H2 Economics: Short Run Supernormal Profit

Questions and Answers

What condition indicates that a perfectly competitive firm is earning supernormal profits?

Total Revenue is equal to Total Cost.

Average Revenue is less than Average Cost.

Average Revenue is greater than Average Cost. (correct)

Average Revenue equals Average Cost.

At the profit maximizing output level for a perfectly competitive firm, what is true about the relationship between Marginal Cost (MC) and Marginal Revenue (MR)?

MC equals MR. (correct)

MC is greater than MR.

MC is independent of MR.

MC is less than MR.

What graphically represents supernormal profit in a perfectly competitive firm's short-run equilibrium?

The area above the Average Revenue curve.

The intersection point of Demand and Average Cost curves.

The shaded area between Total Revenue and Total Cost. (correct)

The area below the Average Cost curve.

When a perfectly competitive firm is producing at its equilibrium quantity Qe, what can be said about its Average Revenue (AR)?

AR equals the price level. Signup and view all the answers

What effect does the entry of new firms into a perfectly competitive market have on supernormal profits?

It eliminates supernormal profits over time. Signup and view all the answers

What happens to the supernormal profit of a perfectly competitive firm in the long run?

It turns into subnormal profit due to increased competition. Signup and view all the answers

Which statement accurately describes the role of average cost in a perfectly competitive firm's decision-making process?

Firms need to ensure average cost is lower than average revenue to maintain supernormal profits. Signup and view all the answers

What characterizes the demand curve faced by oligopolistic firms?

Downward sloping demand curve Signup and view all the answers

Which factor contributes to mutual interdependence among firms in an oligopoly?

Few large firms dominating the market Signup and view all the answers

What is a key feature of differentiated products in oligopolistic markets?

Products have unique features or branding Signup and view all the answers

Why do oligopolistic firms remain price-setters despite selling homogeneous products?

High barriers to entry reduce market share Signup and view all the answers

What does imperfect knowledge imply in an oligopolistic market?

Buyers may be unaware of price and quality variations Signup and view all the answers

Under what condition will a monopolist decide to shut down in the short run?

When total revenue does not cover fixed costs Signup and view all the answers

What happens when an oligopolist changes the price of their product?

Competitors will likely engage in price reductions Signup and view all the answers

Which market structure is characterized by a few firms having significant control over market prices due to high barriers to entry?

Oligopoly Signup and view all the answers

What occurs to a monopolist's economic profit in the long run, assuming demand and cost conditions remain unchanged?

Economic profit remains positive Signup and view all the answers

What is a key difference between monopolies and perfectly competitive firms regarding pricing?

Monopolies can set prices above marginal cost Signup and view all the answers

In an oligopolistic market, what is a consequence of having low price elasticity of demand?

Firms can increase prices without losing many customers Signup and view all the answers

Which of the following best describes supernormal profits?

Revenue exceeding total costs Signup and view all the answers

In a monopoly, barriers to entry primarily result in:

Heightened ability to maintain supernormal profits Signup and view all the answers

What condition signifies that a monopolist is earning subnormal profit?

TR < TC Signup and view all the answers

What does the shutdown condition imply for both monopolists and perfectly competitive firms?

They will stop production if variable costs are not recoverable Signup and view all the answers

What impact does a monopolist's market power have on consumer prices?

Prices tend to be higher than in competitive markets Signup and view all the answers

What is a characteristic behavior of firms in an oligopoly when it comes to pricing?

Firms tend to maintain similar prices and avoid frequent changes. Signup and view all the answers

Which of the following best defines collusion in an oligopolistic market?

Firms cooperate to act as a monopoly and maximize joint profits. Signup and view all the answers

What happens in a competitive oligopoly when a firm raises its prices?

Competitors will likely match the price increase. Signup and view all the answers

What is a potential outcome of mutual interdependence in an oligopoly?

Firms balance price strategies to maintain market stability. Signup and view all the answers

Which of the following models applies to firms that prioritize cooperation over competition?

Cartel and price leadership model. Signup and view all the answers

What feature is unique to oligopolies that impacts pricing behavior?

High barriers to entry and mutual interdependence. Signup and view all the answers

What describes the price rigidity characteristic in an oligopolistic market?

