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Flashcards in Module 7 - Organisation of Industries Deck (81):
1

Definition of Perfect Competition:

  • All firms in this market produce an identical good – no real or perceived difference in the good
  • Resource owners have information on the opportunity cost of their resources
  • Each firm in a perfect market faces a perfectly elastic demand curve – at the equilibrium price he can sell as much as he can produce, but only at the equilibrium price
  • If above normal profits are made, then resources flow into the industry  until no resources can earn a higher return by flowing between industries, when this happens each firm is in long run equilibrium
  • Above normal profits (new firms entering) causes the supply curve to shift to the right. This causes the price to decrease and quantity supplied to increase
    • Since the firm is a price taker and the demand curves are elastic, the effect is to reduce the demand curve
  • Resources stop moving into the industry when Price = Average Cost, this occurs for a firm at the very bottom of its LRAC curve, when P=LRMC=min LRAC

1

In the world of perfect competition

I. firms set prices in the short run to maximise profit or minimise loss

II. firms set prices in the long run to maximise sales
Which of the following is correct?

A. I only
B. II only
C. Both I and II
D. Neither I nor II

The correct answer is D. Perfectly competitive firms are price takers in both the short run and long run. They can sell all they can produce at the going market price and would therefore never charge a lower price. They can sell nothing at a price higher than the equilibrium price. Thus I and II are both wrong.

2

In response to above normal profit/returns firms move into an industry. Which of the following reflects this movement?

A. The demand and supply curves shift to the right, price decreases

B. The supply curve shifts to the right, price decreases, consumers move down the demand curve

C. MU/price for the good in question decreases; total utility increases

D. Existing firms increase output, shifting the supply curve to the right.

The correct answer is B. Firms moving into an industry cause the supply curve to shift to the right but do not affect the position of the demand curve. Thus A is wrong. The shift to the right of the supply curve will cause price to decrease and consequently MU/price to increase. Thus C is wrong. The price decrease will cause existing firms to decrease output as they move down their supply (marginal cost) curves. Thus D is wrong. The new supply curve will intersect the existing demand curve at a lower equilibrium price; consumers will move along the demand curve.

3

By regulating the price of a monopoly good so that its equal to the MC...

  • more of the monopolists good and less of the competitive are produced.
  • Society’s utility will be increased by shifting resources from compeitive firms to the monopoly and economic efficiency will prevail because marginal equivalency conditions (P=MC) will  be satisfied

4

Name the type of product for each firm:

  • Perfect competition: Homogeneous
  • Monopolistic/ imperfect competition: Differentiated
  • Oligopoly: Homogeneous
  • Monopoly: Unique

 

5

Name the number of firms for each organisation:

  • Perfect competition: Very Large
  • Monopolistic/ imperfect competition: Large
  • Oligopoly: Small
  • Monopoly: One

 

5

Definition of principal-agent problem:

the principal (the govt) gives the agent (the monopoly firm) the ability to set prices at a level which covers cost and gives normal profit, there is no incentive for the agent to minimize costs and so the firm will not be economically efficient

6

Imperfect Competition

Explain why each imperfectly competitive firm has spare capacity?

  • not operating at the minimum point on its ATC
  • each firm would not be economically efficient for the same reason as monopoly – P is not equal to MC

6

Common features of perfectly and imperfectly competitive firms are

I. in the long run in equilibrium both produce at the minimum points on their long run average cost curves

II. facing downward sloping demand curves in the short run
Which of the following is correct?

A. I only
B. II only
C. Both I and II
D. Neither I nor II

The correct answer is D. Imperfectly competitive firms have some control over prices, i.e. can raise price without losing all customers because they face downward sloping demand curves. Perfectly competitive firms have no control over price – they face horizontal demand curves. Thus II is wrong. Because imperfectly competitive firms face downward sloping demand curves, in equilibrium, the demand curve will be tangent to the ATC but not at its minimum point. This I is incorrect.

