Micro Chapter 7-11 PDF
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This document contains a sample exam covering microeconomics chapters 7-11. It includes multiple-choice questions, problem-solving exercises, and short-answer questions focusing on concepts such as explicit and implicit costs, production in the short run, and firm behavior in a perfectly competitive market.
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Micro Chapter 7-11 Sample Exam: Microeconomics Chapters 7-11 Multiple Choice Questions (MCQs) 1. A firm’s economic profit includes: o A) Explicit costs only o B) Implicit costs only o C) Both explicit and implicit costs o D) None of the above...
Micro Chapter 7-11 Sample Exam: Microeconomics Chapters 7-11 Multiple Choice Questions (MCQs) 1. A firm’s economic profit includes: o A) Explicit costs only o B) Implicit costs only o C) Both explicit and implicit costs o D) None of the above Solution: C) Economic profit considers both explicit and implicit costs. 2. In the short run, which of the following is fixed? o A) Technology o B) Capital o C) Labour o D) Production Solution: B) Capital is typically fixed in the short run. 3. What is true about a firm’s marginal cost (MC)? o A) It decreases indefinitely as output increases. o B) It intersects the average total cost (ATC) curve at ATC’s minimum point. o C) It is always greater than average variable cost (AVC). o D) It is constant across all output levels. Solution: B) The marginal cost curve intersects the ATC curve at its minimum. 4. In a perfectly competitive market: o A) Firms have significant market power. o B) Products are differentiated. o C) Firms are price takers. o D) Entry and exit are restricted. Solution: C) Firms in perfect competition are price takers. 5. Diminishing marginal returns occur when: o A) Each additional worker increases output at a decreasing rate. o B) Total product begins to decline. o C) Marginal cost falls below average cost. o D) The firm expands production in the long run. Solution: A) Diminishing returns happen as each additional input adds less to output. Problem-Solving Questions 6. Calculate explicit and implicit costs: Total Revenue: $500,000 Wages: $200,000 Rent: $105,000 Depreciation: $25,000 Owner’s opportunity cost of time: $80,000 Risk-free return on owner’s capital: $15,000 a) What are the explicit costs? b) What are the implicit costs? Solution: o Explicit costs: $200,000 (Wages) + $105,000 (Rent) + $25,000 (Depreciation) = $330,000 o Implicit costs: $80,000 (Opportunity cost) + $15,000 (Risk-free return) = $95,000 7. Graph the cost curves: Given the following data, graph the marginal cost (MC), average variable cost (AVC), and average total cost (ATC): o Total Fixed Costs: $50 o Total Variable Costs: $100, $200, $400, $600 (for 1, 2, 3, 4 units of output) Solution: o Calculate AVC = TVC/Q, ATC = (TFC + TVC)/Q, and MC = ΔTVC/ΔQ. o Use these values to plot curves. True/False Questions 8. A monopolist produces where price equals marginal cost. Solution: False. A monopolist produces where marginal revenue equals marginal cost. 9. In the long run, firms in monopolistic competition make zero economic profits. Solution: True. Free entry and exit erode economic profits in the long run. 10. Price discrimination is only possible in markets with homogeneous goods. Solution: False. Price discrimination requires a downward-sloping demand curve and the ability to segment consumers. Would you like additional sections, such as essays or short-answer questions? 4o You said: yes provide short answer as well ChatGPT said: ChatGPT Short Answer Questions 1. Explain the difference between accounting profit and economic profit. Solution: Accounting profit is calculated as total revenue minus explicit costs, which are the direct, out-of-pocket expenses like wages, rent, and materials. Economic profit includes both explicit costs and implicit costs (opportunity costs). It provides a more comprehensive measure of a firm's profitability by accounting for the value of foregone alternatives. 2. Why does a perfectly competitive firm produce where price equals marginal cost in the short run? Solution: In a perfectly competitive market, price equals marginal revenue because firms are price takers. To maximize profits, firms produce where marginal revenue equals marginal cost (MR = MC). Since MR = price in perfect competition, the profit-maximizing condition simplifies to price = marginal cost. 3. What causes a monopoly to experience deadweight loss? Solution: A monopoly creates deadweight loss because it restricts output to raise prices above marginal cost. This reduces the quantity produced below the socially optimal level (where price equals marginal cost), leading to a loss of total surplus that neither the producer nor consumers gain. 4. Define the law of diminishing returns and give a real-world example. Solution: The law of diminishing returns states that as additional units of a variable input (e.g., labor) are added to fixed inputs (e.g., capital), the marginal product of the variable input eventually decreases. Example: In a factory with a fixed number of machines, adding more workers initially increases production, but after a point, overcrowding and inefficiency lead to smaller gains in output per worker. 5. How does price discrimination increase a monopolist’s profits? Solution: Price discrimination allows a monopolist to charge different prices to different groups of consumers based on their willingness to pay. By capturing more consumer surplus, the monopolist increases its total revenue and profits. This is feasible only when the monopolist can prevent resale and segment the market effectively. Chapter 7 Organization of Firms Firms come in six basic types: 1. Single proprietorships 2. Ordinary partnerships 3. Limited partnerships 4. Corporations 5. State-owned (“Crown”) corporations 6. Non-profit organizations 7.1 What Are Firms? Some firms are transnational corporations (TNCs), or often called multinational enterprises (MNEs). Firms use financial capital — equity and debt. A firm acquires funds from its owners in return for stocks, shares, or equity (as they are variously called). Profits may be distributed as dividends, or may be retained. A firm’s creditors are lenders — using debt instruments or bonds. Goals of Firms Economists usually make two key assumptions about firms: 1. Firms are assumed to be profit-maximizers 2. Each firm is assumed to be a single, consistent, decision-making unit Based on these assumptions, economists can predict the behaviour of firms in various situations. But are firms interested in more than just profits? 