Term
| ) You are a manager in a perfectly competitive market. The price in your market is $35. Your total cost curve is C(Q) = 10 + 2Q + .5Q2. Here MC=2+Q |
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Definition
a. What level of output should you produce in the short run?
- $35 = 2 +Q -> Q = 35-2 -> Q=33
b. What price should you charge in the short run?
- market price, which is $35
c. Will you make any profits in the short run? P(Q) – C(Q)
- $35(33) – 10 + 2(33) + 0.5(33^2) -> 1155 – 620.5 = $534.50 profit
d. What will happen in the long run?
- In the long run, more firms will enter the industry causing the supply curve to shift right thus lowering the equilibrium price. This will result in zero economic profit for the firm in the long run
e. How would your answer change if your costs were C(Q) = 80 + 5Q + 30Q2?
MC= 5+ 60(Q) -> $35 = 5 + 60(Q) -> $30 = 60(Q) -> Q = 30/60 -> Q=0.5
- $35(0.5) = 80 + 5(0.5) + 30(0.5^2) -> $17.5 = 90
- Fixed costs = $80 and variable costs = $10
- P>AVC, so the firm should continue operate in order to minimize loss by offsetting fixed costs with revenues in excess of the variable costs of production, but they will still be losing money at this cost as opposed to profiting with the cost in the question above. |
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Term
| Explain why, when all adjustment have taken place, the perfectly competitive firm will operate at the minimum of its short-run and long-run average total cost curves and earn zero economic profit. |
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Definition
| at this point all economies of scale have been exhausted and the firm is just covering its opportunity cost. |
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Term
| Assume a perfectly competitive firm is currently producing 5,000 units of output and is earning $15,000 in total revenue. The marginal cost of the 5,000th unit of output is $3. The corresponding average total cost is $3.50 and total fixed costs equal $1250. Based on this information, should this firm continue to operate in the short run? Why or why not? |
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Definition
ATC= $3.5(5000) = $17,500 - $1,250 (fixed costs) = $16,250 (variable costs)
P ($3) < AVC (3.25), so the firm should not continue to operate in the short run because the price is less than the average variable costs, and cannot cover the variable costs of production |
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Term
| Explain why a firm should continue to operate in the short run so long as market price is greater the firm's average variable cost at the profit-maximizing level of output |
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Definition
| when price is above AVC the firm should continue to operate since the firm is earning revenues in excess of the variable costs of production. As long as price is above AVC the firm should continue to operate regardless of whether they are making a profit or not. All revenue that exceeds the variable costs of production will contribute towards the firms fixed costs, thus minimizing losses. |
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Term
| 1) Suppose all firms in a competitive market are currently in both short-run and long-run equilibrium. What impact will a lump sum tax have on each firm in the short run? in the long run? |
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Definition
- In the short run, the lump sum tax will increase fixed costs, which will create the need for frims to increase price in order to cover it. This results in a shift in the supply curve to the left (reduction in supply), which will hurt both producers and consumers in the short run.
- In the long run, the lumpsum tax will result in zero profits, no producer surplus, and higher barriers to entry for other firms. Consumer surplus will be reduced. This all due to the fact that the long run supply curve is perfectly elastic. |
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Term
| 2) Why does the government grant patents to investors? Why does the government give monopoly power to utility companies? |
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Definition
- Patents protect inventions from being copied for a specified amount of time which helps investors justify making large investments in inventions since they know they will be the only ones who can develop the product for that given period of time.
