02.02. Competitive Markets

Question 1

Why do economists think that competition on free markets is good?

1.
2.
3.
4.
5.

Answer 1

• drives efficiency
• innovation
• growth
• individual freedom
• superiority over planned economies

Question 2

Definition Market

Answer 2

Collection of buyers and sellers that, through their actual or potential interactions, determine the price of a product or set of products

Question 3

What are the 7 (+1) characteristics of perfeclty competitive markets?

1.
2.
3.
4.
5.
6.
7.
8.

Answer 3

1. numerous buyers and sellers and no one has a substantial share of the market.
2. All buyers and sellers can freely and immediately enter or leave the market.
3. Every buyer and seller has full and perfect knowledge of what every other buyer and seller is doing.
4. The goods being sold in the market are so similar to each other that no one cares from whom each
   buys or sells.
5. All buyers and sellers are fully informed about the characteristics of the good.
6. All buyers and sellers are utility maximizers.
7. No external parties (i.e. government) regulate the price, quantity, or quality of any of the goods
   being bought / sold in the market.
8. Buyers and sellers are both price takers

Question 4

Why is it that in perfectly competitive markets, not only consumers but also producers are price takers?

Answer 4

because a firm that is perfectly competitive in output markets (which in reality rarely exist) has no or little ability individually to affect the market price

Question 5

The supply curve is determined by…

Answer 5

marginal costs of production

Question 6

A buyer’s willingness to pay is influenced by…

1.
2.
3.
4.
5.

Answer 6

• The buyer’s tastes or needs
• A consumer’s income or wealth
• Prices and availability of substitute goods
• Complementary goods
• The number of buyers in the market

Question 7

Where the price elasticity of demand (supply) is high, the demand (supply) curve is…

Which means what? And what are the consequences?
1.
2.
3.

Answer 7

nearly flat

it means that a small increase in price evokes a lot of new output on the supply side
o Facilities used for other things can be readily converted to producing the good in question
o Capacity can be easily expanded
o New firms can enter the business readily

Question 8

A seller’s marginal cost is influenced by…

1.
2.
3.

What do changes in these factors imply?

Answer 8

• The seller’s costs of production
• Technological progress
• The number of sellers in the market

Changes in the factors above alter the marginal costs -> shift the seller’s supply curve up or down

Question 9

Definition of Market Mechansim

Answer 9

Tendency in a free market for price to change until the market
clears.

Question 10

For a competitive firm, price equals (1) which means that it can only decide on (2)

As a result, its managers need to worry (3)
They choose output so that (4)

Answer 10

1. marginal costs
2. the quantity of the product it is willing to sell at a given price
3. only about the cost side of the fimrs operation
4. price is equal to marginal costs

Question 11

Together, consumer and producer surplus
measure the

Answer 11

welfare benefit of a
competitive market

Question 12

If demand is very inelastic relative to supply,
the burden of the tax falls mostly on… (1)

If demand is very elastic relative to supply, it falls
mostly on… (2)

Answer 12

1. buyers
2. sellers

Question 13

Definition Perfect Competition

Answer 13

In a perfectly competitive market, each firm is a price taker, which means the firm faces a horizontal demand curve for its product

Question 14

What do we know about….

1. Competition in the Short Run?
2. Competition in the Long Run?

Answer 14

1. Short-run marginal costs determine a profit-maximizing, competitive firm’s short-run supply curve and the market supply curve, which, when combined with the market demand curve, determines the competitive equilibrium
2. Firm supply, market supply, and the competitive equilibrium may be different in the long run than in the short run because firms can vary inputs that were fixed in the short run

Question 15

What is meant by “Perfect Competition Maximizes Economic Well-Being”?

Answer 15

Perfect competition maximizes a widely used measure of economic well-being for society

Question 16

What is a “Supply and Demand-Analysis”?
What are examples of it?

Answer 16

a fundamental and powerful tool that can be applied to a wide variety of interesting and important problems

1. understanding and predicting how changing world economic conditions affect market price and production
2. evaluating the impact of government price controls, minimum wages, price supports, and production incentives
3. determining how taxes, subsidies, tariffs, and import quotas affect consumers and producers

Question 17

What are the two key decisions a firm has to make?

1.
2.

Answer 17

1. whether to compete in the market at all (long run)
2. how much to produce in the light of current market conditions (short run)

Question 18

A firms decision about how much to supply in the short run starts with….

Answer 18

its costs

Question 19

Fixed costs?

Variable costs?

Marginal Costs?

Answer 19

1. Fixed costs are unavoidable and should not influence immediate choices (in the short run)
2. Variable costs vary with level of production
3. only marginal costs should affect short run supply decisions (here: consider both cash and opportunity costs)

Question 20

The slope of the marginal costs curve typically….