7.2 Production, Costs, and Pro Production Firms use four types of inputs for production: 1. Intermediate products 2. Inputs provided directly by nature 3. Inputs provided directly by people, such as labour services 4. Inputs provided by the services of physical capital (machines). The production function relates inputs to outputs. It describes the technological relationship between the inputs that a firm uses and the output that it produces. Remember that production is a flow: it is a number of units per period of time. In simple functional notation we have: q = f(L,K) Costs and Profits Unlike the accounting definition of profit, economic profit includes the (implicit) opportunity cost of the owner’s time and capital in the firm’s costs. Economic profit includes both implicit and explicit costs. Economic profits are therefore less than accounting profits. If economic profit is positive, then the owner’s capital is earning more than it could in its next best alternative use. Total Revenues ($) 500 000 Total Costs ($) - wages and salaries 200 000 - risk-free return of 6% on owners' capital of 250 000 15 000 - rent 105 000 - depreciation of capital equipment 25 000 - risk premium of 8% on owners' capital of 250 000 20 000 - intermediate inputs 150 000 - forgone wages of owners in alternative employment 80 000 - interest on bank loan 10 000 Profit-Maximizing Output A firm’s economic profit is equal to total revenues minus total (economic) costs: p = TR - TC What happens to profits as output changes depends on what happens to both revenues and costs. Time Horizons for Decision Making The short run is a length of time over which some of the firm’s factors of production are fixed - typically capital is fixed in the short run The long run is the length of time over which all of the firm’s factors of production can be varied, but its technology is fixed. The very long run is the length of time over which all the firm’s factors of production and its technology can be varied. Multiple Choice Total Revenues ($) 500 000 Total Costs ($) - wages and salaries 200 000 - risk-free return of 6% on owners' capital of 250 000 15 000 - rent 105 000 - depreciation of capital equipment 25 000 - risk premium of 8% on owners' capital of 250 000 20 000 - intermediate inputs 150 000 - forgone wages of owners in alternative employment 80 000 - interest on bank loan 10 000 The explicit costs for this family-owned firm are A) $500 000. B) $605 000. C) $490 000. D) $505 000. E) $115 000. The implicit costs for this family-owned firm are A) $115 000. B) $35 000. C) $80 000. D) $490 000. B) E) $100 000. Multiple Choice The choices listed below involve costs to the firm. For which is the implicit cost potentially different than its explicit cost? A) The services of hired workers. B) The use of firm-owned assets. C) The purchase of raw materials used in production. D) The use of rented land. E) The interest paid on borrowed money. 7.3 Production in the Short R Total, Average, and Marginal Products Total product (TP) is the total amount of output that is produced during a given period of time. Average product (AP) is the total product divided by the number of units of the variable factor used to produce it (usually thought of as labour): AP = TP / L Diminishing Marginal Product The law of diminishing returns: As more workers are added to a production process, each can specialize in one task, and the workers’ marginal product initially rises. But if there is a fixed amount of physical capital, eventually the marginal product is likely to fall. APPLYING ECONOMIC CONCEPTS 7- 2 Three Examples of Diminishing Returns The Average–Marginal Relationship ==> the AP curve slopes upward as long as the MP curve is above it (and AP slopes downward when MP is below it). If an additional worker’s output raises the average product, the MP must exceed AP. Similarly, if the marginal worker’s output reduces the average product, the MP must be less than the AP. It follows that the MP curve must intersect the AP curve at its maximum point.` Multiple Choice Consider a firm in the short run. If the AP curve is rising, then the MP curve A) must be falling. B) can be either above or below the average-product curve, although it must be rising over the entire range. C) must lie below the average-product curve over this range. D) must lie above the average-product curve over this range and must also be rising. E) must lie above the average-product curve over this range Multiple Choice Which of the following statements about the relationship between marginal product and average product is correct A) When average product exceeds marginal product, marginal product must be rising. B) When marginal product exceeds average product, average product must be rising C) When marginal product is falling, average product is falling. D) Average product equals marginal product at marginal product's lowest point. E) Average product equals marginal product when marginal product is at its maximum. Multiple Choice In the short run, the firm's product curves show A) TP begins to decrease when AP begins to decrease. B) TP is at its maximum when MP is at its maximum. C) AP is at its minimum when MP = AP. D) when MP < AP, AP is increasing. E) when the MP curve cuts the AP curve from above, the AP curve begins to fall Multiple Choice Diminishing marginal product of labour is said to exist when there is A) a reduction in the level of labour input that causes output to increase. B) an increase in the division and specialization of labour. C) technological advancement. D) a successively smaller