Final Exam

Question 1

What are assumptions of perfect competition?

Answer 1

Identical products, a large amount of buyers/sellers, easy entry/exit, perfect information

Question 2

What is the difference demand curve faced by a market vs a firm in perfectly competitive market?

Answer 2

Market: downward sloping / Single firm: perfectly horizontal (elastic)

Question 3

What are the formulas for revenue, price, and profit of a competitive firm?

Answer 3

P = MR, Revenue = P * output, Profit = Revenue - Costs

Question 4

How does a market know how much to produce based on comparing MC and MR?

Answer 4

Look at when MC = MR

Question 5

Where is the competitive firm’s supply curve?

Answer 5

When MC > ATC

Question 6

Explain a competitive firm’s decision making in the Short run: to operate or to shut down.

Answer 6

If the firm’s TR > VR, it should continue to operate in the short run, even if it is making losses. This is because by continuing to produce, the firm is at least covering its variable costs and is contributing something to its fixed costs, which it will have to pay regardless of whether it operates or shuts down.

In short run: costs are variable, can get out of leases, firms can add or reduce capital

Question 7

How to measure a competitive firm’s profit/loss in a graph?

Answer 7

1: find where MC = MR. that’s the price of product.
2: find at that output where ATC is. That’s the cost of production.
Do price * quantity and ATC * quantity. Then do revenue - cost

Question 8

Explain a competitive firm’s long-run decisions: to exit or enter a market

Answer 8

As long as TR > TC. The firm exits the market if the revenue it would get from producing is less than its total costs.

Question 9

Why in the Long-Run does each competitive firm makes Zero Economic Profit.

Answer 9

If the existing firms are making positive economic profits, new firms will keep on entering the business. This would cause the market supply to keep increasing …. Until all the positive economic profits are eliminated

Question 10

Why competitive firms stay in business if they make Zero Economic Profits.

Answer 10

If economic Profit is zero, accounting profit is positive.

Since total cost includes all the opportunity costs of the firm, the accounting profit is positive even though the long-run economic profit is zero. As the accounting profit (i.e. benefit) equals cost (opportunity costs), firms may stay in business.

From the empirical perspective: in the real world, perfect competition does not exist, all the markets around us are imperfectly competitive meaning that many firms are earning positive economic profits even in the long run.

Question 11

Explain Long-Run Industry Supply Curves under: (1) Constant Cost industry, (2) Increasing Cost industry, and (3) Decreasing Cost industry.

Answer 11

constant cost industry: the production cost of each firm does not change as the industry output increases or decreases. As a result, the industry supply curve is a horizontal line at the minimum average total cost of the firms, indicating that firms can supply any quantity of output at that price level.

increasing cost industry: In an increasing cost industry, the production cost of each firm increases as the industry output increases, due to the scarcity of resources or input factors. This means that firms in the industry are facing upward sloping supply curves in the long run. The industry supply curve slopes upward due to the higher costs of production for each firm, resulting in higher prices and a smaller quantity of output supplied by the industry.

decreasing cost industry: In a decreasing cost industry, the production cost of each firm decreases as the industry output increases, due to economies of scale, technological advances, or access to cheaper inputs. This means that firms in the industry are facing downward sloping supply curves in the long run. The industry supply curve slopes downward because as the output of the industry increases, the production cost of each firm decreases, resulting in lower prices and a larger quantity of output supplied by the industry.

Question 12

What is a monopoly?

Answer 12

A single firm that is the sole seller of a product for an entire market. In real life, almost nothing is perfect monopoly, ex: Amazon, Airbnb.

Question 13

What is a price setter?

Answer 13

A producer who can influence the market price of its product.

Question 14

What are assumptions of a monopoly?

Answer 14

No identical products, a large amount of buyers and sellers, hard to enter, imperfect information

Question 15

What are barriers to entry in a monopoly?

Answer 15

Either key resource owned by single firm or government gives single company the right to produce a good/service

Question 16

What is an industry?

Answer 16

Industry: a natural monopoly where a single firm can produce a good or service to a market at a smaller cost than could two or more firms (postal service, cable, utilities) Hard to enter because of huge fixed cost.

