Econ Test 2

Identify ways a firm becomes a monopoly.

1) government blocks the entry of other firms into the market 2) the firm has control of a key resource 3) there are important network externalities in supplying the product 4) economies of scale are so large that one firm has a natural monopoly

Would a firm earning zero economic profit continue to produce, even in the long run?

A firm earning zero economic profit would continue to produce, even in the long run, because the firm's owners are earning as much as they would earn elsewhere-they are covering the opportunity cost of their investment.

Why does a local McDonald's face a downward sloping demand curve for its quarter pounders?

A local McDonald's faces a downward-sloping demand curve for quarter pounders because if it increases in price, customers will substitute aware from quarter pounders and buy something else-like burgers at Wendy's or Burger King. If a local McDonalds raises its prices, it won't lose all of its customers, however, because it might be located more conveniently than other restaurants for some people or some people might strongly prefer quarter pounders to similar products.

Why is a monopolistically competitive firm not productively efficient? In what sense does a monopolisitcally competitive firm have excess capacity?

A monopolistically competitive firm is not productively efficient because it does not produce at minimum average total cost. Excess capacity stems from the fact that when a monopollistically competitive firm produces where MR=MC, it produces a level of output that is below the quantity for which average total cost is minimized.

What are the key factors that determine the profitability of a firm in a monopolisticall competitive market?

A monopolistically competitive firm's profitability depends on its ability to differentiate its product (especially to make it seem more desirable than competitiors' products) and to produce its product at a lower average total cost than competing firms.

What is a monopoly? Can a firm be a monopoly if close substitutes for its product exist?

A monopoly is a firm that is the only seller of a good or service that does not have a close substitute. A firm can't have a monopoly if a close substitute for its product exists.

What is "natural" about a natural monopoly?

A natural monopoly arises when no one firm can supply the entire market at a lower average total cost than can two or more firms. In these cases, a firm doesn't need the government to enact a law to bar the entry of other firms, nor does it need to control a key resource.

Is it possible for a monopolistically competitive firm to continue to earn an economic profit as new firms enter the market?

Although a firm may initially continue to earn an economic profit as new firms enter the market, its economic profit will be driven to zero in the long run. by taking advantage of technological advances and by continuing to differentiate its product, a firm may again earn an economic profit, but once again entry will tend to drive a firm's economic profit to zero in the long run.

What is the law of diminishing marginal productivity? Does it apply in the long run?

At some point, adding more of a variable input, to the same amount of a fixed input will cause the marginal product of the variable input to decline. This principle doesn't apply in the long run because none of the inputs are fixed.

What is the difference between the average cost of production and marginal cost of production?

Average total cost is total cost divided by the quantity of output produced; marginal cost is the change in a firm's total cost from producing one more unit of a good or service.

What do barriers to entry have to do with the extent of competition in the industry? What is the most important reason that some industries, such as music streaming, are dominated by just a few firms?

Barriers to entry keep new firms from entering an industry, limiting the extent of competition. The most important reason why industries such as music streaming are dominated by just a few firms is economies of scale.

If you run the only hardware store in a small town, do you have a monopoly?

Because consumers in your town could buy hardware supplies on the internet or by driving to another town that has a hardware store, you would not have a monopoly under the narrow definition of the term. However, if competition from online sellers and stores in other towns was insufficient to eliminate your economic profit in the long run, you may have a monopoly in the broader sense of the term.

How does perfect competition lead to efficiency?

Consumers purchase output up to the point where price equals marginal benefit. Under perfect competition, firms produce up to the point where price equals marginal cost. Perfect competition generates an equilibrium output where marginal benefit equals marginal cost, which represents allocative efficiency. In a perfectly competitive industry, free entry and exit ensures that, in the long run, firms are producing where average costs are minimized, thereby ensuring that productive efficiency is also achieved.

What are economies of scale? Why might firms experience economies of scale?

Economies of scale exist when a firm's long run average costs fall as the firm increases output. Firms may experience economies of scale because 1) a firm's technology may allow it to increase production with a smaller proportional increase in at least one input 2) both workers and managers can become more specialized as output expands 3) large firms may be able to purchase inputs at lower costs than smaller firms can 4) as a firm expands, it may be able to borrow money at a lower interest rate, thereby lowering its costs

Distinguish between a firm's fixed costs and variable costs and give an example of each.

Fixed costs are costs that remain constant as output changes and variable costs are costs that change as output changes. An example of a fixed cost is the lease payment for a factory or retail store; an example of a variable cost is the cost of raw materials.