increase in output with each successive unit increase in labour input E) an increase in the amount of capital available for each unit of labour. Marginal cost (MC) is the increase in total cost resulting from increasing output by one unit. Because fixed costs do not vary with output, the only part of TC that changes is the variable cost. MC = DTC DQ Why U-Shaped MC and AVC Curves? Eventually diminishing AP of the variable factor implies an eventually rising AVC. ==> AVC is at its minimum when AP reaches its maximum. Eventually diminishing MP of the variable factor implies eventually rising MC. ==> MC reaches its minimum when MP reaches its maximum. Key idea: Each additional worker adds the same amount to total cost but a different amount to total output. Capacity The level of output that corresponds to the minimum short-run ATC is the capacity of the firm. Capacity is the largest output that can be produced without encountering rising average cost per unit. A firm that is producing at an output less than the point of minimum ATC is said to have excess capacity. EXTENSIONS IN THEORY 7-1 Idle Capital Equipment and Flat Cost Curves Multiple Choice A firm's short-run cost curves, as conventionally drawn, show that A) AFC increases as output increases. B) ATC decreases and then increases as output increases C) ATC = TFC + TVC. D) the MC curve intersects the AVC and ATC curves at their maximum points. E) AVC decreases as long as MC > AVC. Multiple Choice In the short run, when capital is a fixed factor, a rise in the cost of labour A) shifts the AVC curve down. B) leaves the ATC curve unchanged. C) leaves the MC curve unchanged. D) shifts the marginal cost curve upwards E) shifts the total product curve downwards. Q1: A firm characterized as having one owner-manager who is personally responsible for all aspects of the business is a ________. 1A) limited partnership 2B) single proprietorship 3C) state-owned enterprise 4D) corporation Q2: The theory of the firm is based on the assumption that firms attempt to maximize ________. 1A) employment 2B) revenue 3C) output 4D) profits Q3: Accounting profits minus implicit costs equals ________. 1A) total revenues 2B) economic profits 3C) explicit costs 4D) fixed and variable costs Copyright © 2011 Pearson Canada Inc. Q4: It is always true that ________. 1A) accounting profits are positive 2B) economic profits exceed accounting profits 3C) economic profits are positive 4D) accounting profits exceed economic profits Q5: A period of time in which the quantity of some inputs cannot be changed is known as the ________. 1A) short run 2B) long run 3C) intermediate run 4D) very long run Q6: The long run is the period of time in which ________ of a firm’s factors of production can be varied but technology is fixed. 1A) none 2B) some 3C) all 4D) most Q7: Diminishing marginal returns means that ________. 1A) total product is diminishing 2B) marginal product is negative 3C) total product is rising at a diminishing rate 4D) marginal product is zero Q9: Total variable cost equals ________. 1A) total fixed cost (TFC) – total costs 2B) total costs (TC) + total fixed costs (TFC) 3C) total costs (TC) – total fixed costs (TFC) 4D) total costs (TC) ÷ output (Q) Q10: Average fixed costs ________ as output increases. 1A) rise and then fall 2B) continually rise 3C) are constant 4D) continually fall Q12: If marginal costs (MC) are rising then ________. 1A) average product (AP) must be rising 2B) average total costs (ATC) must be rising 3C) marginal product (MP) must be falling 4D) marginal product (MP) must be rising Q13: TC = ________. 1A) TFC – TVC 2B) AFC × Q 3C) TVC + TFC 4D) MC/Q Q14: TFC = ________. 1A) TVC/Q 2B) AFC × Q 3C) TVC + MC 4D) MC/Q Q15: ATC = ________. 1A) TVC/Q 2B) TC/Q 3C) TVC + MC 4D) MC/Q Copyright Q16: MC = ________. 1A) ΔTC/ ΔL 2B) TC/Q 3C) TVC/Q 4D) ΔTC/ ΔQ Q17: You have written three tests and have a current average of 80%. In order to increase your test average, the mark on test four must ________. 1A) be higher than the mark on test three 2B) be higher than the mark on all previous tests 3C) be higher than 80% 4D) be equal to 80% Chapter 8 Producers in the Long Run Copyright © 2011 Pearson Canada Inc. In the long run, all inputs are variable. Firms strive for both technical efficiency and economic efficiency. Concepts of efficiency used by economists differ from those used by other professionals, especially engineers. For a detailed explanation of the differences, look for Explaining Different Concepts of Efficiency in the Additional Topics section of this book’s MyEconLab. www.myeconlab.com 8.1 The Long Run: No Fixed Factors Multiple Choice By expressing the cost-minimizing condition as MPK/MPL = PK/PL, we are able to see A) how the firm can adjust the marginal products of the factors of production to the prices of the factors given by the market B) that the ratio of factor prices is constant over time. C) that the capital-labour ratio is fixed. D) how the firm determines its profit-maximizing output. E) that the firm is producing at a lower cost if the left- hand side of the equation is greater than the right- hand side. Multiple Choice 6 of 15 A profit-maximizing firm will increase its use of capital and decrease its use of labour when the A) total product of capital is higher than the total product of labour. B) average product of capital is higher than the average product of labour. C) marginal product of capital is higher than the marginal product of labour. D) marginal product of capital, per dollar spent on capital, is less than the marginal product of labour, per dollar spent on labour. E) marginal product of capital, per dollar spent on capital, is greater than the marginal product of labour, per dollar spent on labour Multiple Choice 7 of 15 A cost-minimizing firm will increase its use of labour and decrease its use of capital when the A) marginal product of capital is higher than the marginal product of labour. B) total product of capital is higher than the total product of labour. C) marginal product of capital, per dollar spent on capital, is less than the marginal product