Firms maintain stable prices and avoid price competition. Signup and view all the answers

What happens to the entry of new firms into an industry when existing firms earn supernormal profits?

New firms will be attracted to the industry. Signup and view all the answers

How do monopolistic competitive firms differ from oligopolistic firms in their decision-making?

They determine their decisions without considering competitors. Signup and view all the answers

What is a key characteristic of products in monopolistic competition?

Products are slightly differentiated. Signup and view all the answers

What effect does product differentiation have on a monopolistic competitive firm's pricing strategy?

Firms can raise prices without losing all customers. Signup and view all the answers

Why do firms in monopolistic competition face a downward sloping demand curve?

They have some degree of pricing power due to differentiation. Signup and view all the answers

What limits the market power of firms in monopolistic competition?

Large number of close substitutes. Signup and view all the answers

What aspect of knowledge is typically imperfect in monopolistic competition?

Knowledge of price variations in the market. Signup and view all the answers

Which of the following businesses is an example of a monopolistic competitive firm?

A local family-owned bakery. Signup and view all the answers

Study Notes

Equilibrium Output and Profit Maximization

Firms aim to maximize profits, which influences their equilibrium output based on production costs (MC) and revenue (AR).
Changes in cost and demand conditions will impact the output levels of profit-maximizing firms.

Short Run Supernormal Profit in Perfect Competition

In a perfectly competitive market, firms can earn supernormal, normal, or subnormal profits in the short run.
Supernormal profit occurs when Average Revenue (AR) exceeds Average Cost (AC).
The profit-maximizing output is achieved when Marginal Cost (MC) equals Marginal Revenue (MR), depicted as Qe.
The area of supernormal profit is represented graphically as the shaded area (APEB) where total revenue (TR) is greater than total cost (TC).

Shutdown Decision in Monopoly

Monopolists will only continue production if total revenue covers total variable costs.
The shutdown condition applies similarly across all market structures, including monopolies and perfectly competitive firms.

Long Run Profit in Monopoly

Monopolies can sustain supernormal profits in the long run due to high barriers to entry which prevent new firms from entering the market.
If a monopolist earns supernormal profits in the short run, these profits can persist in the long run, conditioned by consistent demand and cost conditions.

Mutual Interdependence in Oligopoly

Oligopolistic markets are characterized by a few large firms where the actions of one firm significantly impact competitors.
Firms in oligopoly must account for rivals' potential reactions when making business decisions, leading to mutual interdependence and high rival consciousness.

Product Differentiation in Oligopoly

Products in oligopoly can be either homogeneous (e.g., crude oil) or differentiated (e.g., automobiles).
Regardless of product type, firms set prices and face less price elasticity due to limited substitutes available in the market.

Imperfect Knowledge in Oligopoly

Imperfect knowledge exists in oligopolistic markets where buyers lack awareness of price and quality differences.
Potential competitors are also uninformed regarding technology, input costs, and profit margins.

Competitive vs. Collusive Behavior in Oligopoly

Oligopolists decide between colluding (acting together as a monopoly) to maximize joint profits or competing to increase their market share.
Both strategies contribute to price rigidity, where firms avoid engaging in intense price competition.

Kinked Demand Curve Model

The kinked demand curve describes that rival firms will match price decreases but not price increases, leading to a rigid price structure in competitive oligopolies.
This model predicts stability in pricing despite changes in demand or costs.

Characteristics of Monopolistic Competition

Comprises many small firms with negligible market impact by any single firm, akin to perfect competition.
Firms operate independently, making pricing and output decisions without significant competitor influence.

Product Differentiation in Monopolistic Competition

Firms produce slightly differentiated products, which may vary in packaging, quality, and branding.
Each firm has some pricing control, enabling price increases without losing all customers due to available close substitutes, although competition limits market power.

Imperfect Knowledge in Monopolistic Competition

Consumers may not be fully aware of price differences in the market, illustrating the presence of imperfect knowledge similar to other competition structures.

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Description

Explore the dynamics of firms under perfect competition and how changes in production costs and revenue influence equilibrium output. This quiz delves into the concepts of profit maximization and market conditions affecting firm decisions.