ECO405 exam 3 review

What makes a perfectly competitive market?

- There are a large number of firms, each producing the same homogeneous product - Each firm attempts to maximize profits - Each firm is a price taker: its actions have no effect on the market price - Information is perfect: prices are assumed to be known by all market participants - Transactions are costless: Buyers and sellers incur no costs in making exchanges

7. A monopoly will always make a profit in the long run.

. False - Barriers to entry keeps other firms from entering and stealing a monopolists profits. However, they are still constrained by demand. If the demand for their produce falls then they could eventually end up making a loss.

2. The long run supply curve will always be horizontal in a perfectly competitive industry.

. False. The long run supply will be horizontal in the long run as long as costs don't change as the size of the industry changes. In the short-run as demand increases, the firms need to charge higher prices to offset the higher MC of producing more. But since P>ATC firms will be making profits. These profits will entice new firms to enter. And they will continue to enter as long as profits are being made. So as long as average costs don't increase as new firms enter, then the price will be pushed back down to the min ATC and the price will go back to the original price. So it will be horizontal in this case. (However if average costs rise as new firm enter due to more people using a scarce resource or higher costs firms entering the market) then the price will not go back to it's original price. So the LR curve will be upward sloping to compensate the firms for the higher average costs. But firms will still be breaking even.

6. Total surplus is maximized in a competitive market.

. True. Total surplus = CS + PS =( Marginal Benefit -market price) - (Market Price-Marginal Cost of production) = Marginal Benefit - Marginal Cost. This will be maximized at the output level where Marginal benefit to the last buyer is just equal to the Marginal cost of the last unit. Ie where P=MC. At this point it is not possible to increase Total surplus by increasing or decreasing output. Under a monopoly a firm produces where P>MC. So the value that the last person will be willing to pay exceeds the cost of producing the good. So society would benefit by producing more output.

1. The more elastic is demand the higher the price the firm can charge over it's marginal cost.

. false- If demand for a good is fairly elastic then if a firm raises the price then people will easily find other substitutes so demand will decrease significantly. Thus a firm with elastic demand will not be able to raise price over MC very much. However, remember that the monopolist will always produce where the demand is elastic... Since relationship between mark-up and elasticity is (p-mc)/p = -1/Ed (p-mc) will always be smaller than p so the left side must be smaller then 1. This can only be true if Ed >1. .. Intuitively, the reason is that if demand is inelastic, the monopolist can raise revenue by raising price even more..

Cournot Model of Oligopoly

firms choose how much to produce simultaneously and the price clears the market given the total quantity produced.

1. When a firm's demand curve is downward sloping, its marginal revenue at any positive sales quantity is ______ its price. A. Greater than B. Less than C. Equal to D. Less than or equal to

A

12. The market demand for milk is Qd=150-5p . Additionally, suppose that a dairy's variable costs are VC=2Q^2(where Q is the number of gallons of milk produced each day), its marginal cost is MC=4Q and there is an avoidable fixed cost of $50 per day. In the long run there is free entry into the market. Suppose the demand for milk doubles. How many new firms enter the market in the long run due to the increased demand? A. 10 B. 20 C. 100 D. 2

A

16. Which of the following is not a technical barrier to entry in a monopolized market? a.A patent b.Decreasing average cost c.A low cost method of production known only by monopolists d.Increasing returns to scale

A

27. The Nash equilibrium in a Bertrand game in which firms produce perfect substitutes and have equal marginal costs is: a. efficient because all mutually beneficial transactions will occur. b. efficient because of the free entry assumption. c. inefficient because some mutually beneficial transactions will be foregone. d. inefficient because of the uncertainties inherent in the game.