7

A firm’s stated objective was ‘to motivate employees for results’. Which of the following is best suited for solving the implicit principal/agent problem? Paying each employee

A. for hours worked
B. the same wage as every other
C. for his/her contribution to output
D. the average product of labour in the firm

The correct answer is C. In options A, B and D there is no incentive for each employee to give of his/her best because pay is not related to output. Only in option C is there a correlation between reward and productivity, i.e. only there will each employee (agent) be motivated to do what the firm owner (principal) wishes.

8

An imperfectly competitive firm discovers that at its present level of output average total cost, which is at a minimum, is $16.50 and its average revenue is $18. Marginal revenue is $12. To maximise profit what should the firm do?

A. Leave price and output unchanged.
B. Increase price and leave output unchanged.
C. Increase price and decrease output.
D. Decrease price and decrease output.

The correct answer is C. The marginal cost curve intersects the average variable cost curve at its minimum point, i.e. at the current output level, and at a price of $16.50. However, at this output level, marginal revenue is only $12. Thus, marginal cost exceeds marginal revenue, and to maximise profit the firm must contract its output. However, at a lower output level the market clearing price must be higher on a downward-sloping demand curve.

9

A monopolist is a producer that... 

....supplies the complete market for a good or service – they are price makers rather than takers

10

Given that marginal revenue is less than average revenue under monopoly (either in the short run or in the long run), the profit-maximising monopolist will... 

...produce an output level where price is greater than marginal cost.

10

When an unregulated profit maximizing monopolist is the supplier in a market, economic efficiency...

... will not prevail as marginal equivalency will not be met

  • To achieve economic efficiency, prices must be equated with marginal cost of the good in question
  • In some cases replacing a monopoly with competitive firms can achieve economic efficiency

11

The marginal equivalency conditions for economic efficiency specify that the ratios of marginal utility to marginal cost,

MU
MC

must be equal for all goods and service. This will be achieved when the ratios of

MU
P

are equal and when P = MC for all goods and
services. Under monopoly, however...

  • Price is greater than marginal cost
  • Thus the marginal equivalency conditions cannot be met, since marginal cost cannot be substituted for price in the equivalency equation
  • The ratio of

    MU
    MC

    for the monopo- list’s product will be greater than the ratio of

    MU
    MC

    for competitively produced goods since, for each good produced under monopolistic conditions, P > MC.
  • Conse-quently it would be possible to increase society’s utility by reallocating resources so that more of the monopolist’s good and fewer of other goods were produced

11

With economies of scale in place, regulation to equate price with MC...

... is necessary to achieve economic efficiency

12

When monopoly exists in an economy, economic efficiency will...

...not prevail

12

In a long run monopoly situation, the firm may make above normal profits...

P>ATC and P>LRAC

12

Suppose a fully employed economy had only two industries, one being monopolistic and the other being competitive. Assuming that there are no economies of large-scale production, what would be the result of government action to break up the monopoly into many competitive firms? There would be

A. an increase in output for the monopolised industry and a decrease in output for the competitive industry.

B. a decrease in output for the monopolised industry and an increase in output for the industry.

C. an increase in output for both industries.

D. a decrease in output for both industries.

The correct answer is A. The existence of the monopoly in one of the two industries implies that, in that industry, price is higher than marginal cost. If that industry were to become competitive, then price would be bid down and output would be increased in the long run since the existence of excess profits would result in new firms entering the industry. As the output of the previously monopolised industry expanded, resources would be bid away from the competitive industry, which would result in lower output in that industry.

13

Give example of each firm:

  • Perfect competition: Many agricultural
    products
  • Monopolistic/ imperfect competition: Restaurants, clothing stores
  • Oligopoly: Cars, chemicals, oil
  • Monopoly: Public utilities

 

14

Name the control over price for each firm:

  • Perfect competition: None
  • Monopolistic/ imperfect competition: Some
  • Oligopoly: Substantial
  • Monopoly: Complete

 

14

In the case that the regulation price is less than ATC and LRAC...