of labour, per dollar spent on labour D) marginal product of capital, per dollar spent on capital, is greater than the marginal product of labour, per dollar spent on labour. E) average product of capital is higher than the average product of labour. Long-Run Cost Curves When all factors of production can be varied, consider the least-cost method of producing any level of output. The long-run average cost (LRAC) curve separates unattainable and attainable cost levels, given technology and factor prices. The LRAC curve is usually U-shaped. When output exceeds qM , the firm has rising unit costs. Such an increasing-cost firm is said to encounter decreasing returns to scale. This results from either difficulties in managing and controlling an enterprise as its size increases. Note: Decreasing returns to scale (LR) is not the same as diminishing marginal returns (SR). Shifts in LRAC Curves Changes in technology and factor prices cause the long-run cost curve to shift. A rise in factor prices shifts the LRAC curve upward. A fall in factor prices or a technological improvement shifts the LRAC curve downward. Multiple Choice 13 of 15 The long-run average cost curve is an envelope curve, with each point associated with a short-run average cost curve A) lying below it. B) at its minimum point. C) crossing that point from above. D) tangent at that point E) intersecting that point. Multiple Choice 14 of 15 Increasing returns to scale A) means that output rises proportionately more than inputs, resulting in lower per unit costs in the long run B) means that output rises proportionately less than inputs, increasing per unit cost of production in the short run. C) implies that the long-run average cost curve is shifting downward. D) means that output rises proportionately more than inputs, resulting in increasing per unit costs. E) has the same meaning as increasing costs of production. Multiple Choice 15 of 15 Assume a firm is using 10 units of capital and 10 units of labour to produce 10 widgets per hour. By doubling both inputs the result is a doubling of output. This firm is experiencing A) diseconomies of scale. B) decreasing returns. C) increasing costs. D) constant returns to scale E) economies of scale. Multiple Choice 16 of 15 If there is an improvement in the firm's technology, A) both the long-run and short-run average cost curves will shift downward B) the firm will move to a lower point on its long-run average cost curve only. C) there will be no change in the cost curves in the long run. D) there will be a downward shift in the long-run average cost curve but not in the short-run average cost curve. E) the firm will move to a lower point on both its long- run and short-run average cost curves. 8.2 The Very Long Run: Changes in Technology Technological change refers to all changes in the available techniques of production. Economists use the notion of productivity to measure the extent of technological change. Technological Change Changes in technology are often endogenous responses to changing economic signals. Three kinds of changes in the very long run: 1. New techniques – process innovation 2. New inputs 3. New products – product innovation Firms’ Choices in the Very Long Run Faced with increases in the price of an input, firms may either substitute away (LR) or innovate away (VLR) from the input. APPLYING ECONOMIC CONCEPTS 8- 2 Substitution & Innovation with Automated Teller Machines (ATMs) These two options can involve different actions and can have different implications for productivity. Multiple Choice Movement from one point to another along an isoquant implies a change in A) output levels, holding factor combinations constant. B) the level of output, independent of what happens to factor combinations. C) factor combinations, holding output constant D) product prices. E) money income. 29 of 15 Multiple Choice Movement from one point to another along an isocost line implies a change in A) output levels, holding factor combinations constant. B) expenditure. C) factor combinations, holding expenditure constant D) the level of output, independent of what happens to factor combinations. E) factor prices. 30 of 15 Multiple Choice Isoquants are usually drawn convex when viewed from the origin, reflecting the standard assumption A) the positive marginal productivity of all factors. B) that both factors are subject to the law of diminishing returns C) that the variable factor is subject to the law of diminishing returns. D) negative marginal productivity of all factors. E) that both factors are subject to increasing returns. 31 of 15 Q1: In the long run, a firm can vary ________. 1A) capital only 2B) labour only 3C) neither capital or labour 4D) both capital and labour Q2: When a given number of inputs are combined in such a way to maximize the level of output, a firm is achieving ________. 1A) allocative efficiency 2B) revenue maximization 3C) productive (technical) efficiency 4D) economies of scale Q3: The necessary condition for cost minimization is ______. 1A) MPK / PK > MPL / PL 2B) MPL/ MPK = PK / PL 3C) MPK / PK = MPL / PL 4D) MPK / PK < MPL / PL Q4: If at the current level of output, MPK / PK < MPL / PL then the firm should ________. 1A) hire more labour and less capital 2B) hire more capital and less labour 3C) not adjust the quantities of capital and labour 4D) hire more capital and more labour Q5: If at the current level of output, MPK / PK = MPL / PL and the price of labour falls, the firm should ________. 1A) substitute labour for capital 2B) substitute capital for labour 3C) keep the quantities of capital and labour constant 4D) increase capital and labour in equal proportions Q10: A fall in factor prices or a technological improvement shifts the LRAC curve ________. 1A) upward 2B) to the left 3C) to the right 4D) downward Q11: Total output divided by the quantity of labour used measures ________. 1A) returns to scale 2B) minimum efficient scale 3C) the productivity of labour 4D) the productivity of capital Q12: The invention of new production techniques and the development of new and better inputs lead to ________. 