Question 17

How does a monopolist make pricing/production decisions?

Answer 17

1) monopolist demand curve is market demand curve and 2) monopolist’s goal is to maximize profit
There is no supply curve in monopoly. As long as MR > MC, increasing output increases profit

Question 18

How does a monopoly calculate profit?

Answer 18

1) look at the quantity where MR = MC
2) price = point at demand / cost = ATC
3) profits - loss

Question 19

How is Welfare loss (Dead weight loss) under monopoly compared to welfare under perfect competition?

Answer 19

High monopoly prices lead to a deadweight loss of consumer welfare because output is lower and price higher than a competitive equilibrium

Question 20

What is Perfect and imperfect price discriminations by monopolists?

Answer 20

Price discrimination: selling the same good at different prices to different customers

Imperfect: Ability to separate customers based on willingness to pay, raises economic welfare as a whole, gets more customers

Perfect: when the monopolist can observe each buyer’s willingness to pay perfectly

Question 21

What are Public policies to remedy the problem of monopoly

Answer 21

Marginal cost pricing? Problems: the firm might lie, the firm will make losses if MC is always below AC
Average cost pricing? Problems: the firm might lie, there is no incentive to reduce AC through better technology, management, etc.

Question 22

What is a monopolistic competition?

Answer 22

A competition in which multiple firms sell a similar product at different prices (e.g: market for phones)

Question 23

How should market demand look like under monopolistic competition?

Answer 23

It should be downward facing (unlike a perfect competition were it is perfectly inelastic)

Question 24

How will a single price monopoly try to maximize profits?

Answer 24

At demand when MR is equal to MC

Question 25

How to calculate profits/loss in monopolistic competition?

Answer 25

like in a monopoly
1) look at the quantity where MR = MC
2) price = point at demand / cost = ATC
3) profits - loss

Question 26

In the long run, each firm that is monopolistic competitive earn?

Answer 26

Zero economic profit. As firm enter, demand falls. As firms exit, demand rises for individuals.

Question 27

How does long run efficiency of monopolistic competition compare to efficiency of perfect competition?

Answer 27

In terms of efficiency, monopolistic competition is less efficient in the long run compared to perfect competition.

This is because monopolistic competition results in a higher price and lower quantity of output compared to perfect competition.

In perfect competition, firms produce at the minimum of the average total cost curve, resulting in productive efficiency. In monopolistic competition, firms do not produce at the minimum of the average total cost curve, resulting in allocative inefficiency. there is also the issue of excess capacity in monopolistic competition where firms have a higher production capacity than what is actually being used, which is also inefficient.

Question 28

What is an oligopoly?

Answer 28

A market structure in which only a few sellers offer similar or identical products

A key feature of oligopoly is the tension between cooperation and self-interest. This tension causes each firm to set its own price/quantity strategically (to find the best possible profit which depends on what other firms are doing).

Question 29

What is collusion?

Answer 29

an agreement among firms in a market about quantities to produce or prices to charge

Question 30

What is a cartel?

Answer 30

a group of firms colluding (i.e. operating in unison to act like a monopoly). All cartel members should agree on how to share the profit, as well as their production decision.

Question 31

What happens when oligopolies individually produce to maximize their own profits?

Answer 31

In summary, when firms in an oligopoly individually choose production to maximize profit, they usually (unless they strictly cooperate with, and trust each other) produce a quantity of output greater than the level produced by monopoly, and less than the level produced by a competitive market. In addition, the oligopoly price is less than the monopoly price but greater than then competitive price.

Question 32

What is game theory?

Answer 32

It is a sub-discipline of economics. It is an analytical framework in which two or more entities interact. Each entity’s payoff (e.g. profit or benefit) depends not only on his strategy, but also what others are doing. The goal of game theories is to predict the outcomes of interactions of different players, and prescribe rules that can avoid harmful outcomes.

Question 33

What is preventing global cooperation in trade, weapons technology, and genetics?

Answer 33

Extreme nationalism and illiberal Democracy

Question 34

What is the prisoner’s dilemna ?