...a subsidy will have to be put in place to avoid resources leaving the industry

15

When a firm in imperfect competition is in long-run equilibrium...

  •  the price of its product will be greater than marginal cost
  • economic inefficiency results
    because the ratios of marginal utility to marginal cost in different industries will not
    be equal
  • The achievement of economic efficiency would require that price be set
    equal to marginal cost by imperfectly competitive firms, but since this would result
    in a non-profit-maximising output, given rational firm behaviour, it will not occur
  • a firm in imperfect competition produces an output level above the minimum point on the average total cost curve

16

In the world of perfect competition it is assumed that

I. on the demand side consumers, with perfect knowledge, are utility maximisers
II. on the supply side firms, with perfect information, face no restrictions on movement in to and out of any industry.

Which of the following is correct?
A. I only
B. II only
C. Both I and II
D. Neither I nor II

The correct answer is C. This is a definitional question; all of the characteristics mentioned in I and II are true.

17

Draw short run profit maximisation for a monopolist

19

The most important sources of economies of scale are

  • Specialization of Labor
  • Lower per unit costs associated with large capital equipment
  • Bulk buying of raw material

20

Assume the jumps were completely automated so that variable costs were zero what price per jump would result in a maximum profit and why?

A. $2.00 because demand is price elastic

B. $4.00 because marginal revenue is zero when output = 40

C. $6.00 because demand is price inelastic

D. The answer cannot be determined from the diagram

The correct answer is B. Profit maximising output occurs where MR = MC. The marginal revenue curve can be drawn; it is twice as steep as the D (AR) curve and intersects the horizontal axis at an output of 40. MC = 0. Thus the profit maximising output is 40 since MR = MC at that output. The corresponding profit maximising price, i.e. the price which clears the market is given by the demand curve at output 40, i.e. at a price of $4.00 per jump.

21

At which price would a monopolist whose cost and revenue curves are those pictured in Figure 7.17 maximise profit?

A. B.
B. C.
C. D.
D. E.

The correct answer is D. A monopolist’s profit-maximising output is determined by the intersection of the MR and MC curve. This occurs in Figure 7.17 at the output level F. The corresponding profit-maximising price, given by the demand (average revenue) curve, is E.

22

At which operating level would a monopolist maximise profit (minimise loss)? At the output where

A. marginal cost equalled average cost.
B. marginal cost equalled marginal revenue.
C. marginal cost equalled price.
D. average cost equalled price.

The correct answer is B. It will always pay a monopolist to add to output as long as each additional unit produced adds more to total revenue than it does to total cost, i.e. as long as marginal revenue exceeds marginal cost. Profit will be maximised at the level where marginal revenue equals marginal cost.

22

If the leisure company wishes to maximise daily revenue what price should it charge and how many jumps will it sell?

A. $2.00 and 80 jumps
B. $4.00 and 40 jumps
C. $6.00 and 30 jumps
D. The answer cannot be determined from the diagram

The correct answer is B. Total revenue equals price × quantity. The largest total revenue possible given demand curve D occurs when the price = $4.00 and quantity of jumps equals 40; total revenue = $160.

23

What is the largest output the monopolist in Figure 7.17 could produce without suffering losses?

A. G.
B. H.
C. I.
D. J.

The correct answer is D. As long as average revenue exceeds average total cost, the monopolist will make a profit (above-normal returns). Those two curves intersect in Figure 7.17 at output point J, beyond which the monopolist will incur losses.

24

Which of the following is correct? In the long run, in monopolistic competition, high profits on the part of one firm

A. will lead to high profits for others, as they imitate the successful firm’s meth-ods.

B. will drive other firms out of the industry, and lead to pure monopoly.

C. will lead to new entry, and tend to drive profits down to normal.

D. will continue indefinitely, since the profitable firm will erect barriers to entry.

The correct answer is C. In monopolistic competition, above-normal profits will attract new firms into the industry, causing the demand curve facing the original firm to shift to the left. This process will continue until only normal profits remain, and this will prevent above-normal profits being earned by successful imitators and will prevent monopoly arising. Monopolistically competitive firms, by definition, cannot erect barriers to entry.