1A) an upward shift in LRAC 2B) a downward shift in LRAC 3C) no shift in LRAC 4D) an upward shift in SRATC Q13: A period of time that is long enough for technological possibilities available to a firm to change is known as ________. 1A) the short run 2B) the long run 3C) the intermediate run 4D) the very long run Chapter 9 Competitive Markets Competitive Market Structure The competitiveness of the market — the influence that individual firms have on market prices. The less power an individual firm has to influence the market price, the more competitive is that market’s structure. 9.1 Market Structure and Firm Behaviour Competitive Behaviour The term competitive behaviour refers to the degree to which individual firms actively vie with one another for business. Examples: 1. GM and Toyota engage in competitive behaviour but their market is not competitive. 2. Two wheat farmers do not engage in competitive behaviour but they both exist in a very competitive market. The Significance of Market Structure The demand curve faced by an individual firm may be different from the demand curve for the industry as a whole. Market structure plays a central role in determining the efficiency of the market. In this chapter we focus on competitive market structures. 9.2 The Theory of Perfect Com The Assumptions of Perfect Competition 1. All firms sell a homogeneous product. 2. Customers know the product and each firm’s price. 3. Each firm reaches its minimum LRAC at a level of output that is small relative to the industry’s total output. 4. Firms are free to exit and enter the industry. This does not mean the firm could actually sell an infinite amount at the market price. è “Normal” variations in the firm’s level of output have a negligible effect on total industry output. Multiple Choice All of the following pertain to a perfectly competitive market except which one? A) All firms have realized the possible economies of scale. B) Consumers can shop for the lowest available price. C) There is freedom of entry and exit of firms in the industry. D) Consumers prefer certain brands over others. E) All firms in the industry are price takers. Multiple Choice 12 A perfectly competitive firm's total revenue is equal to which of the following? A) the revenue received on the last unit sold. B) average revenue multiplied by price. C) marginal revenue times quantity of the product sold D) price times quantity of the product sold, divided by quantity of the product sold. E) price multiplied by marginal revenue. Multiple Choice 13 If a firm in a perfectly competitive market were to raise its price, its A) total costs would increase. B) revenue would fall to zero C) profits would increase as long as costs remained constant. D) revenue would increase if market demand were inelastic. E) revenue would decrease if market demand were elastic. Multiple Choice 14 Firms have several different concepts of revenue: total revenue, average revenue, marginal revenue, and price. For a perfectly competitive firm, which statement below is true? A) Average revenue, marginal revenue, and price are equal B) Total revenue, average revenue, marginal revenue, and price are all equal. C) Only average revenue and price are equal. D) Only marginal revenue and price are equal. E) None of these revenues are equal. 9.3 Short-Run Decisions Should the Firm Produce at All? A firm should produce only if at some level of output, price exceeds AVC. At the shut-down price the firm can just cover its average variable cost, and so is indifferent between producing and not producing. Suppose p > AVC è firm does not shut down To maximize profits, the firm chooses the output where MR = MC. But for a competitive firm, MR = p: è The rule: choose output where p = MC. How Much Should the Firm Produce? But how large are each firm’s profits in this SR equilibrium? There are three possibilities: Short-Run Equilibrium in a Competitive Market When an industry is in short-run equilibrium, two things are true: - market price is such that the market clears - each firm is maximizing its profits at this price Multiple Choice In the short run, a profit-maximizing firm will expand output A) as long as marginal revenue is greater than marginal cost. B) until marginal revenue equals average variable cost. C) as long as marginal cost is greater than marginal revenue. D) until marginal cost begins to rise. E) until total revenue equals total cost. Multiple Choice Suppose a perfectly competitive firm is producing a level of output for which price equals average total cost, and average total cost is less than marginal cost. In order to maximize its profits, the firm should A) shut down. B) increase the market price. C) not change its output. D) expand its output. E) reduce its output. Multiple Choice 31 Consider a perfectly competitive firm in the following position: output = 4000 units, market price = $1, fixed costs = $2000, variable costs = $2000, and marginal cost = $1. To maximize profits the firm should A) not change its output. B) shut down. C) increase the market price. D) reduce its output. E) expand its output. 9.4 Long-Run Decisions Entry and Exit If existing firms have positive economic profits, new firms have an incentive to enter the industry. If existing firms have zero profits, there are no incentives for new firms to enter, and no incentives for existing firms to exit. If existing firms have economic losses, there is an incentive for existing firms to exit the industry. Long-Run Equilibrium The LR industry equilibrium occurs when there is no longer any incentive for entry or exit (or expansion). In long-run equilibrium, all existing firms: must be maximizing their profits. are earning zero economic profits. are not able to increase their profits by changing the size of their production facilities. Consider a competitive industry that is in long-run equilibrium. Now suppose that the market demand for the industry’s product increases. The price will rise, and profits will rise. Entry will then occur, and price will eventually fall. But what will the new long-run equilibrium look like? Changes in