Market Structure

Question 1

Differentiate between Subnormal, Supernormal and zero profit

Answer 1

Subnormal: TR < TC, Considered Unprofitable (May lead to shutdown)
Supernormal: TR > TC, Considered Profitable
Zero Profit: TR=TC, Considered Profitable

Question 2

Define fixed and variable costs

Answer 2

Fixed Costs: Factor inputs that do not vary with output, Only exist in the short run
Variable Costs: Factor inputs that vary with output, exist in both short and long run

Question 3

Define MargInal Cost

Answer 3

The increase in additional cost added to the total cost given the production of one more unit of output

Question 4

Define internal Economies of Scale (IEOS)

Answer 4

Internal Economies of Scale refer to the cost savings arising from the increase in output by expanding the firm’s scale of production. Internal EOS enables firms to spread its cost over a larger output, hence lowering its Long Run Average Cost (LRAC)

Question 5

What are the five types of IEOS and definition

Answer 5

1) Technical Economies of Scale: A large firm with higher output is able to efficiently use machinery with
larger productive capacity to produce a large quantity of output.
2) Administrative Economies of Scale: Output expansion allows firms to spread overhead costs involving the
employment of management staff, thus administrative cost per unit of
output is lowered.
3) Marketing Economies of Scale: Large firms are in a better bargaining position than small firms, thus
able to purchase inputs in bulk at discounted prices.
4) Financial Economies of Scale: Large firms are thought to be more credit worthy and less risky than
small firms and are given banks loans with more favorable rates of
interest. This lowers the cost of borrowing and thus lowers the cost of
production, if loans are needed to finance production.
5) Risk-Bearing Economies of Scale: Firms may diversify their products to spread out risks as losses incurred
by one product can be offset by profits earned from another product.
In the process of diversification, firms may also enjoy risk-bearing
economies of scale.

Question 6

What are the sources of Internal Diseconomies of Scale

Answer 6

1) Problems with bureaucratic structure; The larger firm tends to be bogged down by rules, regulations and standard procedure
2) Problems of coordination and management of information; As the firm expands, there is greater complexity in coordination
between several large departments performing different functions.
3) Problems with motivation; As the firm grows larger and hire more workers, this could result in
workers to feel more isolated and less appreciated.

Question 7

Define External Economies of Scale

Answer 7

External Economies of Scale refer to the cost savings firms enjoy due to industry based expansion. All firms in the industry will experience decrease in average cost

Question 8

Causes of External Economies of Scale

Answer 8

1) Development of Industrial Amenities, for eg: water, electricity, gas
2) Development of a better transport system
3) Development of Research facilities

Question 9

What are the sources of external diseconomies of scale?

Answer 9

1) Factor Prices
2) Crime Rates
3) Infrastructural Bottleneck; too much traffic etc

Question 10

What are the four different market structures? (Arrange from most to least competitive)

Answer 10

1) Perfect Competition
2) Monopolistic Competition
3) Oligopoly
4) Monpoly

Question 11

What factors affect the market structure

Answer 11

1) Barriers to Entry (BTE)
2) Number and Size of Firms
3) Nature of Product
4) Imperfect Information

Question 12

What are the six barriers to entry?

Answer 12

1) Cost Barriers
2) Financial Barriers
3) Government regulations and legal barriers
4) Information Barrier
5) Anti-Competitive Strategies of Incumbent Firm
6) Access to inputs and markets

Question 13

Explain Cost Barrier to Entry

Answer 13

For example, high
start-up or operating costs -> existing firms enjoy very large
economies of scale -> cost savings arising from spreading its cost over
a larger output (AC falls) -> ability of these firms to price
competitively -> difficult for new firms to enter and compete with the
existing firms.

Question 13

Differentiate Perfect and Imperfect Markets

Answer 13

1) Firms in Perfect Market are price takers; Firms in Imperfect Market are price setters
2) Firms in perfect market have no market power; Firms in imperfect market have market power

Question 14

What are the shutdown conditions + explanation

Answer 14

P < AVC
If firm were to shut down, its loss would be the entire FC
If it continues production the revenue is insufficient to cover FC & part of the VC which it cannot cover. Compared to shutting down, loss is greater so to minimise loss should shut down

Question 15

How do different market structures react to increase in firms

Answer 15

Perfect Competition: Market supply increases … Firms supernormal profit reduce, eqm price decrease until equal to price, no incentive for new firms to enter
Monopolistic Competition: Since more substitutes available, indivudal firms demand decreases becomes more price elastic… supernormal profit reduces, eqm price decreases with entry of new firms until eqm price = cost, no incentive for new firms to enter

Question 16

When do firms use cost plus pricing?

Answer 16

When they have imperfect information

Question 17

What is tacit collusion?

Answer 17

Tacit collusion is an unwritten and unspoken understanding through
which firms agree to limit their competition.

Question 18

What is the definition of Price Elasticity of Demand (PED) ?

Answer 18

PED is a measure of the degree of responsiveness of
quantity demanded to a change in the price of the good itself, ceteris
paribus.

Question 19

What is Limit Pricing

Answer 19

Limit pricing is the practice where a monopolist or oligopolist set price
below the average cost of potential entrants to deter potential entrants
from entering the market.

Incumbent firm can set price lower than the potential entrant’s average cost but still higher than its own average cost

*Not profit maximising

Question 20

What is price discrimination?

Answer 20

Price Discrimination is the practice of firms charging a different price for the same product and the price difference cannot be explained by differences in cost of production

Question 21

What are the conditions for the firm to implement price discrimination

Answer 21

1) It must be able to set its own price
2) Markets are separable (firm can clearly tell the distinct groups of people to charge different prices to
3) Differing price elasticity of demand between separated markets
4) Resale of goods between consumers is not possible

Question 22

What are non-price strategies to raise revenue

Answer 22

1) Product Differentiation
a. Product Development and Innovation
b. Creation of salience bias for their product
2) Marketing Strategies
a. Based on loss aversion bias
b. Based on sunk cost bias

Question 23

What are strategies to reduce costs?

Answer 23

1) Innovation and Improved Efficiency
2) Outsourcing (Vendors specializing in the particular good often produce the good or factor input cheaper
3) Offshoring (is when a firm’s production is carried out in another country)
4) Online trading (E-commerce, lowers the cost of production tremendously such as rental cost)

Question 24

What are some methods of growth

Answer 24

1) Internal Growth ( Firms plough back profit in terms of additional fixed assets and so expands its productive capacity)
2) External Growth (Firms combine its existing assets with assets of at least one other firm)
a. Acquisition
b. Merger

Question 25

What are the reasons for Mergers & Aquisitions

Answer 25

1) Acquiring brand loyalty
2) Diversification
3) Cost- Sharing
4) Market Domination

Question 26

How do you determine the performance of a firm

Answer 26

1) Allocative Efficiency
2) Dynamic Efficiency
3) Productive Efficiency
4) Scale of EOS reaped
5) Production compared to minimum efficient scale (MES) of production

Question 27

What are criteria for the consumer welfare

Answer 27

1) Price
2) Consumer Surplus & Consumption
3) Variety