25

Name the degree of concentration for each firm:

  • Perfect competition: Zero
  • Monopolistic/ imperfect competition: Low
  • Oligopoly: High
  • Monopoly: 100%

 

26

Explain why an ‘enforced’ competitive industry would not only have higher per unit costs but could also yield a lower total output than the monopoly.

  • Consider Figure 7.9 and suppose that a government legislates that no firm can produce more than 0q1
  • All firms will produce 0q1 at minimum cost for that level of output, having plant size ATC1.
  • Industry output would be 0Q1; aggregate demand would equal aggregate supply; and the industry would be in short-run equilibrium
  • Each firm would be operating at the minimum point of its ATC1
  • the ‘competitive’ price would be Pc and each firm would be in short-run equilibrium, i.e. MC = MR = Pc.
  • The monopolist, on the other hand, would produce output 0QM (> 0Q1), i.e. the output where MR = MC4 and charge the profit-maximising price of PM (
  • Because PM > MC, the marginal equivalency condition will not hold and we shall have an inefficient allocation of resources.
  • Despite this fact, society is obviously better off under the monopolistic situation compared with the enforced competitive situation.
  • Thus society wants the monopoly
    with the economies of scale

27

Which of the following relationships would be true for a perfectly competitive firm where AR = average revenue, MR = marginal revenue, TR = total revenue, Q = quantity, P = price?

A. MR = P x Q
                □Q

B. AR = P × Q

C. TR = P × ΔQ

D. P = AR = MR

 

The correct answer is D.  

MR = △TR△PxQ
           △Q      △Q      ; therefore A is wrong.

AR =   TR =  PxQ
            Q         Q       ; therefore B is wrong.

TR = P×Q  ; therefore C is wrong.

Since competitive firms face a completely elastic demand curve each unit sells for the same price; therefore P, AR and MR are all equal.

28

Imperfect Competition

This market consists of a large number of firms facing a... 

...downward sloping demand curve – this is different from the perfectly price elastic demand curve of the perfectly competitive market

29

Which of the following is the key economic objection to a profit-maximising, unregulated monopoly?

A. Price will not equal average cost.
B. Price will be above marginal cost.
C. Marginal revenue will be below marginal cost.
D. Marginal cost will not equal average cost.

The correct answer is B. A profit-maximising monopolist produces up to the point at which marginal revenue equals marginal cost. At this output level, the price that clears the market exceeds marginal cost. Thus, the price the consumer pays for a good produced by a monopolist does not reflect the marginal cost to society of producing that good.

29

It is stated that the demand curve facing a perfectly competitive firm is completely price elastic. This means that

I. price equals average revenue
II. price equals marginal revenue
III. price times quantity sold by the firm is constant

Which of the following is correct?

A. I and II
B. I and III only
C. II only
D. I, II and III

The correct answer is A. A perfectly competitive firm can sell all it wants at the market price but nothing at any higher price; each unit sells for the same price and thus average revenue, marginal revenue and price must be equal. Thus I and II are true. The firm is a price taker but can decide what quantity to produce. Thus total revenue, price times quantity will vary with quantity produced and sold. Thus III is wrong.

30

Imperfect Competition

The short run curves are the same as...

...the monopoly

31

If the average total cost (ATC) of operating the jump were constant at all levels of output and equalled $4.00 what would be the profit maximising output and price?

A. 60 and $2.00
B. 40 and $4.00
C. 20 and $6.00
D. The answer cannot be determined from the diagram and data

The correct answer is C. Given a constant ATC of $4.00, marginal cost must equal $4.00 at all levels of output. Profit maximisation occurs when MR = MC. The MR curve intersects the MC ($4.00) curve at an output level of 20, the corresponding market clearing price being $6.00.

31

The profit maximising output is that output level at which marginal revenue equals marginal cost. This statement applies to

I. perfectly competitive firms
II. monopolistically competitive firms
III. monopolistic firms

Which of the following is correct?