- Utility companies are assumed to be natural monopolies. In order to efficiently serve the public they must make massive investments in infrastructure in order to deliver their products to consumers. For this reason, utility companies almost have to operate as monopolies in various areas in order to make products such as electricity available to the public at a reasonable price. |
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| 3) Monsanto, the maker of NutraSweet, owned the patent to aspartame, the official name of the sweetener. In 1987 Monsanto's patent expired in Europe, allowing other firms to produce aspartame under other brand names. What impact do you think this (had on the market for aspartame and Monsanto's profits? |
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Definition
| - the expiration of the patent created a huge increase in supply in the aspartame market, causing the supply curve to shift to the right and price to decrease. This also allowed for huge companies, such as coca cola, to begin producing aspartame at a cost that Monsanto was not likely able to match, thus drastically reducing Monsanto’s profits. |
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Term
| 4) Why is the monopoly total welfare lower than the competitive total welfare? |
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Definition
| The main reason is that monopolies charge a price that is higher than their marginal costs, while competitive firms has to take the market price and produce a level of output where marginal costs are equal to marginal revenues in order to be efficient. Since monopolies charge prices that are higher than they would be in perfect competition and produce more, consumer demand is less which in turn reduces consumer welfare. Monopolies are less concerned with satisfying consumer’s needs. Monopolies also do not always use scarce resources efficiently which once again results in a higher price to consumers, thus reducing total welfare. |
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Term
| Is it true that in the long run, a monopolistically competitive firm has market power but earns no profit? Explain. |
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Definition
| It is true that in the long run a monopolistically competitive firm earns no economic profits, because P = ATC. Monopolistically competitive firms do have market power due to their differentiated products, close substitutes, and freedom of entry and exit. In the long run, all firms earn normal profits, so few new firms enter or exit the market. |
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| Consider a town with a single movie theater, and that movie theater faces a downward sloping demand curve for its tickets. The movie theater has a fixed number of seats available for each show but the marginal cost of filling a seat is zero. Why might it be in the movie theater's interest to not to sell out every show even though the marginal cost of selling additional seats is virtually zero? |
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Definition
| since the demand curve for the movie theater is downward sloping and MC = 0, if the theater the theater would have to reduce the price to zero in order to fill every seat, thus reducing profits. In order to maximize profits, the theater should sell tickets at the level where MR=MC, which is not at the level of full capacity. The marginal revenue curve would also be downward sloping to the left of the demand curve, so the theater would want to see at what level of output the marginal revenue curve equals zero and set the price on the based off of that output level on the demand curve |
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Term
| Would you expect the demand for a monopolistically competitive firm's product to be more or less elastic than that for a monopolist's product? Explain. |
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Definition
| monopolistically competitive firms have many close substitutes, which will cause their product to be more elastic, while monopolist’s product has no close substitutes, so the demand would be inelastic. The monopolistically competitive firm’s product would be much more elastic than the monopolist’s product. |
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Term
You are a monopolist with the following cost and demand conditions: P = 100 - 2Q and C(Q) = 50 + Q2. Note that MC=2Q and MR =100-4Q
a. Determine the profit-maximizing output and price.
d. Determine the actual amount of deadweight loss. |
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Definition
a. Determine the profit-maximizing output and price.
- MC=MR
- 2Q = 100 – 4Q
- 6Q = 100 - 100/6 = 16.67 Q*=16.67
- Q= 16.67 P = 100 – 2(16.67) P*=$66.67
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Determine the actual amount of deadweight loss.
- MR=0 0 = 100 – 4Q 4Q = 100 Q = 25
- 2(25) = 50
- P = 100 – 2Q P = 100 – 2(0) P=100
- P*= 100 – 2(16.67) P*=66.67
- Q* = 2Q = 100-4Q 6Q = 100 Q*=16.67
- MC= 2(16.67) = 33.33
- MR- 100 – 4(16.67) =33.33
- DWL = 0.5(66.67 – 33.33)*(25 – 16.67) = 138.86 |
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Term
| What real-world evidence would lead you to believe that firms were acting as Cournot oligopolists? Stackelberg oligopolists? Bertrand oligopolists? Please give example of industries where these firms might exist |
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Definition
a good example of Cournot ologopolists would be firms in the oil market. Several large firms and countries make decisions on how much oil is going to be produced in a given amount of time, then they make decisions on the price.
- A good example of Stackelberg oligopolists would be new smartphone producers competing with large producers, such as Samsung and iphone, they set their price and levels of production based of of the output and price of these “leader firms.” I would consider LG to be a “follower.”
- A good example of Bertrand oligopolists would be the major phone service providers, such as AT&T and Sprint, who compete mostly based off of the price of the services provided as opposed to the quantity of service provided. |
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Term
| (game theory) C. Explain how "history" affects the ability of firms in this game to achieve an outcome superior to that of the one-shot version of the game. |
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Definition
| - History plays an important role in determining whether games played by firms will be infinite or finite. Managers can adopt a trigger strategy which is contingent on past plays of each firms. In this situation, if managers had colluded and agreed to both charge the high price and neither of the firms have ever cheated before they would be better off continuing to cooperate provided the present value of the cost of cheating exceeds the one-time benefit of cheating. In this situation, it does not make sense for either firm to cheat. If one firm cheats, the other firm will punish the cheating firm by charging the low price in all the future periods which would result in a profit of zero for both firms. Firms that have a history of sticking to their agreements and not cheating are more likely to have infinite repeated games which are much more profitable in the long run as long as neither firm decides to cheat. Firms who have a history of cheating are more likely to have a finite game. |
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