Technology Suppose technological development reduces the costs for newly built plants. New plants will earn economic profits, expand industry output and drive down price. The price will fall until it is equal to the SRATC of the new plants. Old plants may continue, but will earn losses. They will eventually exit. Declining Industries What happens when a competitive industry in LR equilibrium experiences a continual decrease in demand? The e]icient response is to continue operating with existing equipment as long as variable costs of production can be covered. As demand shrinks, so will capacity. Antiquated equipment in a declining industry is often the e]ect rather than the cause of the industry’s decline. Multiple Choice 44 If firms in a competitive industry are earning positive economic profits, in the long run we expect A) the supply curve for the product will shift to the right as new firms enter the industry, causing industry output to increase and price to fall. B) there would be no change in the industry as long as P = MC for the individual firms. C) the government would intervene and force the firms to lower prices. D) the demand curve for the product will shift to the left, so that the price of the product will fall. E) the individual firms will lower their price to discourage new firms from entering the industry. Multiple Choice 45 Which of the following statements about a perfectly competitive industry in long-run equilibrium is true? A) Each firm is producing at the minimum point on its LRAC curve. B) Losses are tolerable because of high fixed costs. C) In order to stay in the industry each firm is making an economic profit. D) Firms must exhibit economies of scale. E) Individual firms will have no incentive for technological improvement. Q2: Perfectly competitive firms sell products that are ________. 1A) complements 2B) similar 3C) identical 4D) di]erent Q3: Long-run profits in perfectly competitive industries will not exist because of ________. 1A) homogeneous products 2B) price takers 3C) easy entry/exit 4D) consumer knowledge of prices Q4: If a perfectly competitive firm were to raise its price above the market price, it would ________. 1A) sell slightly less than at the market price 2B) sell significantly less than at the market price 3C) sell slightly more than at market price 4D) sell nothing Q6: Given that the firm should produce, a perfectly competitive firm will maximize profits by choosing a quantity where ________. 1A) MR > MC 2B) MR < MC 3C) MR = MC 4D) P > MC Copyright © 2011 Pearson Canada Inc. Q10: In the short run, each firm in a perfectly competitive industry takes the price as given and produces a level of output that aims to _______. 1A) maximize revenues 2B) minimizing total costs 3C) maximize profits 4D) minimize average total costs Q15: In the long-run, a firm will leave the industry unless ________. 1A) price at least covers average variable cost 2B) price at least covers marginal cost 3C) price at least covers average fixed cost 4D) price at least covers average total cost Q18: In the short run, a firm will continue to operate as long as ________. 1A) price at least covers average variable cost 2B) price at least covers marginal cost 3C) price at least covers average fixed cost 4D) price at least covers average total cost Chapter 10 Monopoly, Cartels, and Price Discrimination Copyright © 2011 Pearson Canada Inc. Revenue Concepts for a Monopolist A monopolist faces the (downward-sloping) market demand curve. If the monopolist charges the same price for all units sold, its total revenue (TR) is: TR = p x Q 10.1 A Single-Price Monopolist Average revenue (AR) is total revenue divided by quantity: AR = TR/Q = (p x Q)/Q = p Marginal revenue (MR) is the revenue resulting from the sale of an additional unit of production: The monopolist must reduce the price to increase its sales – therefore the MR curve is below the demand curve. MR = DTR/ DQ Unlike a competitive firm, the monopolist does not have a supply curve because it chooses its price. Can we compare the monopoly outcome to the competitive outcome? In a perfectly competitive industry price equals MC. But a monopolist produces at a lower level of output, with price exceeding MC. Multiple Choice One similarity between a monopolist and a perfectly competitive firm is that both A) can make economic profits in the long run. B) may have similarly shaped cost curves C) need to know the shape of the market demand curve. D) choose the price at which to sell their product. E) are large relative to their markets. Multiple Choice For a single-price monopolist, marginal revenue falls faster than price (as output rises) because A) in order to sell additional units, the price must be lowered on all units B) profits are maximized when marginal cost equals marginal revenue. C) the cost of producing extra units of output increases as production is increased. D) the firm has no supply curve. E) none of the above -- marginal revenue does not fall faster than price. Multiple Choice A monopolist will be earning positive economic profits A) at all times, since it controls the market. B) when price equals marginal cost. C) whenever marginal revenue is positive. D) when price exceeds average total cost E) whenever marginal revenue equals marginal cost. Entry Barriers and Long-Run Equilibrium Despite incentives to enter, effective entry barriers allow monopoly profits to persist in the long run. Entry barriers are of two types: - “natural” – such as economies of scale - “created” – by advertising campaigns, or – by government regulation, or _ by patents The Very Long Run and Creative Destruction In the very long run, technological changes and innovations can circumvent effective entry barriers. Joseph Schumpeter defended monopoly on the basis that the pursuit of monopoly profits provides incentives to innovate. Multiple Choice 16 Natural barriers to entry include A) a patent which allows production by only the patent holder. B) large economies of scale in the industry C) control or ownership of the entire supply of an essential raw material. D) increasing-cost