the point where the marginal cost is rising and intersecting with the average variable cost line

Question 15

Where is the short-run supply curve in relation to the MC and the AVC curves?

Answer 15

The part of the MC line that lies above the AVC curve

Question 16

What must be covered in order for firms to remain in production?

Answer 16

The Average Total Costs (ATC)

Question 17

Why is does the supply curve curve upwards?

Answer 17

Because the greater amount that is received from the price at which the goods are sold (x axis), the larger the quantity that can be produced (y axis) - this means that it can cover a greater amount of the marginal costs needed to produce one extra unit each time. The greater the prices, the greater the quantity because the greater the firm can cover marginal costs to produce that one extra unit.

Question 18

Where is the long run supply curve in relation to MC and ATC on a graph?

Answer 18

The portion of the MC that lies above the minimum point of ATC

Question 19

What is the supply curve?

Answer 19

The sum of all the outputs of all the firms of an industry over a period of time in question

Question 20

What does a market supply curve show?

Answer 20

The sum of the supplies of the individual firms in the industry

Question 21

Why do firms need a higher marginal price in the short term?

Answer 21

Because the increase in labour (the only option in the short run to increase output) creates greater marginal cost - does not necessarily apply for the long term, when the scale of operations can be changed

Question 22

What is long-run competition like?

Answer 22

Firms are free to enter/exit the industry, (if firms think they can incur losses they can exit); if economic profits can be earned, new firms can enter. P > AVC implies entry, P

Question 23

What happens when new firms enter into the industry?

Answer 23

Prices fall because supply expands. This causes the market price to fall and above-normal profits (economic profits) to decline

Question 24

What shows a healthy margin?

Answer 24

Prices above ATCs

Question 25

At what point will new firms stop entering the industry/the market supply curve will stop shifting to the right?

Answer 25

When the market is so saturated and prices are so low that there are no opportunities to make economic profits - the market price touches the minimum point of the ATC on the cost curve,

Question 26

At which point is there no incentive for firms to stop leaving?

Answer 26

When enough firms have left for prices to start rising again (so that the supply curve shifts to the left because output decreases), touching the minimum ATC where the firm is just breaking even

Question 27

When does long run equilibrium prevail?

Answer 27

When all firms earn normal profits (no incentive to entry or exit), and when the market price is just sufficient to cover minimum ATC (breakeven point)

Question 28

What happens when companies enter in the short run?

Answer 28

1) Prices will be pushed up to a higher level by a hike in demand. 2) The supply curve will increase and shift to the right until the companies are just about to breakeven. 3) The new equilibrium is established (increase in demand absorbed by an increase in quantity - both rise)

Question 29

What happens when companies enter in the long run?

Answer 29

Prices of production do not go up and only the quantity produced goes up. (Greater efficiency?)

Question 30

Can perfectly competitive firm/s industry earn above normal profits in the long run?

Answer 30

No, only in the short run because of potential competition in the market (which eventually drives prices down)

Question 31

What are monopolies?

Answer 31

1) One firm that supplies an entire market, 2) that does not have any substitutes. 3) Significant barriers to entry. 4) 25% is the maximum % market share that a monopoly typically has

Question 32

What can monopolies be created by?

Answer 32

1) Size of market; 2) patent rights; 3) lower costs for an established firm; 4) government licensing; 5) strategic pricing; 6) brand loyalty; 7) ownership of raw materials

Question 33

When can natural monopolies be established?

Answer 33

When the size of the market is small, relative to the range of production over which economies of scale can be achieved - single firm can produce at relatively low ATC

Question 34

in the short term, do costs matter for monopolies?

Answer 34

No - only difference is whether they want to employ large or small scale operations.

Question 35

What happens to marginal revenue for a monopolist?

Answer 35

Positive for price reductions in the elastic region (greater elasticity and greater response in quantity supplied); 0 at the unit elastic region; negative for price reductions in the inelastic region (less responsive to quantity supplied given a change in price, less % change)

Question 36

When do monopolies maximise profits?

Answer 36

When marginal costs (MC) = marginal revenue (MR) [breakeven]

Question 37

How could a monopoly find a way to become profitable if it is making losses, by setting a price below average costs?

Answer 37

Move to a smaller scale of operations that are more in line with the amount that people will purchase (and reduce average costs)

Question 38

What is price discrimination?

Answer 38

When a firm changes prices to target different individuals/groups. Different prices charged to different consumers reflect different preferences in the demand curve.

Question 39

How would price discrimination affect profits?

Answer 39

Profits = difference between price and average cost for each unit;

Question 40

What is first degree price discrimination?

Answer 40

When individuals are collectively willing to buy at each price point above the breakeven cost (MC = AC)

Question 41

What is second degree price discrimination?

Answer 41

Charging different prices depending on how much consumers buy

Question 42

What is third degree price discrimination

Answer 42

Exploiting differences in willingness to pay (dividing consumers into groups and charging different prices for premium vs ordinary products etc)

Question 43

How can monopoly firms limit pricing?

Answer 43

By setting the price just below the costs potentially incurred by new entrants (prevents prices from falling as supply floods the market)

Question 44

Why is it difficult for monopolists to maintain their positions of advantage in the long term?

Answer 44

Their profits incentivize other firms to join the market. It becomes difficult to sustain its developments, changes in demand and the development of substitute products

Question 45

Often, monopoly power is____

Answer 45

Transitory

Question 46

Firms can earn above normal profits in the ______ run, but free entry of other firms ensures that only normal profits can be earned in the ______ run

Answer 46

Short, Long

Question 47

What is monopolistic competition?

Answer 47

When each company is a monopoly supplier for a specific product, but it is a competitive industry because there are other companies doing the same thing with different products

Question 48

Consumer loyalty implies that monopolistic firms face a ______ sloping demand curve

Answer 48

Downward