Chapter 4

Question 1

Characteristics of perfect competition

Answer 1

Atomistic firms
Homogenous products
Perfect information
Free entry

Question 2

Firm & market supply (perfect competition)

Answer 2

Firm: effectively flat demand curve, it can sell all it wants at the market price and nothing at a higher price. MR = MC = p

Industry: Supply = S(p) = q1 + q2 +… qn

Question 3

The law of supply and demand

Answer 3

Tendency of the price to move in the direction of the equilibrium price

Question 4

Comparative statistics

Answer 4

Describes the exercise of looking at what happens to the equilibrium if an exogenous factor changes

Question 5

Short-run and long-run equilibrium (perfect competition)

Answer 5

Short-run: number of firms is fixed; profits are positive/zero/negative. p = MC

Long-run: possible entry and exit; firms produce at minimum average cost. p = MC = AC

Question 6

Rent

Answer 6

referred to as a cost advantage (in perfect competition) that earns a positive profit in the long run

Question 7

Characteristics of monopolistic competition

Answer 7

Large number of firms, so impact is negligible
Firm’s demand curve is not horizontal due to product differentiation –> price setters
Free entry and access to technology

So, perfect competition without the product homogeneity.

Question 8

Short-run & long-run equilibrium (monopolistic competition)

Answer 8

Price setter due to product differentiation both in short & long-run –> MR = MC

Profits are possible in the short-run but not in the long-run (p=mc=ac)

If p > ac companies would enter until p = ac

Question 9

Allocative efficiency

Answer 9

requires that resources be allocated to their most efficient use –> requires output to be at the right level

Question 10

Productive efficiency

Answer 10

refers to how close actual production cost is to the lowest cost achievable -> requires that such output be produced at the least expensive way given the available set of technologies

Question 11

Dynamic efficiency

Answer 11

the rate of introduction of new products, as well as the improvement in the production techniques of existing ones, is the basis of an industry’s dynamic efficiency –> refers to improvement of products and production techniques overtime

Question 12

The fundamental theorem

Answer 12

Competitive markets are efficient. In a competitive market the equilibrium levels of output and price correspond to the maximum total surplus

Question 13

Caveats of the Fundamental Theorem (3)

Answer 13

It is a statement about efficiency rather than equity, concerns total surplus not its distribution

Theorem applies to competitive markets, which has some strong assumptions

Theorem is about static efficiency, optimal allocation of resources in an economy with a given set of goods. It is not a statement on dynamic efficiency

Question 14

Competitive selection and efficiency

Answer 14

Each firm’s output decision in each period is efficient. and firm’s entry and exit decisions are also optimal from a social point of view –> similarly to perfect competition, market equilibrium under competitive selection is efficient.

Question 15

Monopolistic competition and efficiency

Answer 15

product inefficiency: costs are not minimized as firms act as price setters rather than takers

Allocation inefficiency: price is higher than minimum average cost. Thus (a) we could lower industry cost by reallocation production between firms and (b) an increase in output would increase total surplus

Question 16

Characteristics competitive selection

Answer 16

firms are price takers
homogenous products
perfect price information
firms must pay a sunk cost to enter the market
not all firms have acces to the same technology

different firms have different productivity levels
each firm is uncertain about its own productivity level

Question 17

Conclusions model of competitive selection

Answer 17

Different firms earn different profit rates, even in the long run
Simultaneous entry and exit in the same industry
Firms that enter and exit are smaller than the average