production. E) a government-awarded franchise. Any one firm within the cartel has an incentive to cheat. But if all firms cheat, the price will fall back toward the competitive level, and joint profits will not be maximized. Enforcing output restrictions and preventing entry are di]icult. Thus, cartels rarely last for long. Multiple Choice 20 Suppose all of the firms in a perfectly competitive industry form a cartel and agree to restrict output, thereby raising the price of the product. Individual Firm A will gain the most from the existence of the cartel if A) Firm A restricts output, while the other firms do not. B) all firms, except Firm A, cooperate and restrict output C) all firms, including A, cooperate and restrict output. D) all firms revert back to their competitive outputs. E) no firms restrict output. Price Discrimination A producer practices price discrimination by charging different prices for the same product that have the same cost. Central to this is that different consumers value the product by different amounts. Price Discrimination Any firm facing a downward-sloping demand curve can increase profits if it is able to price discriminate. When Is Price Discrimination Possible? 1. When firms have market power. 2. When consumers differ in their valuations of the product. 3. When firms can prevent arbitrage. Hurdle pricing Firms create obstacle that consumers must overcome to get a lower price The Consequences of Price Discrimination Price discrimination increases firms’ profits (otherwise they wouldn’t do it!). For price discrimination by the unit, firms will often increase their output and overall efficiency will increase. The effect on consumers is unclear – they may lose consumer surplus, but they could also gain surplus (if output increases as a result). Q1: A monopoly is a market containing ________. 1A) many small firms 2B) a few large firms 3C) many large firms 4D) a single firm Q2: The monopoly firm faces a demand curve that is ________. 1A) horizontal 2B) vertical 3C) downward sloping 4D) upward sloping Q3: For a monopolist, marginal revenue (MR) ________. 1A) = price 2B) < price 3C) > price 4D) is unrelated to price Q4: For a monopolist, marginal revenue ________. 1A) is always positive 2B) is always negative 3C) is always positive or negative 4D) can be positive, negative, or zero Q5: Assuming the monopoly firm does produce, the profit-maximizing monopolist will choose a level of output so ________. 1A) P = MR 2B) MC = ATC 3C) MR = MC 4D) P = ATC Q7: A monopolist will eventually go out of business if ________. 1A) P > MR 2B) MR < ATC 3C) P < ATC 4D) ATC > AVC Q10: The principal reason why a monopolist is likely to enjoy profits in the long run is ________. 1A) marginal cost pricing 2B) price exceeding marginal revenue 3C) barriers to entry 4D) constant long-run average costs Q11: When an industry is a natural monopoly, _______. 1A) the economies of scale are great 2B) it faces a perfectly elastic demand curve 3C) long-run average costs are increasing 4D) profits are a certainty Q13: Cartels tend to be unstable because there exists incentives for firms to ________. 1A) violate output restrictions 2B) lower the price 3C) lower the price and violate output restrictions 4D) produce an ever-declining level of output Chapter 11 Imperfect Competition and Strategic Behaviour Copyright © 2011 Pearson Canada Inc. Industries with Many Small Firms Industries with a Few Large Firms The perfectly competitive model does not adequately explain many industries that have a large number of relatively small firms. Most modern industries that are dominated by large firms contain several firms. These are not competitive markets. 11.1 The Structure of the Canadian Economy Industrial Concentration The concentration ratio measures economic power in an industry and shows the market shares of the largest 4 or 8 producers. Defining a market with reasonable accuracy is difficult. Sometimes the market is much smaller than the whole country. Other times, it is much larger than the entire country. Due to globalization, a lone firm in one Canadian industry may be competing with foreign firms operating in Canada. The ongoing forces of globalization have been changing the world economy for centuries. For more information on how relatively recent advances in transportation and communications technologies have led to changes in the location of production and the nature of competition, look for The Nature of Globalization in the Additional Topics section of this book’s MyEconLab. www.myeconlab.com 1.2 What Is Imperfect Competit Firms Choose Their Products A differentiated product: a group of products that are similar enough to be called the same product but different enough that they can have different prices. Most firms in imperfectly competitive markets sell differentiated products: - laundry soaps, beer, cars, running shoes Firms Choose Their Prices Typically, firms are price setters. Often, these prices vary only slowly over time. Firms often let output vary in response to demand shocks to avoid costs of changing prices (unless the shock is long- lasting). Non-price Competition Imperfectly competitive firms typically engage in behaviour that is absent in either monopoly or perfect competition: firms often spend large sums of money on advertising firms often engage in non-price competition firms may create entry barriers to prevent erosion of current pure profits Two Market Structures The preceding discussion applies in general to imperfectly competitive market structures. Industries with a large number of small firms — the theory of monopolistic competition. Industries with a small number of large firms — the theory of oligopoly (which involves game theory). A key difference: strategic behaviour displayed by firms. 11.3 Monopolistic Competitio The Assumptions of Monopolistic Competition 1. Each firm produces one variety of the differentiated product. Thus, it faces a negatively sloped and highly elastic demand curve. 3. The industry contains so many firms that each one ignores competitors when making price and output decisions. 