Micro 9-14

Suppose that the pen-making industry is perfectly competitive. Also suppose that all current firms and any potential firms that might enter the industry have identical cost curves, with minimum ATC = $1.25 per pen. If the market equilibrium price of pens is currently $1.50, what would you expect the equilibrium price to be in the long run?

$1.25

Compare the elasticity of a monopolistic competitor's demand with that of a pure competitor and a pure monopolist.

A monopolistic competitor's demand curve is less elastic than that of a pure competitor. A monopolistic competitor's demand curve is more elastic than that of a pure monopolist.

Why do economists classify normal profits as costs?

A normal profit is the amount required to ensure continued supply of the product

Which of the following statements is true?

Accounting profit equals revenue minus explicit costs

b. Which of the following are products or services of oligopolists that you own or regularly purchase?

Automobiles, personal computers, and gasoline b. Oligopolies in which we deal include manufacturers of automobiles, ovens, refrigerators, personal computers, gasoline, and courier services.

b. Assess the economic desirability of collusive pricing.

Collusive pricing is economically desirable from the oligopoly's viewpoint because it results in monopoly profits b. From the viewpoint of society, collusive pricing is not economically desirable. From the oligopoly's viewpoint, it is highly desirable since, when entirely successful, it allows the oligopoly to set price and quantity as would a profit-maximizing monopolist.

Which of the following statements is true regarding the costs associated with owning and operating an automobile?

Fixed costs include insurance, and variable costs include gasoline.

Complete the following statements:

In a constant-cost industry, a decrease in demand will result in economic losses. As a result, firms will exit the industry, resulting in a decrease in supply over time. A long-run adjustment will eventually cause the price level to increase, causing it to return to the level where it was before the demand shift. There will be fewer firms in the industry, and the long-run industry supply curve will be horizontal.

You are considering whether to drive your car or fly 1,000 miles to Florida for spring break. Which costs would you take into account in making your decision?

The variable costs of the trip, the opportunity cost of your time, and the need for transportation in Florida.

b. True or False. In the long run, monopolistic competition leads to a monopolistic price but not to monopolistic profits.

True, since P > MC, but the availability of close substitutes pushes the price of the average firm down until it equals ATC

Answer the following questions about the barriers to entry that shield monopolies from competition. a. Which of the following is not a major barrier to entry into an industry?

Unfair competition Economies of scale Diminishing marginal returns Correct Patents

b. Which of the following is a true statement?

Unfair competition is a barrier with no social justification

c. Which of the following statements is true?

When advertising either leads to increased monopoly power or is self-canceling, economic inefficiency result

Suppose that the paper clip industry is perfectly competitive. Also assume that the market price for paper clips is 2 cents per paper clip. The demand curve faced by each firm in the industry is:

a horizontal line at 2 cents per paper clip.

Consider an oligopoly industry whose firms have identical demand and cost conditions. If the firms decide to collude, then they will want to collectively produce the amount of output that would be produced by:

a pure monopolist

Collusive agreements can be established and maintained by:

credible threats Collusive agreements can be established and maintained by credible threats. This is true because credible threats that are made by a strong enforcer can help to prevent cheating and thereby maintain the group discipline required for collusion to succeed in driving up prices and reducing output.

Explicit costs are payments the firm makes for

inputs such as wages and salaries to employees, whereas implicit costs are nonexpenditure costs that occur through the use of self-owned resources such as forgone income

Indicate how each of the following would shift the (1) MC curve, (2) AVC curve, (3) AFC curve, and (4) ATC curve of a manufacturing firm. In each case specify the direction of the shift.

a. A reduction in business property taxes MC AVC AFC ATC No change No change Shift down Shift down b. An increase in the nominal wages of production workers MC AVC AFC ATC Shift up Shift up No change Shift up c. A decrease in the price of electricity MC AVC AFC ATC Shift down Shift down No change Shift down

A firm with no fixed costs

is really in the long run In a more general sense, a firm with no fixed cost is really in the long run. By definition, the short run implies there are fixed costs present that the firm cannot get out of paying. The long run implies all factors and costs can adjust to the economy.