Give an example of a government-imposed barrier to entry. Why should a government be willing to erect barriers to firms entering an industry?

Government imposed barriers to entry include patents, occupational licenses, barriers to international trade, and public franchises. One reason governments are willing to erect barriers to entering an industry is that these barriers may improve the standard of living in the long run. Another reason is that politicians may intentionally reduce competition to aid certain firms and their employees in exchange for campaign contributions or other favors from the firms or the unions that represent their employees.

Is it possible for marginal revenue to be negative for a firm selling in a perfectly competitive market? Is it possible for marginal revenue to be negative for a firm selling in a monopolistically competitive market?

In a perfectly competitive market, marginal revenue is equal to price so marginal revenue cannot be negative because price cannot be negative. Because the marginal revenue curve is downward sloping for a monopolistically competitive firm, at a high enough level of output marginal revenue will become negative. However, firms produce where marginal revenue equals marginal cost. Because marginal cost is never negative, a monopolistically competitive firm will never produce where marginal revenue is negative.

What is the difference between a firm's shutdown point in the short run and in the long run? Why are firms willing to accept losses in the short run but not in the long run?

In the short run, a firm will shutdown if the price falls below the minimum point on its average variable cost curve. In the long run, a firm will shut down (and exit the industry) if the price is below the minimum point on its average total cost curve. In the short run, the firm is willing to accept losses because it cannot do anything about its fixed costs and must pay them whether or not it is producing anything. In the long run, however, the firm will close down and exit the industry if it expects continued losses.

What is the difference between the short run and the long run? Is the amount of time that separates the short run and long run the same for every firm?

In the short run, at least one of the firm's inputs is fixed, while in the long run, the firm can vary in all of its inputs, adopt new technology, and change the size of its physical plant; time varies from firm to firm

Explain why market power leads to deadweight loss.

Market powers allows a firm to set its price above marginal cost. If the firm had not market power, it would set its price at marginal cost, and more people would buy the good or service at that lower price. The deadweight loss is a result of the lower quantity sold. There are some customers who are not receiving the good or service even though they value that good or service more than its cost.

What effect does the entry of new firms have on the economic profit of existing firms?

New firms entering an industry cause the demand curves for the products of existing firms to shift to the left. Existing firms will sell less at every price, so their profits will decline.

What is the relationship between a monopolist's demand curve and the market demand curve? What is the relationship between a monopolist's demand curve and its marginal revenue curve?

The monopolist's demand curve is the market demand curve. The marginal revenue curve is derived from the demand curve. For a linear demand curve, the marginal revenue will be below the demand curve (and also twice as steep as the demand curve).

What is the relationship between a perfectly competitive firm's marginal cost curve and its supply curve?

The perfectly competitive firm's supply curve can be directly derived from its marginal cost curve. The firm will produce P=MC if price is at or above the shutdown point at the minimum point on the AVC curve.

When are firms likely to enter an industry? When are they likely to exit?

When firms in an industry are earning economic profits, new firms will enter the industry. When firms in an industry are suffering economic losses, some of those firms will exit the industry.

Where does the marginal cost curve intersect the average variable cost curve and the average total cost curve?

When marginal cost is below average total cost, marginal cost pulls average total cost down, so we are on the downward-sloping section of the u-shaped average total cost curve. When output expands enough, marginal cost rises to equal and then exceed average total cost. When marginal cost is above average total cost, marginal cost pulls average total cost up, so we are on the upward-sloping section of the u-shaped average total cost curve. Therefore, at the point where marginal cost equals average total cost, the average total cost curve stops sloping downward but hasn't begun sloping upward, the average total cost curve is at its lowest point where it intersects it.

What is a price taker? When are firms likely to be price takers?

a buyer or seller who is unable to affect the market price. Firms in competitive markets are price takers. Because a firm in a perfectly competitive market is very small relative to the market, and because it is selling exactly the same product as every other firm, it can sell as much as it wants to without having to lower its price. If the firm raises its price, the firm will sell nothing.

Explain why it is true that for a firm in a perfectly competitive market, P=MR=AR

a firm in a perfectly competitive market is a price taker and can sell as many units as it wishes at the market price P. By selling an additional unit, the firm receives marginal revenue P. Because each unit is sold at P, the average revenue will also equal P, and we get the result P=MR=Ar

What are three conditions for a market to be perfectly competitive?

many buyers and sellers, all firms sell identical products, there are no barriers to firms entering the market