4. Firms are free to enter and exit the industry. 2. All firms have access to the same technology and thus have the same cost curves. In contrast to perfect competition, the LR equilibrium in monopolistic competition does not minimize ATC — there is excess capacity. This excess capacity may not be wasteful if consumers value product variety. Society faces a tradeoff between product variety and lower cost per unit. Empirical Relevance of Monopolistic Competition The theory of monopolistic competition is useful for analyzing industries with low concentration ratios and differentiated products: - restaurants - clothes - hair stylists - mechanics Multiple Choice 18 Compared with perfect competition, monopolistic competition results in A) fewer varieties of the good produced at lower unit costs. B) a wider variety of the good produced at higher unit cost C) fewer varieties of the good produced at higher unit costs. D) the same degree of variety of the good, but higher unit costs. E) a clearly more efficient social outcome. Multiple Choice 19 A monopolistically competitive firm maximizes profits in the short run A) by maximizing total revenue. B) by equating MC with price. C) when P = AVC. D) by equating MC with MR E) when P = ATC. 11.4 Oligopoly and Game Theo Oligopoly: an industry containing two or more firms, at least one of which produces a significant portion of the industry’s total output. An oligopolistic firm faces only a few competitors. è Strategic behaviour is central to their actions. The Basic Dilemma of Oligopoly Oligopolistic firms will make more joint profits if they cooperate, or collude. But each individual firm may make more profits if it “cheats”. How could firms reach a cooperative outcome to maximize their joint profits? Game theory is used to study decision making in such situations — each player takes account of the others’ expected reactions when making a move. Some simple game theory The players are firms, their strategies are the price or output decisions, and their payoffs are profits. Consider a simplified duopoly in which two firms choose to cooperate or compete: Compete: produce 2/3 of the monopoly output — yields high output and low price Cooperate: produce 1/2 of the monopoly output — yields low output and high price Oligopoly in Practice Types of Cooperative Behaviour When firms agree to cooperate in order to restrict output and raise prices, their behaviour is called collusion. explicit collusion occurs when firms formally agree - DeBeers and OPEC cooperation without explicit agreement is called tacit collusion. The Importance of Entry Barriers In the absence of natural entry barriers, oligopolistic firms must create entry barriers if they are to earn profits in the long run. Brand Proliferation as an Entry Barrier A large number of differentiated products leaves small market share available to a new firm. This is one explanation for many varieties of a product being produced by the same firm. Advertising as an Entry Barrier Heavy advertising can force an “outside” firm to spend heavily on its own advertising. If the “outside” firm had a low MES, the new advertising costs may result in a much higher MES è deters entry. Predatory Pricing A firm will not enter a market if it expects continued losses after entry. The existing firm loses profits, but it also discourages potential future rivals. Existing firms can create such an expectation by keeping prices below their own costs until the entrant goes bankrupt. Oligopoly and the Economy Temporary changes in demand lead to more price volatility in competitive markets than in oligopoly markets. Permanent changes in demand, however, lead to similar adjustments in both market structures. Oligopoly is an important market structure in modern economies because there are many industries in which the MES is simply too large to support many competing firms. the market. Q1: The fraction of total market sales controlled by a specified number of the industry’s largest firms is known as ________. 1A) imperfect competition 2B) the cooperation ratio 3C) the concentration ratio 4D) the monopoly ratio Copyright © 2011 Pearson Canada Inc. Q2: Differentiated products refers to a group of commodities that are similar enough to be called the same product, but dissimilar enough to be ________. 1A) easily distinguishable in quality 2B) easily identified as different 3C) sold at different prices 4D) only sold in separate stores Q3: Advertising is more prevalent in monopolistic competition than it is for a monopoly because ________. 1A) a monopoly always earns large profits 2B) a monopoly can always sell all they desire to produce 3C) a monopoly does not need to attract consumers from other brands 4D) a monopoly product is always well known of Q4: A market structure where there are many firms, freedom of entry/exit, and products that are somewhat differentiated from others is know as ________. 1A) perfect competition 2B) oligopoly 3C) monopolistic competition 4D) monopoly Q5: A firm’s ability to raise price without losing all of its sales refers to its ________. 1A) market power 2B) concentration ratio 3C) administered price 4D) tacit collusion Q10: An industry that contains two or more firms, at least one of which produces a significant portion of the industry’s total output, is known as ________. 1A) a monopoly 2B) monopolistic competition 3C) an oligopoly 4D) perfect competition Q11: The theory that studies decision-making in situations where one player anticipates the reaction of other players to its own action, is known as ________. 1A) a cooperative outcome 2B) a non-cooperative outcome 3C) game theory 4D) tacit collusion Q13: Brand proliferation, advertising, and predatory pricing can all serve as ________ in an oligopoly market. 1A) tacit collusion 2B) cooperative behaviour 3C) barriers to entry 4D) explicit collusion Q14: In an oligopoly market, a new entrant with small sales but large required advertising costs finds itself at a substantial ___________ relative to its established rivals. 1A) revenue advantage 2B) cost advantage 3C) cost disadvantage 4D) market share advantage