Mod 4 - Topic 1 - Perfect Competition & Monopoly

Question 1

What are the five features of perfect competition?

Answer 1

1. Market power - None
2. Buyers & Sellers - Lots who are relatively small
3. Product - Standardised
4. Market entry & exit - Very easy
5. Non-price competition - not possible

Question 2

What are four examples of perfect competition industries?

Answer 2

1. Agricultural products
2. Financial instruments
3. Precious metals
4. Petrol

Question 3

What are the five features of a monopoly?

Answer 3

1. Market power - absolute subject to govt regulation
2. Buyers & Sellers - One firm (firm is the industry)
3. Product - Unique (no close substitutes)
4. Market entry & exit - Difficult or legally impossible
5. Non-price competition - not necessary

Question 4

What are three examples of monopoly industries?

Answer 4

1. Pharmaceuticals
2. Microsoft
3. Gas station on the edge of a desert

Question 5

What are five features of monopolistic competition?

Answer 5

1. Market power - based on product differentiation
2. Buyers & Sellers - large number of small firms acting independently
3. Product - differentiated
4. Market entry & exit - relatively easy
5. Non-price competition - very important

Question 6

What are three examples of monopolistic competition industries?

Answer 6

1. Boutiques
2. Restaurants
3. Repair shops

Question 7

What are the five features of an oligopoly?

Answer 7

1. Market power - product differentiation and/or the firms dominance in the market)
2. Buyers & Sellers - small number of large mutually independent firms
3. Product - Differentiated or standardised
4. Market entry & exit - difficult
5. Non-price competition - Important

Question 8

What are four examples of an Oligopoly industry?

Answer 8

1. Oil refining
2. Processed foods
3. Airlines
4. Internet access

Question 9

What is market power?

Answer 9

It is the power to establish the market price

Question 10

What is market structure?

Answer 10

It is the number and relative sizes of the buyers and sellers in a market

Question 11

What is a price maker?

Answer 11

Firms that exercise market power through product differentiation or by being dominant players in their markets

Question 12

What is a price taker?

Answer 12

Firms that operate in perfectly competitive markets.

Question 13

Managers must make a business case for entering a perfectly competitive market based on what questions?

Answer 13

1. How much should we produce?
2. If we produce such an amount, how much profit will we earn?
3. If we earn a loss rather than a profit, is it worthwhile to continue over the long-run or should we exit?

Question 14

To determine the firms output decision in perfect competition, what economic assumptions must they have?

Answer 14

• They are a price taker (as it is perfectly competition)
• Distinction make between short and long run
• Objective is to maximise profit (or minimise loss) in the short run
• Opportunity cost (implicit) is factored in as part of its total cost of production to get total economic cost.

Question 15

What is economic cost?

Answer 15

All cost incurred to attract resources into a company’s employ (includes explicit and implicit costs).

Question 16

What is normal profit?

Answer 16

Amount of profit earned in a particular endeavour that is just equal tot he profit that could be earned in a firm’s next best alternative activity.

Question 17

When a firm earns a normal profit what is it equivalent to?

Answer 17

The accounting cost and opportunity cost combined.

Question 18

What is economic profit?

Answer 18

Total revenue minus total economic cost. The amount earned above what the firm could have earned in its next-best alternative.

Question 19

What are two other names for economic profit?

Answer 19

1. Abnormal profit

2. Above-normal profit

Question 20

What is an economic loss?

Answer 20

Where a firm’s revenues cannot cover its account cost and opportunity cost.

Question 21

As a price taker, what does the demand curve look like?

Answer 21

It is perfectly elastic (vertical) - which means customers are willing to buy as much as the firm is willing to sell at the going market price.

Question 22

What is the total revenue / total cost approach?

Answer 22

Compares the total revenue and total cost schedules and finds the level of output that either maximises the firm’s profits or minimises their losses

Question 23

What is the marginal revenue / marginal cost approach?

Answer 23

Aims to produce a level of output at which the additional revenue received from the last unit is equal to the additional cost of producing that unit (ie. MR = MC)

Question 24

How is MR=MC restated in a perfectly competitive market?

Answer 24

P=MC because P=MR in the perfectly competitive market

Question 25

For economic profit, where is the optimal level of quantity output?

Answer 25

The point where MR and MC cross, ie P=MR=MC.

Question 26

Where the firm incurs a loss at optimum output the price is below average cost. How do you determine if the firm is worth continuing to produce in the short run?

Answer 26

IF the Price is still greater than AVC, as a firm will still incur its fixed costs.

Question 27

What is contribution margin?

Answer 27

It is the amount by which total revenue exceeds total variable cost. Where contribution margin > 0 then the firm should continue to produce in the short run in order to defray some of the fixed cost. CM = TR-TVC

Question 28

What is the shut down point?

Answer 28

The lowest rice at which the firm would still produce. At shutdown point P=minimum point of AVC

Question 29

What happens if price falls below the shut down point?

Answer 29

Revenue fails to cover fixed and variable costs and the firm would e better off if it shut down and just paid its fixed costs.

Question 30

Why in the long term will the price in a competitive market settle at the point where the firm earns a normal profit?

Answer 30

• Because economic profit invites entry of new firms, which shifts the supply curve to the right and puts downward pressure on price and therefore reduces profits
• And economic loss causes exit of firms, shifts the supply curve to the left, puts upward pressure on prices and therefore increases profits.

Question 31

In a competitive market, is it more advantageous to be first into market and why?

Answer 31

Yes, because there are better chances of earning above normal profit - as new firms enter, they must find new ways to produce at the lowest cost.

Question 32

If a firm in a competitive market firms unable to compete on the basis of cost have what option available?

Answer 32

Compete on the basis of product differentiation

Question 33

What does the demand curve look like for a monopoly?

Answer 33

It is downward sloping because the firm is a price setter.

Question 34

Where is the optimal level of output found?

Answer 34

Where MR = MC