A. I only
B. I and II only
C. III only
D. I, II and III

The correct answer is D. A profit maximising/loss minimising firm will always produce an additional unit of output if its contribution to revenue (marginal revenue − MR) exceeds its contribution to costs (marginal cost − MC). When MR = MC a further increase in the output level will make profit/return lower than it otherwise would have been. This condition holds for all types of firms.

32

If the demand curve were to shift to the left and average variable costs were to stabilise at $4.00 per jump for all levels of output what would be the profit maximising price?

A. $5.00
B. $6.00
C. $7.00
D. The answer cannot be determined from the diagram and information given

The correct answer is D. Since it is unknown where the new demand curve will be, the marginal revenue curve cannot be derived nor, as a consequence, the profit maximising price and quantity if indeed there remains a profitable output.

33

When AR increases...

MR increases at a greater rate.

33

Empirical evidence suggests that, in certain major industries, regulation is worthwhile but that in many imperfectly competitive industries...

...the costs of regulation would exceed the benefits.

34

Name Industry characteristic's:

  • Perfect competition
  • Monopolistic/ Imperfect competition
  • Oligopoly
  • Monopoly

36

Oligopoly

Explain/ Definition?

  • This occurs when a small number of firms produce the bulk of an industry’s output
  • One firms sales depends on the price it charges and the price charged by its few competitors
  • The goods are more or less homogenous

38

Oligopoly

Barriers to oligopolies are similar to those of monopolies: 

  • patents
  • economies of scale

40

The monopolist Barriers to entry could be...

...legal (patent) and/or economic (economies of scale)

41

The monopolists short run supply curve...

... is the markets supply curve

43

The monopolists demand curve...

... is the market demand curve

45

An economy containing perfectly competitive industries would achieve...

...economic efficiency

45

In a competitive market in long run equilibrium...

...P=MCsr=LRMC=Min(ATC)=Min(LRAC)

48

For a monopolist, which of the following is the best definition of ‘marginal revenue’?


A. The highest price it can charge without attracting competition.

B. The price at which it can sell one more unit.

C. The change in total revenue if it sells one more unit.

D. The difference in the price of the last unit sold and the price of the next unit sold.

The correct answer is C. By definition, marginal revenue equals the additional revenue that would be earned by selling one additional unit of output. The price at
which a monopolist can sell an additional unit is given by the demand curve (or average revenue curve), as it is the difference in price of the last unit sold and the next unit sold. The price that attracts competition will affect a monopolist’s demand curve but not its marginal revenue.

49

Monopoly: When AR decreases...

...MR decreases at a greater rate.

50

The kinked demand curve in oligopolistic industries indicates that as one firm

I. increases its price all other firms follow
II. lowers its price no other firms follow

Which of the following is correct?

A. I only
B. II only
C. Both I and II
D. Neither I nor II

The correct answer is D. If one oligopolistic firm raised its price and no other firm followed the firm in question would suffer a significant decrease in sales. If the firm lowered its price and all others followed the firm in question would not gain significantly in sales. Thus both I and II are wrong.

52

In perfectly competitive industries consumers achieve equilibrium:

Mua = MUb….
Pa       Pb

but P = MC, so...

 

Mua  = MUb ……..
Mca     MCb 

54

Imperfect Competition

As above normal profit is being made...

...new firms will enter the market 

55

Imperfect Competition

The greater the real or imagined differences of a good and/or the greater...

... local monopoly factor, the more inelastic its demand curve will be

56

The monopolist will maximise profit in the long run, thus being in long-run equilibrium, when it produces that level of output at which...

...long-run marginal cost equals marginal revenue

57

Definition of economies of scale

A firm experi-ences economies of scale when, as output expands, average costs decline

59

When significant economies of scale exist in an industry then, in the absence of government interference...

 ...there will be a tendency for monopoly to arise

60

If  a monopoly’s output is subject to economies of scale, economic efficiency will...

