Chap. 7 - Market Structure

Question 1

What are the four market structures?

Answer 1

Perfect Competition, Monopolistic Competition, Oligopoly, Monopoly

Question 2

When examining the structure of a market, we focus on the differentiating characteristics, what are those?

Answer 2

Number of firms, type of product, ease of entry, and market power or price control

Question 3

What are the characteristics of a perfect or pure competition market? Give an example.

Answer 3

Large number of firms, homogeneous product, firms are price takers, perfect information, barriers for entry are low.
Agriculture - wheat, corn

Question 4

What are the characteristics of a monopoly? Give an example

Answer 4

Only one firm, unique product, blocked entry, price maker.

Local utilities

Question 5

What are the characteristics of an oligopoly? Give an example

Answer 5

A few large firms, standardized or differentiated products, high barriers to entry, firms are interdependent.
Steel, Oil, Automobiles

Question 6

What are the characteristics of monopolistic competition? Give an example

Answer 6

Large number of firms, similar but differentiated products, low barriers to entry, limited degree of market power.
Restaurants, Hotels

Question 7

In perfect competition since each producer is a price taker, is demand elastic or inelastic? Explain.

Answer 7

Completely Elastic
Producers are price takers, consumers view each bushel of wheat the same as the next, if producers raise their price above the market price, then demand goes to zero.

Question 8

Why do we see industries that produce a commodity advertise but we typically don’t see individual firms advertise?

Answer 8

Producers are able to sell all the product they can produce at the going market price and have no ability to raise price through advertising, thus they have no incentive to incur the cost of advertising.

Question 9

Since producers have no control over the price of the good, their only decisions are to determine if they should produce and if so, how much. How much should they produce?

Answer 9

With the goal of maximizing profits, firms in pure competition must evaluate both the price they can sell the good for and the respective costs of producing the goods.
Marginal Benefits vs. Marginal Costs

Question 10

On a graph where should the firm in perfect competition produce at?

Answer 10

Where Marginal Revenue is equal to Marginal Cost.

Question 11

What is Marginal Revenue and Marginal Cost?

Answer 11

Marginal revenue is the additional revenue generated from selling one more unit of output.
Marginal Cost is the additional cost incurred to sell one more unit of output.

Question 12

In perfect competition what is Marginal Revenue equal to?

Answer 12

MR = Price = Demand = Average Revenue

Question 13

When looking at a perfect competition graph, and the associated cost curves, where should the firm produce at? How would you calculate Total Revenue and Total Cost to get Profit from the graph?

Answer 13

Find where MR = MC, the profit maximizing point and quantity. Since MR = Demand = Price, we know the price and where MR = MC we know how much to produce at. Where MR = MC the entire shaded area below is TR. TC is the entire shaded area where MC = ATC and over to profit maximizing quantity. To find TC, multiply ATC by Q. Subtract TC from TR to find Profit.

Question 14

How would a firm produce at a loss in perfect competition?

Answer 14

If ATC is above the Demand Curve. The firm will still produce where MR = MC, and as long as the firm can cover all the variable costs and part of the fixed costs it will continue to operate.

Question 15

What is the short run shut down rule in perfect competition?

Answer 15

If the price drops below the average variable cost, the firm is unable to cover even the variable cost and can reduce the loss by shutting down and paying only the fixed costs.

Question 16

In perfect competition what is a firm’s supply curve?

Answer 16

Since profit maximization takes place where marginal revenue is equal to marginal cost, in pure competition the firm’s supply curve will be it’s marginal cost curve above the average variable cost.

Question 17

How do you find the market supply curve in perfect competition?

Answer 17

The horizontal summation of the individual supply curves.

Question 18

A farmer just before harvest suffers a damaging hail storm which cuts his expected wheat yield to only 20 bushels per acre which he can sell for 4 dollar per bushel. The farmer has already invested 300 dollar per acre in seed, fertilizer, and other expenses. To have someone custom harvest the crop will cost him an additional 60 dollars per acre. The alternative is to not harvest and plow the crop under. Assume the plowing costs are the same, regardless if he harvests or not and that there is no crop insurance. Should the farmer harvest or just plow the crop under? Explain why?

Answer 18

The $300 per acre the farmer has already spent is a sunk cost. Fixed costs are sunk and should not be considered in our decision in the short run. So the question is to determine if the additional revenue generated from harvesting will cover the additional expense. By harvesting, he will make 20 per acre, and although he is still going to lose money, he will only lose 280 per acre as opposed to the 300 per acre if he doesn’t harvest.

Question 19

How do firms in pure competition behave in the long run?

Answer 19

With low barriers to entry, if the industry is making an economic profit there is an incentive for other firms to enter the business. As more firms enter, the supply of the product increases, driving down the price and reducing the profits. This will continue until the firm’s economic profit is reduced to zero.

Question 20

In long run perfect competition all inputs are what?

Answer 20

All inputs are variable. It is for this reason that we don’t have fixed costs and that we make no distinction between variable costs and total costs.

Question 21

In the long run in perfect competition economic profits are what?

Answer 21

Profits can be expected to be zero and firms will earn only normal profits.

Question 22

what is productively efficient and how does it relate to long run competition?

Answer 22

Productive efficiency means “least cost” since we are at the minimum ATC, we must be at least cost.
In long run firms still produce where MR = MC. MC crosses Average Cost (AC) at its minimum. At this point MR = MC = AC

Question 23

The state of Illinois is known for having some of most fertile soils in the nation, while parts of Missouri have marginal (low productivity) soils. If the yield per acre is greater in Illinois and the price of the output (corn, wheat, soybeans) is the same for both states, will Illinois farmers make greater profits than Missouri farmers in the long run? Explain why or why not?

Answer 23

Although Illinois farms would be expected to have higher yields, we would expect the economic profits in both states to be zero in the long run. The price will be the same for all farms, but we would anticipate that land in Missouri would sell or rent for less than land in Illinois since it is more productive.