A

4. Consider the relationship given by QCars = 100 + 4xPCars - 2xPSteel - .2xPWorkers, where is the quantity of cars (in thousands), is the price of cars and P is the wage earned by autoworkers. If the price of steel is $10 per unit and the price of workers (the wage) is $20, what is the supply curve for cars? A. QCars = 76 + 4xPCars B. QCars = 100 + 4xPCars - 2xPSteel - .2xPWorkers C. QCars = 100 + 4xPCars D. QCars = 60 + 4xPCars

A

8. With free entry A. The long run market supply curve is horizontal at the market price B. The long run market supply curve is vertical at the market price C. The short and long run market supply curves are the same D. A and D

A

price ceiling

A legal maximum on the price at which a good can be sold lead to shortages, increased CS and decreased PS and TS

price floor

A legal minimum on the price at which a good can be sold CS decrease while PS and TS increase

Oligopoly

A market structure in which a few large firms dominate a market

22 For the practice of price discrimination to be successful, the monopoly must: a.be able to prevent resale of its product. b.face similar demand curves for various markets. c.have similar costs among markets. d.have a downward sloping marginal cost curve.

AA

Taxes and deadweight loss

All non-lump-sum taxes Involve deadweight losses the more inelastic (vertical) both supply and demand are the smaller the dwl is

10. Suppose the market demand for milk is Qd=150-5p. Additionally, suppose that a dairy's variable costs areVC=2q^2 (where Q is the number of gallons of milk produced each day), its marginal cost is MC=4Q and there is an avoidable fixed cost of $50 per day. In the long run there is free entry into the market. What is the market equilibrium price? A. $50 per gallon B. $20 per gallon C. $100 per gallon D. $25 per gallon

B

11. Under perfect competition, if an industry is characterized by positive economic profits in the short run: a. firms will leave the market in the long run and the short-run supply curve will shift outward. b. firms will enter the market in the long run and the short-run supply curve will shift outward. c. firms will enter the market in the long run and the short-run supply curve will shift inward. d. firms will leave the market in the long run and the short-run supply curve will shift inward.

B

19. Suppose Kate's Great Crete (KGC) has annual variable costs VC=30q+.0025q^2 of and marginal costs of 30+.005q , where Q is the number of cubic yards of concrete it produces per year. In addition, it has an avoidable fixed cost of $50,000 per year. KGC's demand function is Qd=20000-400P . What is the profit maximizing sales quantity? A. 20 B. 2,000 C. 8,000 D. 0

B

2 . A demand curve will shift out for any of the following reasons except that: a. preference for a good increases. b. price of a substitute falls. c. income rises. d. price of a complement falls.

B

21. A market is a natural monopoly when A. A good is produced most economically by several firms B. A good is produced most economically by one firm C. The government grants a firm a patent on a good D. The firm's average cost function is everywhere upward sloping

B

5. If a 1 percent increase in price leads to a .7 percent increase in quantity supplied, the short-run supply curve is: a. elastic. b. inelastic. c. unit elastic. d. perfectly inelastic.

B

refer to a monopoly that faces a demand curve given by Q=1-p and has a constant marginal cost as 0.2. 23. In this situation, the monopoly's profits are: a.0.40. b.0.16. c.0.12. d.0.08.

B

13. For an increasing cost industry, the long-run supply curve has a(n) _____ elasticity of supply. a.infinite b.negative c.positive d.Zer0

C

14. In the long run, the greater burden of a specific tax will usually be absorbed by: a. consumers. b. the party—consumers or producers—with the more elastic demand/supply curve. c. the party with the least elastic demand/supply curve. d. shareholders and employees of the firm in the form of reduced dividends and wages. refer to a market in which quantity demanded is given by and quantity supplied by .

C

17. The supply curve for a monopoly is given by: a. the firm's marginal cost curve above the average variable cost curve. b. the one point on the demand curve that corresponds to the quantity for which price is equal to MC. c. the one point on the demand curve that corresponds to the quantity for which MR equals MC. d. the entire demand curve above the point where price is equal to average cost.

C

20. The deadweight loss from monopoly pricing is A. The amount by which aggregate surplus falls short of its minimum possible value, which is attained in a perfectly competitive market B. The amount by which consumer surplus exceeds producer surplus C. The amount by which aggregate surplus falls short of its maximum possible value, which is attained in a perfectly competitive market D. The amount by which producer surplus exceeds consumer surplus

C

24. It is important to understand oligopoly markets because: a.although few real world markets are oligopolies, their existence raises interesting theoretical questions. b.oligopolies typically generate more deadweight loss than monopolies. c.oligopolies can generate a whole range of possible outcomes between monopoly and perfect competition. d.one can predict the market outcome exactly just by knowing the number of firms in the market.