...not be achieved by breaking up the monopoly because for each new firm its price will exceed long run marginal cost

61

The monopolist’s average revenue curve

A. is the line labelled MR.
B. is the line labelled D. C. is the line labelled MC.
D. does not appear on the Figure.

The correct answer is B. By definition a monopolist’s demand curve is his average revenue curve; it tells what quantities can be sold at different prices.

62

Because the monopolist faces a downward sloping demand curve, AR is... 

  • Not equal to MR
  • AR= demand curve
  • When AR decreases, MR decreases at a greater rate:

62

A government regulates a monopoly, in which economies of scale exist, by forcing the monopoly to produce that output level at which price equals long run marginal cost.

I. The monopolist’s profits are reduced but he is guaranteed at least normal returns because normal returns are included in the cost estimate
II. Marginal cost in the short run must equal marginal revenue no matter the government regulation

Which of the following is correct?

A. I only
B. II only
C. Both I and II
D. Neither I nor II

The correct answer is D. If at the output at which price equals long run marginal cost, long run average cost is greater than average revenue (demand) the firm will suffer a loss and will not remain in business in the long run. Thus I is wrong. Because the demand curve is downward sloping and price (a point on the demand curve) equals long run marginal cost, price must equal also short run marginal cost of the optimally sized plant. The output at which marginal revenue equals marginal cost is lower than that at which P = MC and as a consequence II is wrong.

63

Which of the following describes the most consistent difference between a pure competitor and a monopolist?

A. The monopolist has larger total assets.

B. Marginal revenue and price are the same for the competitor, but different for the monopolist.

C. The competitor is in a constant-cost industry; the monopolist is not.

D. The monopolist’s price is government-controlled; the competitor’s is not.

The correct answer is B. The demand curve facing a pure competitor is a horizontal line, i.e. it can sell as much as it wishes at the going price, over which it has no control. For example, if the going price of pencils is 10 cents, it could sell 1 or 1000 without affecting price. The competitor’s average revenue would be 10 cents, as would its marginal revenue, and so P = AR = MR. For the monopolist, facing a downward-sloping demand curve, average revenue and marginal revenue differ: for the monopolist, price exceeds marginal revenue. Both a monopolist and competitor could have equal assets, both could be in a constant-cost industry, and neither need be regulated by government.

64

Monopoly vs Competitive Industry

It is also possible that an ‘enforced’ competitive industry would not only have higher per unit costs but...

... could also yield a lower total output than the monopoly.

65

When is the monopolistic firm in equilibrium?

When earning maximum profit (AR>MC)

67

To which type of industry would the following characteristics, taken together, apply?

High degree of concentration, small number of firms, homogeneous product, significant control over price

A. Imperfectly competitive
B. Monopolistically competitive
C. Monopoly
D. Oligopoly

The correct answer is D. The only industry to which all noted characteristics apply is oligopolistic. The small number of firms applies only to an oligopoly. In imperfectly/monopolistically competitive industries the number of firms is large and in a monopoly there is only one firm. Thus A, B and C are wrong.

69

Which of the following characteristics applies to perfectly competitive industries but does not apply to imperfectly competitive industries?

A. large numbers of firms
B. ease of entry
C. firms have no control over prices
D. ease of exit

The correct answer is C. In both types of industries there are large numbers of firms and few barriers to enter or exit of the industry. Thus A, B and D are common to both. Perfectly competitive firms are price takers; imperfectly competitive firms have some control of over prices.

71

Suppose a certain industry is monopolistic but not subject to government regulation.

Also suppose that the firm or firms in that industry is/are maximising profit. From the viewpoint of the most efficient allocation of resources in the nation as a whole, which of the following will be correct regarding the monopolistic industry?

There will be

A. no research.
B. too much advertising.
C. too many resources devoted to current production.
D. too few resources devoted to current production.