Answer 34

The prisoner’s dilemma is a paradox in decision analysis in which two individuals acting in their own self-interests do not produce the optimal outcome.

Question 35

What are assumptions of an oligopoly?

Answer 35

Identical or similar products, few sellers lots of buyers, high barriers to entry, imperfect information

Question 36

What are the possible outcomes in an oligopolistic market: from Cooperation (causing monopoly outcomes), and non-cooperation.

Answer 36

In an oligopolistic market, firms can either cooperate or not cooperate with each other. When firms cooperate, they act as a single entity and coordinate their actions to maximize profits, leading to outcomes similar to a monopoly. This can be achieved through agreements such as price-fixing or output quotas. Non-cooperation, on the other hand, involves firms acting independently of each other, leading to competition and potentially lower profits. This can result in price wars, aggressive marketing, and innovation to gain a larger market share. Ultimately, the outcome of an oligopolistic market depends on the actions of the firms involved and the degree of competition or cooperation among them.

Question 37

What is the Duo-poly (two-firms) example: how does it lead to tension between cooperation and self-interest?

Answer 37

A duopoly is a market structure with only two firms. In a duopoly, each firm has a choice to either cooperate with the other firm or act in their own self-interest. If both firms cooperate and act as a monopoly, they can maximize their joint profits. However, each firm has an incentive to cheat and produce more output to gain a larger market share and increase their profits at the expense of the other firm. This creates a tension between cooperation and self-interest, known as the prisoner’s dilemma.

Question 38

What is the Nash equilibrium of a game?

Answer 38

states a player can achieve the desired outcome by not deviating from their initial strategy.

Question 39

What is the dominant strategy equilibrium of a game?

Answer 39

the outcome of a game where all players achieve their best outcome regardless of what their competitors are doing.

Question 40

What is the dominant strategy?

Answer 40

A dominant strategy is a strategy that is always the best choice for a player regardless of the other player’s actions. In other words, it is the strategy that yields the highest payoff for a player regardless of what the other player does.

On the other hand, a dominant strategy equilibrium is a solution concept in which all players in a game play their dominant strategies.

Question 41

In game theory, there are non-cooperative and cooperative games. How may cooperation be possible in repeated games?

Answer 41

In repeated games, cooperation can be possible through the use of strategies that involve the players taking into account the potential future consequences of their actions. This means that players can choose to cooperate with each other in the present, with the expectation that their cooperation will be reciprocated in the future.

Question 41

In game theory, there are non-cooperative and cooperative games. How may cooperation be possible in repeated games?

Answer 41

In repeated games, cooperation can be possible through the use of strategies that involve the players taking into account the potential future consequences of their actions. This means that players can choose to cooperate with each other in the present, with the expectation that their cooperation will be reciprocated in the future.

Question 42

Knowing elasticity of different consumers, a price-discriminating monopoly would charge the lowest price to…

Answer 42

the one with the highest elasticity

Question 43

Profit-maximizing monopolies are inefficient because…

Answer 43

… their price is more than marginal cost.

In a perfectly competitive market, firms produce where marginal cost equals marginal revenue, which ensures that resources are allocated efficiently. However, a monopolist has market power and can choose to produce at a quantity where marginal revenue equals marginal cost, but then charge a higher price than the marginal cost, resulting in a deadweight loss.

Question 44

What is economic efficiency?

Answer 44

Economic efficiency refers to the optimal use of resources to produce goods and services, such that society gets the most benefit from the resources it has available.

Question 45

What is economic equity?

Answer 45

Economic equity, on the other hand, refers to the fair distribution of those resources among members of society.

Question 46

What is the relationship between economic equity and efficiency?

Answer 46

There is a tradeoff between equality and efficiency.

In some cases, policies that promote economic equity may reduce economic efficiency. For example, progressive income taxation may reduce economic efficiency by creating disincentives for high earners to work or invest, but it may increase economic equity by reducing income inequality. On the other hand, policies that promote economic efficiency, such as deregulation or free trade, may exacerbate income inequality and reduce economic equity.

