UGBA 101A Week Eight & Nine: Competition & Profit Maximization

Question 1

perfectly competitive markets: price taking

Answer 1

because each individual firm sells a sufficiently small proportion of total market output, its decisions have no impact on market price

Question 2

price taker

Answer 2

firm that has no influence over market price and thus takes the price as given

Question 3

perfectly competitive markets: product homogeneity

Answer 3

When the products of all of the firms in a market are perfectly substitutable with one
another—that is, when they are homogeneous—no firm can raise the price of its
product above the price of other firms without losing most or all of its business.

Question 4

why is the assumption of product homogeneity important?

Answer 4

it ensures that there is a
single market price, consistent with supply-demand analysis.

Question 5

product heterogeneity

Answer 5

In contrast, when products are heterogeneous, each firm has the opportunity to raise
its price above that of its competitors without losing all of its sales.

Question 6

free entry (or exit)

Answer 6

Condition under which there are no special costs that make it difficult for a firm to enter (or exit) an industry.

With free entry and exit, buyers can easily switch from one supplier to another, and
suppliers can easily enter or exit a market.

Question 7

When is a market highly competitive?

Answer 7

Many markets are highly competitive in the sense that firms face highly elastic demand curves and relatively easy entry and exit, but there is no simple rule of thumb to describe whether a market is close to being perfectly competitive.

Because firms can implicitly or explicitly collude in setting prices, the presence of many firms is not sufficient for an industry to approximate perfect competition.

Conversely, the presence of only a few firms in a market does not rule out competitive
behavior

Question 8

Do firms maximize profit?

Answer 8

The assumption of profit maximization predicts business behavior reasonably
accurately and avoids unnecessary analytical complications.

For smaller firms, profit is likely to dominate almost all decisions. In larger firms,
however, managers who make day-to-day decisions usually have little contact with
the owners.

Managers may be more concerned with such goals as revenue maximization,
revenue growth

Firms that do not come close to maximizing profit are not likely to survive. The
firms that do survive make long-run profit maximization one of their highest
priorities.

Question 9

cooperative

Answer 9

Association of businesses or people jointly owned and operated by
members for mutual benefit.

Question 10

condominium

Answer 10

A housing unit that is individually owned but provides access to common facilities that are paid for and controlled jointly by an
association of owners.

Question 11

profit

Answer 11

total revenue - total cost

Question 12

marginal revenue

Answer 12

change in revenue resulting from a one-unit increase in output

Question 13

What is the marginal revenue relative to the marginal cost at the output which maximizes the profit in the short run?

Answer 13

marginal revenue = marginal cost

Question 14

demand curve faced by a competitive firm vs the market demand curve

Answer 14

demand curve facing the firm is perfectly elastic (they only supply small portion of total output in industry therefore firm takes the market price of the product as given, so price will be unaffected by output choice) - HORIZONTAL LINE (MR, AR, price all equal)

market demand curve is still downward sloping

Question 15

a perfectly competitive should choose its output so that _____ equals price

Answer 15

marginal cost

MC = MR = P

Question 16

output rule

Answer 16

if a firm is producing any output, it should produce at the level at which marginal revenue equals marginal cost

this also informs the price as profit is maximized in the short run when MC = P = MR

any change in output will lead to lower profit

Question 17

when should the competitive firm shut down?

Answer 17

A competitive firm should
shut down if price is below AVC.

should produce in short run if P > AVC (at least covers variable cost)

Question 18

A price taker is:
A) a firm that accepts different prices from different customers.
B) a consumer who accepts different prices
from different firms.
C) a perfectly competitive firm.
D) a firm that cannot influence the market price.
E) both C and D

Answer 18

E) both C and D

Question 19

Revenue is equal to:
A) price times quantity.
B) price times quantity minus total cost.
C) price times quantity minus average cost.
D) price times quantity minus marginal cost.
E) expenditure on production of output.

Answer 19

A) price times quantity.

Question 20

producer surplus

Answer 20

Producer surplus measures the total profits of producers, plus rents to factor inputs.

It is the benefit that lower-cost producers enjoy by selling at the market price, shown
by the green-shaded area between the supply curve and the market price.

Question 21

what does consumer and producer surplus measure together?

Answer 21

Together, consumer and producer surplus measure the welfare benefit of a competitive market.

Question 22

Consumer surplus

Answer 22

Consumer surplus, which measures the total benefit to all
consumers, is the yellow-shaded area between the
demand curve and the market price.

Question 23

welfare effects

Answer 23

s Gains and losses to consumers and
producers.

Question 24

deadweight loss

Answer 24

net loss of total consumer and producer surplus

Question 25

change in consumer and producer surplus from price controls

Answer 25

price of a good regulated to be no higher than Pmax, which is below the market-clearing price P0

the gain to consumers is the difference between rectangle A and triangle B

the loss to producers is the sum of rectangle A and triangle C

triangles B and C together measure the deadweight loss from price controlse

Question 26

economic efficiency

Answer 26

maximization of aggregate consumer and producer surplus

Question 27

market failure

Answer 27

situation in which an unregulated competitive market is inefficient because prices fail to provide proper signals to consumers and producers

Question 28

what are the two important instances in which market failure can occur?

Answer 28

externalities
lack of information

Question 29

externality

Answer 29

a side effect or consequence of an industrial or commercial activity that affects other parties without this being reflected in the cost of the goods or services involved, such as the pollination of surrounding crops by bees kept for honey.

Action taken by either a
producer or a consumer which affects other producers or consumers but is not accounted for by the market price.

Question 30

lack of information

Answer 30

Market failure can also occur when consumers lack information about the quality or nature of a product and so
cannot make utility-maximizing purchasing decisions. Government
intervention (e.g., requiring “truth in labeling”) may then be desirable.

Question 31

welfare loss when price is held above market clearing level

Answer 31

when price is regulated ot be no lower than P2, only O3 will be demanded

if O3 is produced, the deadweight loss is given by traingles B and C

At price P2, producers would like to produce more than O3. If they do, the deadweight loss will be even larger

Question 32

minimum price

Answer 32

surplus of goods produced

producers and consumers may be worse off

Question 33

minimum wage

Answer 33

may result in unemployment - deadweight loss - consumers and suppliers worse off

Question 34

Producer surplus is measured as the:

A) area under the demand curve above market price.

B) entire area under the supply curve.

C) area under the demand curve above the supply curve.

D) area above the supply curve up to the market price.

Answer 34

D) area above the supply curve up to the market price.

Question 35

One way to remove the excess labor supply problem from a minimum wage
policy is to have the government hire all
unemployed workers at the minimum wage. What is the key drawback of this
version of a minimum wage policy?

A) The deadweight loss may increase substantially.
B) The cost to the government may be very large.
C) Consumer surplus losses increase further.
D) A and B are correct.
E) B and C are correct

Answer 35

D) A and B are correct.

A) The deadweight loss may increase substantially, this also holds potential validity in this context. Introducing such a policy might distort labor market dynamics in a way that creates inefficiencies. For instance, it could lead businesses to rely more on government employment as a buffer for their workforce needs, potentially reducing their drive to compete for labor based on wages and conditions. Furthermore, it might lead to misallocation of labor, where workers are employed in roles that do not best match their skills or productivity levels, simply because the jobs are government-provided. This mismatch can contribute to deadweight loss, as the economy is not maximizing its potential output for the labor input.