C

3. The market supply of a product A. Is the same as the supply curve of an individual seller B. Graphically is the vertical sum of the individual supply curves C. Graphically is the horizontal sum of the individual supply curves D. A and C

C

6. In a competitive market, an efficient allocation of resources is characterized by: a. a price greater than the marginal cost of production. b. the possibility of further mutually beneficial transactions. c. the largest possible sum of consumer and producer surplus. d. a value of consumer surplus equal to that of producer surplus.

C

7. Suppose Julia and Zach are the only consumers of milk. Julia's demand for milk is defined as at prices below $4 and zero for prices above $4. Zach's demand for milk is defined as at prices below $5 and zero for prices above $5. If the market price for milk is $4.50, market demand is A. Zero B. 1.5 C. 1 D. 10

C

9. Suppose that, in the long run, a dairy's variable costs are (where Q is the number of gallons of milk produced each day), its marginal cost is and there is an avoidable fixed cost of $50 per day. In the long run there is free entry into the market. What is the dairy's total cost function? A. B. C. D.

C

15. In this market, an increase in the parameter c would:​ a. ​increase both price and quantity. b. ​increase price and decrease quantity. c. ​decrease both price and quantity. d. ​increase quantity and decrease price.

D

Short-run supply elasticity

Describes the responsiveness of quantity supplied to changes in market price very short run: esp=0 short run: esp>0

4. With Free entry and exit it is possible to have an industry in which all firms make zero accounting profits in long-run equilibrium.

False. When there is free entry then firms will enter as long as positive economic profits are being made. Entry will stop when all firms are making zero economic profits. Meaning that the firm is making just as much as they would in their next best alternative. So revenue needs to cover both costs of running the business and their opportunity costs,. So Accounting profits which only look at revenue minus operating costs of the business must be positive.

Long-run elasticity of supply (eLS,P)

record the proportionate change in long run industry output to a proportionate change in price can be positive or negative depending on whether the indistry exhibits increasing or decreasing costs

shape of long run supply curve

horizontal of average costs are constant as firms enter (constant cost industry) upward sloping if average costs rise as firms enter (increasing cost industry) negatively sloped if average costs fall as firms enter (decreasing cost industry)

Equilibrium price

Is one at which quantity demanded is equal to quantity supplied - Neither suppliers nor demanders have an incentive to alter their economic decisions

perfect price discrimination

Occurs when a firm charges the maximum amount that buyers are willing to pay for each unit. extracts all consumer surplus leading to no dead weight loss

Monopoly Profit Maximization

Produce Q where MR = MC Produce in the elastic range of demand curve Higher prices & lower quantities to sell an addition unit the monopoly must lower prices on all units

short run change in fixed costs

if fixed costs decrease the AC curve sifts downward and decreases atc mc does not change so the number of firms remains equal and active firms make profits in the long run firms will enter q will increase but each firm will produce less

technical barriers to entry

exhibit economies to scale or decreasing marginal costs at higher output firms may find it profitable to cut prices and drive firms out of their industry creating a natural monopoly entry of new firms is difficult could be a result of special knowledge or unique resources

legal barriers to entry

There are patents, trademarks, and copyright laws to protect inventions and intellectual property. These legal protections do not [necessarily] provide for absolute monopoly for there are often viable substitutes available to consumers

Oligopoly

few seller selling identical products

5. The possibility of more firms entering an industry in the long run tends to make long-run industry supply more price elastic than short-run industry supply.

True - Since both the number of firms in an industry and the amount of capital that each firm has, is fixed in the short run the only way that a firm can justify producing more output is by raising the price since the marginal costs of producing more is rising due to diminishing returns to workers (since you are shoving more workers into a fixed space). Also due to these constraints the firms can only increase output so much. However in the long-run a firm can increase it's capital and more firms can enter. So firms can more easily increase output due to a rise in price so demand is much more elastic.

