Textbook Chapter 5

Question 1

Define market structure.

Answer 1

Refers to the number and size of firms within a market for particular good or service and the extent to which they compete with one another.

Question 2

Define perfect competition. What are some examples?

Answer 2

In theory, it is the most competitive form of market structure. Few examples exist, but the stock market and some agricultural markets, such as wheat farming have been considered close examples.

Question 3

Define a pure monopoly. What are some examples?

Answer 3

Exists when a single firm supplies the market and it is the least competitive form of market, in theory. There are few examples in reality, although the Royal Mail used to have a legally enforced monopoly for the delivery of letters.

Question 4

What is assumed the be the main objectives of firms?

Answer 4

Profit maximisation - A basic economic assumption is that entrepreneurs are encouraged to take business risk and start trading if they believe a profit can be made.

Question 5

What can making large profits enable a firm to do?

Answer 5

• Reinvest funds into developing new products that lead to them to gain more customers
• Pay out higher returns of shareholders, which may encourage more people to buy shares in the company or help boost the share price

Question 6

When does profit maximisation occur?

Answer 6

When a firms total revenue exceeds total costs by the greatest amount.

Question 7

What is the profit-maximising rule for firms in all market structures?

Answer 7

It is stated as the level of output where MC = MR. Costs of producing the last unit is equal to the revenue gained from selling that last unit.

Question 8

What are the possible consequences of a divorce of ownership from control?

Answer 8

• May mean that profit maximisation is not always achieved
• Large corporations may be predominantly owned by shareholders who are separate from the day-to-day running of the business, having bought shares in various businesses
• It could lead to conflicting objectives, with the directors pursuing their own objectives; profit maximisation (the assumed shareholder objective) may not be their top priority

Question 9

What may the objectives of directors, who run the business on a day-to-day basis, include?

Answer 9

• Growth maximisation - could boost the profile and CV of senior manager, or reduce the chance of takeover
• Sales revenue maximisation
• Satisficing - targeting a satisfactory, suboptimal level of profit rather than a maximum one

Question 10

Define sales maximisation.

Answer 10

Occurs when a firm’s sales revenue is at a maximum. Occurs at the level of output at which the sale of one more unit would not add to overall revenue - can help firms benefit from economies of scale.

Question 11

Define survival.

Answer 11

In early stages of a firms life this is a key objective - to survive the critical period before it establishes a customer base and repeat sales, and is able to cover its costs.

Question 12

Explain growth.

Answer 12

Once a firm has survived the critical first few years, owners may pursue an objective of growth - will involve increasing its output and scale of operations, expanding its productive base adds size of workforce.

Question 13

What can having the highest market share give firms?

Answer 13

Monopoly power.

Question 14

Firms that exist in a perfectly competitive market are described as…

Answer 14

price takers, since they are obliged by market forces to accept the market equilibrium price, or risk going out of business.

Question 15

What are the assumptions (characteristics) of perfect competition?

Answer 15

• Few, if any, barriers to entry to a market
• Consumers and firms have complete, or perfect, knowledge of all the products supplied by firms, as well as their prices
• Homogenous products
• Perfectly elastic demand curve
• Large number of buyers and sellers

Question 16

What is the impact of the features of a perfectly competitive market?

Answer 16

Any firm that tries to sell its products at a price higher than the market equilibrium will not make any sales, since consumers will know about cheaper alternatives and, since all products are identical, have no loyalty to any particular firm.

Question 17

What is the long run, in perfect competition, defined as?

Answer 17

When normal profit is being made.

Question 18

Why do perfectly competitive firms make supernormal profits in the short run?

Answer 18

Because the average costs curve is below the average revenue curve.

Question 19

What incentivises firms to enter an industry? Why can firms enter a perfectly competitive industry? What happens when they do?

Answer 19

• Incentivised by the SNP being made
• There are no barriers to entry and perfect information
• When they enter supply, in the industry, shifts to the right
• Because these firms are price takers the shift in supply will decrease the firms prices, until there is no more incentive to enter to market - normal profit is left at the end
• SNP is competed away

Question 20

When in perfect competitive is subnormal profit (loss) made?

Answer 20

When the average costs curve is above the average revenue curve.

Question 21

When will firms perfectly competitive firms be incentivised to leave the market?

Answer 21

When subnormal profit (loss) is made - they can easily leave the market as there are no barriers to exit.

Question 22

In perfect competition, what are the two possibilities in the short-run for firms?

Answer 22

• They make SNP

- They make losses

Question 23

What does a firm need to stay in business in the short run?

Answer 23

They need to cover their variable costs. P is greater than or equal to variable costs.

Question 24

What will firms who continue in business or shut down have to pay for that year? If a firm is obtaining a price above VC what can they?

Answer 24

Fixed costs - if a firm is obtaining a price above variable costs then they can use this revenue to contribute towards paying fixed costs - in effect minimising their losses.

Question 25

What does a firm need to stay in business in the long run?

Answer 25

Firms need to cover their total costs or average costs - it makes no sense in the LR to produce unless you’re covering average costs - because in the LR you will incur further fixed costs by continuing to operate.

Question 26

(Perfect Competition)

What can we assume in the LR if there are SNP being earned?

Answer 26

Firms can enter the industry.

Question 27

(Perfect Competition)

When are all firms making normal profits?

Answer 27

Price = Average Costs

Question 28

Explain perfect competition in the LR.

Answer 28

• There is perfect information - so firms will notice SNP
• There are barriers to entry - so new firms can enter to compete for this profit
• The increase in the number of firms will increase industry supply and therefore reduce the industry price - this will continue until all firms are making normal profit.

Question 29

(Perfect Competition)

What can we assume in the long-run if firms are making losses?

Answer 29

That they can exit the industry.

Question 30

(Perfect Competition)

Explain firms making abnormal losses in the LR.

Answer 30

• Firms will exit the market in the LR if they can’t make a profit
• If firms are making abnormal losses then firms will exit the market - due to low barriers to exit
• This will reduce industry supply and raise the industry price - which will continue until firms in the market are making normal profits
• Due to the higher price and decreased competition each firm will be producing more - but the industry as a whole will be producing a lower quantity

Question 31

What are the advantages of perfect competition, in terms of efficiency?

Answer 31

• Productive efficiency - when goods and services are produced at minimum average cost, or that minimum inputs are used to produce maximum outputs. Producing at lowest level of average costs
• Allocative efficiency - will lead to firms producing what consumers demand since, if they don’t, they will lose market share to firms that are producing the most desired products

Productive and allocative efficiency are the components of static efficiency.

Question 32

Define a pure monopoly.

Answer 32

The sole seller in a market.

Question 33

Define a technical or legal monopoly.

Answer 33

25%, or greater, market share - examples include Microsoft, AT&T and Facebook

Question 34

What are the sources of monopoly power?

Answer 34

• High barriers to entry
• Differentiated products - oppose of homogenous
• Imperfect information

Question 35

What barriers to entry do monopolies have?

Answer 35

• Start-up costs
• Access to factors of production
• Patents
• Economies of Scale
• Red tape