Briefly state the basic characteristics of pure competition, pure monopoly, monopolistic competition, and oligopoly. Into which of these market classifications does each of the following most accurately fit? In each case, justify your classification.

a. A supermarket in your hometown. Oligopoly b. The steel industry. Oligopoly c. A Kansas wheat farm. Pure competition d. The commercial bank in which you have an account. Monopolistic competition e. The automobile industry. Oligopoly

A perfectly competitive firm that makes car batteries has total fixed costs of $10,000 per month. The market price at which it can sell its output is $100 per battery. The firm's minimum AVC is $105 per battery. The firm is currently producing 500 batteries a month (the output level at which MR = MC). This firm is making a __________ and should __________ production.

loss; shut down

Suppose that as the output of mobile phones increases, the cost of touch screens and other component parts decreases. If the mobile phone industry is purely competitive, we would expect the long-run supply curve for mobile phones to be:

downward sloping

a. How does the demand curve faced by a purely monopolistic seller differ from that confronting a purely competitive firm? The demand curve faced by a purely monopolistic seller is

downward sloping, whereas that facing the purely competitive firm is perfectly elastic

The MR curve of a perfectly competitive firm is horizontal. The MR curve of a monopoly firm is:

downward slopping

Firms will enter a monopolistically competitive industry when there are

economic profits. This will shift demand to the left, reducing the firm's market share and its economic profit

a. The most common reason that oligopolies exist is

economies of scale.

a. The difference between monopolistic competition and pure competition is that compared to pure competition, monopolistic competition has

ewer firms, product differentiation, some price control, and relatively easy but not barrier-free entry

The firm should produce in the short run as long as the price

exceeds the average variable cost

Indicate how the location of each of the following curves would be altered if (1) total fixed cost increases and (2) total variable cost decreases at each level of output.

f TFC increases, the AFC and ATC curves would be higher. The AVC and MC curves are not affected by changes in fixed costs. If TVC decreases, MC would be lower for the first unit of output but remain the same for the remaining output. The AVC and ATC curves would also be lower, but the AFC curve would not be affected by the change in variable costs.

Because they can control product price, monopolists can guarantee profitable production by simply charging the highest price consumers will pay.

false

b. The pure monopolist seeks the output that will yield the greatest per-unit profit.

false

Consider the following statement: "Ninety percent of new products fail within two years—so you shouldn't be so eager to innovate."

false, because a firm could capture enough expected economic profit in the short run to cover its initial investment.

When discussing pure competition, the term long run refers to a period of time long enough to allow:

firms already in an industry to either expand or contrast their capacities new firms to enter or existing firms to leave

Which of the following are short-run adjustments, and which are long-run adjustments?

a. Wendy's builds a new restaurant: Long-run adjustment b. Harley-Davidson Corporation hires 200 more production workers: Short-run adjustment c. A farmer increases the amount of fertilizer used on his corn crop: Short-run adjustment d. An Alcoa aluminum plant adds a third shift of workers: Short-run adjustment

The equality of P and MC means the firm is achieving

allocative efficiency, since the industry is producing the amount of product that equates society's valuation of that product and the price of the product.

The main problem with imposing the socially optimal price (P = MC) on a monopoly is that the socially optimal price:

may be so low that the regulated monopoly can't break even

Compared to pure monopoly and pure competition, monopolistically competitive industries

may earn economic profits, but profits will diminish as competitors enter. There will be productive inefficiency

"Monopolistic competition is monopolistic up to the point at which consumers become willing to buy close substitute products and competitive beyond that point." This statement recognizes that the products of monopolistically competitive firms

may give them some monopoly power, given strong consumer preferences for their product, but consumers will substitute away if prices become too high relative to similar products offered in the market

Facepalm, Instarant, and Snaphat are rival firms in an oligopoly industry. If kinked-demand theory applies to these three firms, Facepalm's demand curve will be:

more elastic above the current price than below it

How often do perfectly competitive firms engage in price discrimination?

never

Suppose the marginal cost of a frozen yogurt cake is $10. Farley's Frozen Yogurt should

not produce

Oligopoly differs from monopolistic competition in that

oligopoly has few firms, whereas monopolistic competition has many firms

. The difference between monopolistic competition and pure monopoly is that compared to monopolistic competition, pure monopoly has

one firm, a unique product, price control, and entry barriers

a. There is so much advertising in monopolistic competition and oligopoly because

brand distinction encourages consumer loyalty, which increases profits

Suppose a firm is producing in the long run. When it produces 2,000 units of output, its total cost is $4,000. When it produces 2,300 units of output, its total cost is $4,100, and when it produces 2,600 units of output, its total cost is $4,200. This firm is experiencing __________ returns to scale.

increasing

Suppose a firm is producing in the long run. When it produces 4,000 units of output, its total cost is $8,000. When it produces 4,200 units of output, its total cost is $8,200, and when it produces 4,400 units of output, its total cost is $8,800. This firm is experiencing __________ returns to scale.

increasing, then decreasing

Product differentiation

provides an advantage in the market

b. Advertising helps consumers and promotes efficiency by

providing information about new products, increasing sales and output, and lowering average total cost

b. Why does it differ? Of what significance is the difference? The demand curve facing a

purely competitive firm is perfectly elastic, because it may sell all that it wishes at the equilibrium price.

