Perfect competition and monopoly

Question 1

Objective of firms

Answer 1

Profit maximising

Question 2

Equilibrium condition for profit maximising

Answer 2

MR = MC
No incentive to change output.
All market structures can only maximise profit when MR = MC.

Question 3

MR>MC

Answer 3

Profits rise when output increases.

Fail to profit maximise.

Question 4

MR

Answer 4

Profits rise when output reduces.

Fail to profit maximise.

Question 5

Normal profit

Answer 5

The minimum profit a firm must make to stay in business, while being insufficient to attract new firms into the market.
Economists treat as a Cost of Production as must make this normal profit to stay in business.
In LR, firms unable to make normal profit leave the market.

Question 6

Supernormal profit

Answer 6

Profit over and above normal profit.
In LR, (in absence to barriers of entry) supernormal profit performs the important economic function of attracting new firms into the market.

Question 7

Condition 1: Perfection Competition

Answer 7

1: Large number of buyers and sellers

Question 8

Condition 2: Perfection Competition

Answer 8

2: perfect market information

Question 9

Condition 3: Perfection Competition

Answer 9

3: able to buy/sell as much as they wish at the ruling market price

Question 10

Condition 4: Perfection Competition

Answer 10

4: unable to influence the ruling market price

Question 11

Condition 5: Perfection Competition

Answer 11

5: uniform product

Question 12

Condition 6: Perfection Competition

Answer 12

6: no barriers to entry or exit

Question 13

AC = MC

Answer 13

Productive efficiency

Question 14

Long run Perfect Competition

Answer 14

• Can enter and leave
• SR: Make supernormal profit… signals to firms outside the market that profit can be made, provides incentive for new firms to join the market.
• too many enter
• make a loss (Subnormal profit)
• Therefore firms leave, supply shifts left, and normal profit is maintained in the LR.

Question 15

Subnormal profit

Answer 15

Incentive for firms to leave market

Question 16

**Providing the firm is a profit maximiser…

Answer 16

The equilibrium MR = MC applies to any firm, whatever the market structure.

Question 17

Monopoly equilibrium

Answer 17

Does not distinguish between SR & LR as protected from barriers to entry, which prevent new firms entering the market to share the supernormal profit made for by the monopolist.
Entry barriers enable the firm to preserve supernormal profits in the LR as well as the SR. Supernormal profits in perfect competition are temporary, where as in monopoly supernormal profits are often called monopolist profit. The monopolist has market power to reserve profit by keeping competitors out.

Question 18

Barriers to exit

Answer 18

Fixed assets - capital equipment
Redundancy costs - payments to redundant workers
Closure costs - for cutting contracts short

Question 19

Profit maximisation

Answer 19

Different between total revenue and total cost is at its greatest.
MR = MC

Question 20

Revenue maximisation

Answer 20

Occurs at level of output at which marginal revenue is zero

Question 21

Barriers to entry: Limit pricing

Answer 21

Firms adopt pricing policies by lowering prices to a level which would force new entrant to operate at a loos and in the long run it would be forced out the market.

Question 22

Barriers to entry: Advertising

Answer 22

Allows firms to establish branded products and win customer loyalty. New entrants must therefore spend substantial amounts on advertising to compete, which could deter entry.

Question 23

Barriers to entry: Absolute cost advantages

Answer 23

Cut prices and win price wars as have been in market for long time.

Question 24

Barriers to entry: Sunk costs

Answer 24

Costs unrecoverable once entered the market, therefore disincentive to enter the industry.