Rational Producer Choice

Question 1

What are the Conditions for Perfect Competition?

Answer 1

• Large Number of Identical Firms
• Price Taker (Firms cannot affect P)
• Free entry and exit to the market
• Homogenous products
• Perfect information about products

Question 2

What is the difference between Exogenous Variables and Endogenous Variables?

Answer 2

• Exogenous Variables are taken as given
• Endogenous Variables are discovered in experiments

Question 3

What is the difference between SR and LR cost function?

Answer 3

• SR means that Fixed Costs are already paid off and firms focus on variable costs
• LR means that Fixed Costs are now considered in decision making whether entering or exiting

Question 4

What is the decision making process for an Individual Firm in the Short Run?

Answer 4

• Optimal point to produce at:
• P=MC
• If P>MC, profits are rising
• If P<MC, profits are falling
• Supply = MC
• Firms operating profits can be negative: Only choose q>0 if Profit is greater than 0
• AR>AVC in the SR to not shut down

Question 5

What is the difference between shutting-down and exiting the market?

Answer 5

• Shutting down is temporarily ceasing production whilst remaining within the market
• An example would be a firm not operating during the COVID pandemic
• Exiting the market is when a firm leaves the market for good in the long run

Question 6

What is the Shut-Down point in the Long Run?

Answer 6

• P>ATC(q)
• Or AR>ATC

Question 7

How do you aggregate the Short Run Supply Curve?

Answer 7

• In the SR, the number of firms in the industry is temporarily fixed
• Add firms production all together to get the total market production
• The curve should be a straight line and should be flatter than the individual firms supply curve
• There will be a kink in the curve if the firms offer heterogenous products

Question 8

How do you aggregate the Long Run Supply Curve (referring to types of profits)?

Answer 8

• Incumbent firms are free to leave and new firms can enter
• If profits > 0 ; new firms enter
• Must be 0 economic profit in the Long Run
• Economic Profit = Revenue - explicit costs - implicit costs

Question 9

What Is Total Societal Welfare comprised of?

Answer 9

• Consumer Surplus
• Producer Surplus

Question 10

Which Market maximises Total Surplus?

Answer 10

• Competitive Market

Question 11

What are the Conditions for Monopolies?

Answer 11

• Only Supplier of a Product
• Faces the whole market demand
• ‘Market Power’- Decisions affect Price

Question 12

What are some sources of Monopoly Power?

Answer 12

• Exclusive Rights or Control Over Inputs
• Economies of Scale
• Network Economies
• Government Licences or Patents

Question 13

What is the relationship between Demand and Marginal Revenue?

Answer 13

• The Gradient of MR = 2 x The Gradient of Demand

Question 14

What is the relationship between MR and the optimal quantity produced for monopolists?

Answer 14

• If q < Qmax / 2 , MR>0
• If q = Qmax / 2 , MR=0
• If q > Qmax / 2 , MR<0

Question 15

What is the Lerner Index and what should the markup be (referring to elasticities)?

Answer 15

• (P-MC)/P = 1/|E|
• If |E|<1, mark-up should be large
• If |E|>1, mark-up should be small

Question 15

What Point do Monopolists produce at?

Answer 15

• MR=MC