Economists often debate the trade-offs between economic efficiency and economic equity, and there is no one-size-fits-all answer to how to balance the two goals.

Question 47

What is a lorenz curve?

Answer 47

… the distribution of income or wealth among households ranked from the poorest to the richest

A Lorenz curve is a graphical representation of income distribution, which plots the cumulative percentage of total income received against the cumulative percentage of the population, starting with the poorest individuals. The curve is used to show how income is distributed across a population and to measure income inequality. A perfectly equal income distribution would result in a straight diagonal line, while a curve below the diagonal line indicates inequality, with the degree of curvature indicating the extent of inequality. The further the curve is from the diagonal, the more unequal the income distribution. The area between the diagonal line and the Lorenz curve is a measure of income inequality, with a smaller area indicating greater equality and a larger area indicating greater inequality.

Question 48

Why are economies of a scale a natural barrier to new firms to an industry?

Answer 48

because economies of scale refer to the cost advantages that firms experience as they increase production, leading to a lower average cost of production. These cost advantages are a natural barrier to entry, as new firms will not be able to match the efficiency and lower costs of established firms. Patents (B) grant exclusive rights to the inventor of a new product or process and are not a natural barrier to entry, as they are created by legal means. Licensing of professions (C) and public franchises (D) are also not natural barriers to entry, as they are created by legal or regulatory means rather than market forces.

Question 49

What is the purpose of product differentiation?

Answer 49

because the main purpose of product differentiation is to make a product appear different and unique from its competitors, which can increase demand for the product and reduce the price elasticity of demand. By making the product appear different, firms can create a loyal customer base that is willing to pay higher prices. This can lead to a decrease in the price elasticity of demand, which means that a change in price will not cause a significant change in the quantity demanded. This can enable firms to charge higher prices and earn higher profits.

Question 50

Excess capacity in monopolistically competitive firms is caused by…

Answer 50

the fact that each firm faces a demand that is not perfectly elastic.

Because excess capacity is the result of the demand curve being less than perfectly elastic, which is a characteristic of monopolistically competitive markets. In such markets, firms have some market power to set prices above marginal cost, but because of product differentiation, each firm faces a downward sloping demand curve that is not perfectly elastic. As a result, firms may have excess capacity, which means they are not producing at their efficient scale. This is because firms are producing a quantity of output that is less than what they would produce if they were operating at minimum average total cost.

Question 51

Consider a duopoly with collusion. If the duopoly maximizes profit…

Answer 51

…industry marginal revenue will equal industry marginal cost at the level of total output.

…because, under collusion, the firms in a duopoly act as a monopolist and maximize their joint profit by producing the quantity where the marginal cost of producing an additional unit equals the marginal revenue obtained from selling that unit. In other words, the industry’s marginal revenue will equal its marginal cost at the level of total output. This is the same condition that holds for profit maximization by a monopolist.

Question 52

The larger the gap between the Lorenz curve and the diagonal…

Answer 52

none of the above.

The gap between the Lorenz curve and the diagonal does not provide information on the level of inequality, poverty, or richness in the income distribution. Instead, the Lorenz curve is a graphical representation of the distribution of income in a society, where the horizontal axis represents the cumulative percentage of households, ranked by income from the lowest to the highest, and the vertical axis represents the cumulative percentage of total income received by those households. The closer the Lorenz curve is to the diagonal, the more equal is the distribution of income. In contrast, the further the Lorenz curve is from the diagonal, the more unequal is the distribution of income. However, the gap between the Lorenz curve and the diagonal does not provide any additional information about the degree of inequality.

Question 53

How would you solve this problem?

A monopolist has the following information:
Demand: P = 40-2Qd,
Supply: MC = AVC = ATC = 10,
MR = 40-4Qd
P is the price, MC is the marginal cost, AVC is the average variable cost, ATC is the average total cost, MR is the marginal revenue and Qdis the quantity demanded.
Solve for Monopolist’s profit-maximizing Price and Quantity

Answer 53

Remember, in a monopoly MR is equal to MC. So, make them equal to find quantity, and then plug quantity into the demand function.