The correct answer is D. A profit-maximising monopolist produces up to the point at which marginal revenue equals marginal cost. For the price to equal marginal cost, output would have to be expanded in the monopolistic sector and coincidentally reduced in the competitive sector. When prices equal marginal cost in both sectors, economic efficiency prevails.

72

Draw avgerage and marginal curve under monopoly...

73

If economies of scale exist for a firm it means that

I. the firm receives quantity discount on factor inputs
II. the long run average cost decreases as output increases
III. short run marginal costs decrease as output increases

A. I only
B. II only
C. II and III only
D. I, II and III

The correct answer is B. As a firm chooses larger and larger plant sizes, average cost decreases, i.e. the long run average cost curve is downward sloping. A larger firm may receive quantity discounts in inputs but it is not a necessary condition for the existence of economies of scale. Economies of scale are concerned with the long not the short run. Thus I and III are wrong.

74

Name the barriers to entry for each firm:

  • Perfect competition: None
  • Monopolistic/ imperfect competition: None to few
  • Oligopoly: Scale
  • Monopoly: Scale or legal

 

75

Since, under monopoly, marginal revenue is less than
average revenue, price will exceed...

...marginal cost, i.e. Pm > MCm

76

Ignoring questions of legality it would pay oligopolistic firms to form a cartel because

I. this would increase the size of the market
II. they could charge the profit maximising monopoly price
III. they could divide up the market so each firm is better off

Which of the following is correct?

A. I only
B. I and II only
C. II and III only
D. I, II and III

The correct answer is C. The problem an oligopolistic firm faces is that if it increases price and no competitor follows it will lose market share and revenue; if it decreases price and all competitors follow it will not gain market share and will lose revenue. If all firms got together however to form a cartel, the cartel could act as a monopolist facing the market demand curve, equating MR and MC and earning monopoly profit. Each firm will produce an agreed amount of output and share in the monopoly profit. Each could be better off than operating in isolation. Thus II and III are true. The quantity supplied will be smaller under the ‘monopoly’/cartel set up. Thus I is wrong.

77

Imperfect Competition

Firms have a degree of control over prices because:

  • real or imagined differences between goods (advertising)
  • elements of a local monopoly (corner shop)
  • a firm entering or leaving the market may effect the demand curve faced by other firms

78

In Figure 7.17, which output would yield for the monopolist the greatest total revenue?

A. F.
B. G.
C. H.
D. J.

The correct answer is B. The marginal revenue curve indicates additions to total revenue from the sale of each additional unit of output. When marginal revenue becomes zero, additional production will detract from total revenue. Thus when marginal revenue is zero, total revenue is maximum.

79

If a competitive firm is making above normal profits it means

I. there is a range of output where total revenue exceeds total costs
II. in the short run new firms will move into the industry

Which of the following is correct?

A. I only
B. II only
C. Both I and II
D. Neither I nor II

The correct answer is A. If above normal profit exists it means that at the current level of output average revenue (AR) exceeds average total cost (ATC). Since the ATC curve is U shaped there will be other output levels at which AR will exceed ATC. Only when the ATC curve is tangent to the AR line will normal returns, only, exist. Thus I is correct. In the short run, by definition, the number of firms is fixed; thus II is wrong.

80

Implications of the kinked demand curve are

I. the marginal revenue curve is discontinuous
II. changes in marginal costs may not cause the firm to alter its output

Which of the following is correct?

A. I only
B. II only
C. Both I and II
D. Neither I nor II

The correct answer is C. The kink in the oligopolistic demand (AR) curve produces a discontinuity in the MR curve, through which the MC curve passes. An alteration in MC still allows the MC curve to intersect the MR curve in its discontinuous range, the profit maximising output at the kink will not change. Thus I and II are true.

81

In the long run, the monopolist may expand or contract its output by adjusting its plant size. Whether it expands or contracts output depends on the relation between long-run marginal cost (LRMC) and marginal revenue (MR).

  • If LRMC is less than MR, the monopolist will increase output
  • if LRMC exceeds MR, the monopolist will decrease output

In either case, above-normal profit will be higher in the long run than in the short run.