3. In a perfectly competitive industry, the demand curve for the total output of the industry may be downward sloping.

True. The demand for most goods are negative sloped so the demand curve in the whole market will be negatively sloped. For example the demand for corn by all consumers will fall as the price of corn rises. However, the demand curve facing an individual farmer selling corn will be perfectly elastic since if they raise the price people will buy it from other farmers and they don't need to lower the price since they can already sell as much as they want at the going market price.

short run market supply

firms can adjust their quantity produced by altering their variable inputs. firms will supply more as long as they can charge a higher price. quantity of output supplied: the sum of the quantities supplied by each firm

long-run supply curve

a curve that shows the relationship in the long run between market price and the quantity supplied

cartel model of oligopoly

a model that assumes that oligopolies act as if they were monopolists that have assigned output quotas to individual member firms of the oligopoly so that total output is consistent with joint profit maximization

long-run market equilibrium

an economic balance in which, given sufficient time for producers to enter or exit an industry, the quantity supplied equals the quantity demanded when profits are >0 - the short run supply curve will shift out, price and profits will fall until profits are 0 when profits are negative - the short run supply curve will shift inward, market price and profits will rise until they reach 0

increasing cost industry

an industry that faces higher per-unit production costs as industry output expands in the long run; the long run industry supply curve slopes upward entry will bid up input prices

dynamic views of monopoly

beneficial in the process of economic development can invest in r&d provides an incentive to keep one step ahead of competitors

26. In a Cournot equilibrium, each firm chooses an output level which: a.maximizes joint profits. b.maximizes the price received. c.maximizes profits given what the other firms produce. d.maximizes revenue given what the other firms produce.

c

shifts and movements along market demand curve

changes in px cause movements along the demand curve while changes in other variables (Py, income, preferences) shift the demand curve.

Economic Efficiency and Applied Welfare Analysis

consumer surplus:net benefit to consumers-marginal value of each unit-market price Producer surplus: market price-marginal cost of each unit total surplus: sum of producer and consumer surplus (area between demand and supply curve) maximized at competetive market equillibrium

25. As products become less differentiated A. Consumers are less willing to switch in response to price changes B. Consumers are more willing to switch in response to price changes C. Competition becomes less intense D. A and C

d

very short run supply

in the very short run quantity is fixed and price acts as a rationing device for demand. the supply curve is vertical

constant cost industry

input prices are independent of the level of production inputs can earn the same amount in alternative occupations

perfect competition

lost of sellers selling identical products

monopolistic competition

lots of sellers selling different products

Monopoly Regulation

marginal cost pricing: will cause a natural monopoly to operate at a loss multpirice system: charge some users a high price, maintain low price for marginal users rate of return regulation:allow the monopoly to charge a price above marginal cost that is sufficient to return a fair rate of return.

Segmented Markets Theory

monopoly can segment its buyers into identifiable markets ad follow a different pricing policy in each market the price will be higher in less elastic market

Bertrand Model

oligopoly model in which firms produce a homogeneous good, each firm treats the price of its competitors as fixed, and all firms decide simultaneously what price to charge

Monopoly

one seller selling a unique product

Inverse Elasticity Rule

the gap between a firms price and marginal cost in percentage terms is inversely related to the price elasticity of demand for the firms a monopoly will choose to operate where the demand curve is elastic, the firms markup over marginal cost depend inversely on the elasticity of market demand.

long-run competitive equilibrium

the situation in which the entry and exit of firms has resulted in the typical firm breaking even p=mc profit maximization p=ac 0 profits

market demand

two goods x and y the quantity of x demanded is a function of the price of x, the price of Y and income i represents each individual in the market

Ricardian Rent

very fertile land (low costs of production) poor land (high costs of production) at low prices only the best land is used but at as output increases higher cost land is used owners of low and medium cost land can earn long run profits

short-run market equilibrium

when the quantity supplied equals the quantity demanded, taking the number of producers as given