PERFECT COMPETITION AND MONOPOLY

Question 1

PROFIT MAXIMIZATION

Answer 1

R(Q) - C(Q)

R(Q) is total revenue and C(Q) total costs.

Question 2

Do firms really maximize profits?

Answer 2

• Investors prefer to invest in firms that do maximize profits.
• A firm can hardly survive in a market if it does not earn any profits.
• Non-profit-organizations pursue higher-level goals.

Question 3

Profit maximization problem

Answer 3

max π(Q) = R(Q) − C(Q)

–> in contrast to utility maximization and cost minimization problems, the profit maximization problem is not constrained.

Question 4

Profit maximization solution

Answer 4

“marginal revenue = marginal cost”

R′(Q) = MR(Q) = C′(Q) = MC(Q).

Question 5

Perfect competion : assumption

Answer 5

1. Market participants are price takers
   There are many (small) independent suppliers and consumers who cannot influence the market price P.
2. Homogeneous products
   * From the perspective of the consumers the firms’ products are
   identical.
   * Hence, there is only one market price P.
3. Free market entry and exit
   * There is no specific (cost) barriers to entry or exit.
   * Consumers can easily switch among suppliers.

Question 6

PROFIT MAXIMIZATION FOR A PERFECTLY COMPETITIVE FIRM

Answer 6

• The perfectly competitive firm is a price taker (P is fixed, see below).
• The firms see the demand curve as a horizontal straight line, i.e.
  P = MR(Q) = AR(Q).

Question 7

Profit maximization problem

Answer 7

max π(Q) = PQ − C(Q).

“price = marginal costs”
P = C′(Q) = MC(Q).

Question 8

monopoly

Answer 8

is a market with many consumers served by only one supplier.

Question 9

Market power

Answer 9

is the ability of a market participant to influence the market price of a good.

Question 10

A monopolist can set the price above the marginal cost, so he has ?

Answer 10

market power

Question 11

There are various sources of market power such as

Answer 11

– exclusive control over essential inputs.
– “natural monopoly”.
– state protection or regulation.
– patents

Question 12

The cost function of a monopolist is given by C(Q), with…

Answer 12

C′(Q) > 0 and C′′(Q) > 0

Question 13

The (inverse) demand function is P(Q), with…

Answer 13

P′(Q) < 0 and P′′(Q) ≤ 0

price to find input (contrary in normal demand is input to find price)

Question 14

In Monopolist does it make a difference if we maximizes the profit with respect to quantity or price ?

Answer 14

No, It makes no difference whether a monopolist maximizes the profit with respect to quantity or price.

Question 15

In Oligopolist does it make a difference if we maximizes the profit with respect to quantity or price ?

Answer 15

In oligopolistic competition it makes a difference whether the firms compete in quantities or prices

Question 16

PROFIT MAXIMIZATION FOR A MONOPOLIST: solution

Answer 16

P(Qm) + P′(Qm)Qm = C′(Qm)

Question 17

Lerner index : definition

Answer 17

The Lerner index measures the difference between the firm’s price and its marginal cost in percentages. This difference is also called markup.

–> The Lerner index is a measure of a firm’s market power and is between 0 and 1.

Question 18

Lerner index : calculation

Answer 18

Pm −C′(Qm) / Pm

Question 19

The lower the price elasticity of demand η (absolute value), the larger…

Answer 19

the markup

Question 20

If demand is perfectly elastic (η → ∞), the Lerner index…

Answer 20

converges to zero (perfect competition).

Question 21

The profit-maximizing monopolist always supplies in the price-elastic region (η > 1)

Answer 21

• profit maximiwing : mean the ealsticity need to be always more than 1
• If I can increase the price and my revenu go up
• I do that as long as the elastic below 1
• makes no longer efficient : to decrease the price

Question 22

Price elasticity of demand

Answer 22

measures how sensitive the quantity demanded of a good or service is to a change in its price

Question 23

Elastic Demand
(η>1)

Answer 23

This means that a change in price results in a larger percentage change in quantity demanded. For example, if the price of a product decreases by 10% and the quantity demanded increases by 20%, the demand is considered elastic.

Question 24

Inelastic Demand (
η<1)

Answer 24

This indicates that a change in price results in a smaller percentage change in quantity demanded. For instance, if a price decrease of 10% leads to only a 5% increase in quantity demanded, the demand is inelastic.

Question 25

Unitary Elastic Demand (η=1)

Answer 25

In this case, a change in price results in an equal percentage change in quantity demanded. A 10% price drop would lead to a 10% increase in quantity demanded.

Question 26

Price elasticity of production

Answer 26

measures how much the quantity of output changes in response to a change in the price of inputs (such as labor, materials, and capital)

Question 27

The monopolist solves the profit maximization problem

Answer 27

max π(κ, p; λ) = [p − c(κ)]D(κ, p; λ)

Question 28

consumer surplus (competition)

Answer 28

is the area above the price and below the demand curve, representing the benefit to consumers.

Question 29

Producer surplus (competition)

Answer 29

Under competition, the producer surplus is 0, as producers sell at marginal cost, not making a profit above this level.

Question 30

consumer surplus (market power)

Answer 30

s the difference between what consumers are willing to pay for a good and what they actually pay. Under market power, firms charge a higher price than in a competitive market, reducing the consumer surplus.

Question 31

Producer surplus (market power)

Answer 31

is the difference between the price producers receive for a good and the marginal cost of producing it. Under market power, producers can charge a price higher than marginal cost, increasing their surplus.

Question 32

Deadweight loss from market power

Answer 32

In the context of market power, deadweight loss arises because firms restrict output to increase prices, resulting in fewer goods being sold than would occur in a perfectly competitive market.

Question 33

Deadweight loss

Answer 33

loss is the loss of total economic welfare (the sum of consumer and producer surplus) that occurs when a market is not operating efficiently

Question 34

The producer surplus

Answer 34

he area above the marginal cost curve and below the demand curve

Question 35

short-run supply curve

Answer 35

equal to the marginal cost curve

Question 36

long-run supply curve

Answer 36

firms produce where marginal cost equals average cost