Farley's Frozen Yogurt is a purely competitive firm that sells frozen yogurt cakes. The market price is $6 per cake. Assume that AVC is $9 per cake, AFC is $2 per cake, and Farley's sells 200 frozen yogurt cakes. a. Farley's Frozen Yogurt

should shut down should not produce in the short run will have an economic profit will have a normal profit

Farley's Frozen Yogurt is a purely competitive firm that makes frozen yogurt cakes. The market price is currently $7 per cake. Assume that AVC is $6 per cake, AFC is $4 per cake, and Farley's sells 200 frozen yogurt cakes. a. Farley's Frozen Yogurt

should shut down will incur a short run loss should produce in the short run

The explicit costs of going to college include

the cost of tuition and books, while implicit costs include forgone income.

When an industry is purely competitive, price can be substituted for marginal revenue in the MR = MC rule because

the demand curve is perfectly elastic and the price is constant regardless of the quantity demanded, so MR is constant and equal to price.

The equality of marginal revenue and marginal cost is essential for profit maximization in all market structures because when this is true

the last unit produced adds more to revenue than costs, and its production must necessarily increase profits or reduce losses.

An excess of price over marginal cost is the market's way of signaling the need for more production of a good.

true

The monopolist has a pricing policy; the competitive producer does not.

true

With respect to resource allocation, the interests of the seller and of society coincide in a purely competitive market but conflict in a monopolized market.

true

a. Consider the statement: "Even if a firm is losing money, it may be better to stay in business in the short run." This statement is

true, if the loss is less than the fixed cost.

Profits encourage entry into purely competitive industries and losses encourage exit from purely competitive industries because

when profits are zero, firms are earning sufficient revenue to cover their opportunity costs

c. Complete the following statement. The pure monopolist's demand curve is not

perfectly inelastic, because MR is negative when demand is inelastic, so MR = MC < 0

b. Monopolistically competitive firms frequently prefer nonprice competition to price competition because

price competition can lead to lower economic profits or even loss

Price collusion might occur in oligopolistic industries because

price competition can lower revenue for all firms

b. Price can be substituted for marginal revenue in the MR = MC rule when an industry is purely competitive because

price is constant regardless of the quantity demanded

. Price leadership is legal in the United States, whereas price-fixing is not. This is because

price leadership is not an agreement, whereas price-fixing is c. Price leadership entails a type of implicit understanding in which prices are coordinated without engaging in outright collusion based on formal agreements and secret meetings. Rather, a practice evolves whereby the dominant firm initiates price changes and all other firms typically follow the leader.

Suppose the marginal cost of a frozen yogurt cake is $7. Farley's Frozen Yogurt should

produce the same quantity

c. In long-run equilibrium, P = minimum ATC = MC. The equality of P and minimum ATC means the firm is achieving

productive efficiency

What is the meaning of the following four-firm concentration ratios? a. A four-firm concentration ratio of 60 percent means the largest four firms in the industry account for _____ percent of sales.

60

Assume a monopolistic publisher has agreed to pay an author 10 percent of the total revenue from the sales of a book. Will the author and the publisher want to charge the same price for the book?

The author would prefer a lower price than the publisher

If it is possible for a perfectly competitive firm to do better financially by producing rather than shutting down, then it should produce the amount of output at which:

MR = MC

a. The equality of MR and MC is essential for profit maximization in all market structures because if

MR and MC are equal, any other output level will result in reduced profits.

Which of the following best describes the efficiency of monopolistically competitive firms?

Neither allocatively efficient nor productively efficient

It has been proposed that natural monopolists should be allowed to determine their profit-maximizing outputs and prices, and then government should tax their profits away and distribute them to consumers in proportion to their purchases from the monopoly. Is this proposal as socially desirable as requiring monopolists to equate price with marginal cost or average total cost? Explain.

No, it does not consider that the output of natural monopolists would still be at the suboptimal level where P > MC

Consider a firm that has no fixed costs and that is currently losing money. a. Are there any situations in which it would want to stay open for business in the short run?

No, the firm will want to shut down.

A purely competitive firm whose goal is to maximize profit will choose to produce the amount of output at which:

TR exceeds TC by as much as possible

Classify the following as fixed or variable costs:

a. Fuel: Variable costs Correct b. Interest on company-issued bonds: Fixed costs Correct c. Shipping charges: Variable costs Correct d. Payments for raw materials: Variable costs Correct e. Real estate taxes: Fixed costs Correct f. Executive salaries: Fixed costs Correct g. Insurance premiums: Fixed costs Correct h. Wage payments: Variable costs Correct i. Sales taxes: Variable costs Correct j. Rental payments on leased office machinery: Fixed costs

The more profitable a firm, the greater its monopoly power.

cannot be determined

a. "Competition in quality and service may be just as effective as price competition in giving buyers more for their money." This statement is true if

consumers value quality and service more than a lower price