Answer 20

… slopes upwards, since it becomes increasingly costly to
squeeze incremental output out of busy production lines and already hard-working personnel

Question 21

In a long run decision, xxx are pivotal for a firm to enter or leave the market

1. in the long run, xxxx are avoidable

Answer 21

fixed costs

Question 22

The typical average cost curve has a distinctive (1)-shape due to (2)
As long as the price remains above the average cost curve, (3)

Answer 22

1. U-shape
2. the opposing effect of fixed and marginal costs
3. economic theory says that the firm should continue to reinvest in fixed assets to stay in business

Question 23

1. A firm should enter or remain in business as long as…
2. The firm should expand its output until

Answer 23

1. it expects the market price to
   be greater than it’s average total costs
2. the marginal cost of an incremental unit rises to the market price

Question 24

Impact of Price Controls | Do firms as producers benefit or suffer from it?

Answer 24

they profit from minimum prices (also from tariffs) beacue they increase producer surplus (at the cost of consumers)

Question 25

impact of an import quota | do domestic firms benefit or suffer from it?

Answer 25

they profit from import quotas (as well as from tariffs) because they increase their producer surplus (at the cost of consumers, facing decreasing consumer surplus)

Question 26

impact of a tax | do firms as sellers benefit or suffer from it?

Answer 26

Firms as sellers always bear some burden of a tax, the amount of which depends on elasticities

Question 27

Why do economists do not support government interventions?

Answer 27

because all these forms of government intervention (price controls, import quota, tax) result in welfare losses, which is why economists do not
support them

Question 28

The degree to which a tax is passed through to consumers depends on…

Answer 28

the shapes of the demand and supply curve

Question 29

In the long-run, the supply curve is….
However, the U.S. shortrun supply curve of gasoline is….

Answer 29

upward sloping, as in our typical figure
very close to vertical

Question 29

In a perfectly competitive market, each firm faces a (1: elastic, inelastic?) demand curve, meaning they (2: sell at which Q?) but (3)

Answer 29

1. perfectly elastic
2. sell any quantity of their product at the market price
3. charge a higher price

Question 30

Production Function Definition

Answer 30

summarized how a firm conerts inputs into outputs using one of possibly many available technologies

Question 31

Define:

1. Short run production
2. long run production

Answer 31

1. in the short run, only some inputs can be varied, so the firm changes its output by adjusting its variable inputs
2. in the long run, all factors of production can be varied, and the firm has more flexibility than in the short run in how it produces and how it changes its output level

Question 32

What is Returns to scale used for?

Answer 32

its the ratio of output to input. it varies with the size of the firm and is an important factor in determining the size of a firm

Question 33

Categories of Elasticity. What do the following numbers imply:

1. Ep>1
2. 0<Ep<1
3. Ep=1
4. Ep= (infinite)
5. Ep= 0

Answer 33

1. relative elasticity of demand
2. relative inelasticity of demand
3. unitary elasticity of demand
4. perfect elasticity
5. perfect inelasticity

Question 34

What are factors affecting demand elasticity?

1.
2.
3.
4.

Answer 34

• ease of subsitution
• proportion of total expenditures
• length of time period
• durability of product (possibility of postponing purchase; possibility of repair; used product market)

Question 35

Regression analysis is used to estimate consumer demand. What are the two types of regression?

1.
2.

Answer 35

1. cross-sectional: analyze several variables for a single period of time
2. time series data: analyze a single variable over multiple periods of time

Question 36

What are common subjects of business forecasts?

1.
2.
3.

… And what should a good forecast entail?

1.
2.
3.
4.

Answer 36

• GDP (gross domestic product); components are for example, consumption expenditure, producer durable equipment expenditure, residential construction
• industry forecasts, e.g. sales of products across an industry
• ## sales of specific product
• be consistent with other parts of the business
• be based on knowledge of the relevant past
• consider the economic and political environment as well as changes
• be timely

Question 37

Name the six forecasting techniques

1.
2.
3.
4.
5.
6.

Answer 37

• expert opinion
• opinion polls and market research
• survey of spending plans
• economic indicators
• projections
• econometric models

Question 38

Whar are factors in choosing the right forecasting technique?

1.
2.
3.
4.

Answer 38

• item to be forecast
• interaction of the situation with the forecasting methodology (the value and costs)
• amount of historical data available
• time allowed to prepare forecast

Question 39

What is….

1. a process innovation?
2. an organizational innovation?

Answer 39

1. it changes the production function (is also called technological progress): more output can be produced with same input levels!
   -> techn. progress is neutral if more output is produced using the same ratio of inputs
   -> techn. progress is non-neutral if it is capital or labor saving
2. this may also alter the production function and increase the amount of outpur produced by a given amount of inputs (e.g. henry ford who revolutionized mass car production through interchangeable parts the the assembly line)

Question 40

Quota | Definition

Tariff (ZOLL!!!!) | Definition

Answer 40

A quota is a limit on the amount of a specific good that can be imported into a country. (-> results in higher prices)

A tariff is a tax imposed on imported goods.

Question 41

If demand is very inelastic relative to supply,
the burden of the tax falls mostly…

Answer 41

… on buyers

Question 42

A (any) firm sets its output where….

1. marginal profit is zero
2. marginal revenue is maximized
3. profit is mazimized
4. marginal profit equals marginal revenue
5. marginal profit is maximized

Answer 42

1. yes
2. no
3. yes
4. no
5. no