Unit 5: Perfect Competition, Objectives Of Firms

Question 1

Give assumptions for a perfectly competitive market:

Answer 1

Many small firms- low percentage of market output- no control over ruling price. Many individual buyers- no control over market price- no monopoly power. Perfect freedom of entry and exit from industry- no sunk costs- make normal profits in the long run. Homogeneous products are supplied- firms are price takers. Perfect knowledge- consumers have all available information about prices and products from competing suppliers- can access this at zero cost- few transaction costs involved in searching for price info. No production/consumption externalities from outside the market.

Question 2

Define homogeneous products:

Answer 2

They are perfect substitutes. Buyers perceive no actual or real differences between the products offered by different firms.

Question 3

What is the implication for identical products?

Answer 3

Customers won’t pay more for brands

Question 4

What is the implication for perfect knowledge?

Answer 4

Advertising won’t persuade customers to buy

Question 5

Dynamic efficiency definition:

Answer 5

The improvement of technical, allocative or X-efficiency over time.

Question 6

Productive efficiency definition:

Answer 6

When average costs are minimised (when ac=mc).

Question 7

Give 2 causes of productive inefficiency:

Answer 7

Inappropriate factor mix or failing to gain all the economies of scale

Question 8

Define technical efficiency:

Answer 8

When maximum output is obtained from available inputs. If all firms in the whole economy are technically efficient then the economy is operating at it’s PPF.

Question 9

Define X inefficiency:

Answer 9

Organisational slack due to lack of competitive pressures. Cost curve is above minimum possible curve. Occurs a lot in monopolies. Firms with X inefficiency in perfect competition would make sub-normal profits and leave the industry.

Question 10

How do you label and draw diagram for consumer and producer surplus?

Answer 10

. X axis: Quantity, Y axis: Price.
. Positive g curve getting flatter called ‘supply curve’.
. -ve g curve that gets steeper then gets flatter once at equilibrium called ‘demand curve’.
. Label equilibrium, ‘equilibrium quantity’ on x axis and ‘market price’ on y axis.
. Shade area that has vertices at ‘market price’, y-i of ‘demand curve’ and ‘equilibrium’ and label it ‘Consumer surplus’.
. Shade area that has vertices at ‘market price’, y-i of ‘supply curve’ and ‘equilibrium’ and label it ‘Producer surplus’.

Question 11

How do you label and draw diagram for perfect competition long run equilibrium?

Answer 11

. 2 diagrams horizontal to and next to each other.
. Left diagram (label it ‘Market demand and supply’): . x axis: ‘Industry output m (Q)’, y axis: ‘Price (P)’.
. -ve g line labeled ‘Market demand’, +ve g line labeled ‘Market supply’.
. Q1 under equilibrium and P1 to left of equilibrium.
. Right diagram (label it ‘Individual firm’s costs and revenues’): . x axis: ‘Firm output (Q)’, y axis: ‘Price (P)’.
. U-shaped AC curve labelled ‘AC’, +ve g curve that is gradually getting steeper labeled ‘MC (supply)’.
. One horizontal line that goes through equilibrium of left diagram and through equilibrium of MC and AC curve of right diagram labeled ‘AR (demand)= MR.
. MC curve must cross LOWEST point of AC curve and this equilibrium is also at equilibrium with horizontal line, ‘Q2’ goes under it.

Question 12

How do you label and draw diagram for short run supernormal profits perfect competition?

Answer 12

. 2 diagrams horizontal to and next to each other.
. Left diagram (label it ‘Market demand and supply’): . x axis: ‘Industry output m (Q)’, y axis: ‘Price (P)’.
. -ve g line labeled ‘Market demand’, +ve g line labeled ‘Market supply’.
. Q1 under equilibrium and P1 to left of equilibrium.
. Right diagram (label it ‘Individual firm’s costs and revenues’): . x axis: ‘Firm output (Q)’, y axis: ‘Price (P)’.
. U-shaped curve labelled ‘AC’, +ve g curve that is gradually getting steeper labeled ‘MC (supply)’.
. One horizontal line that goes through equilibrium of left diagram and through right diagram. labeled ‘AR (demand)= MR.
. MC curve must cross LOWEST point of AC curve.
. Shaded rectangle on right diagram with vertices at: ‘MC’ and ‘MR’ equilibrium (labeled q2 on x-axis), point on AC curve directly under previous equilibrium, point on y-axis directly left to previous point (labelled AC1), point on y-axis that crosses MR line (labelled P1).
. Majority of AC curve must be under MR line.

Question 13

How do you label and draw diagram, showing perfect competition shut down and break-even in the short run?

Answer 13

. X-axis: ‘Output (Q)’, Y-axis: ‘Revenue and cost’.
. +ve g curve that is getting steeper labelled ‘MC (supply)’.
. U-shaped curve that is getting steeper towards end labelled ‘ATC’.
. U-shaped curve that is getting steeper towards end labelled ‘AVC’.
. ‘ATC’ is above ‘AVC’ curve.
. Horizontal line labelled ‘AR1 (demand)=MR1’.
. Lowest point of AVC curve in equilibrium to horizontal line and ‘MC (supply)’ curve.

Question 14

How do you label and draw diagram for long run equilibrium monopolistic competition?

Answer 14

. X axis: ‘Output’, Y axis: ‘Cost and revenue’.
. -ve g line labelled ‘MR’.
. -ve g line labelled ‘AR’ (starts from same point on y-axis as ‘MR’ but ‘MR’ is steeper).
. U shaped ‘AC’ curve.
. Tick ✔️ shaped ‘MC’ curve.
. Equilibrium where ‘AR’ and -ve g part of ‘AC’ curve meet with q1 and p1 under and to left of it, MC and MR equilibrium is directly under previous equilibrium (q1 represents 2 equilibriums).
. MC curve at equilibrium with lowest point of AC curve.

Question 15

Formula for consumer surplus:

Answer 15

Consumer surplus= Price willing to pay- actual price.

Question 16

Producer surplus formula:

Answer 16

Producer surplus = Actual price- Price willing to supply for

Question 17

How do you label and draw an oligopoly kinked demand curve diagram?

Answer 17

. Y-axis: ‘Output (Q)’, X-axis: ‘Price (P)’.
. -ve g ‘AR’ line that gets steeper gradient at one particular point (label this point ‘Q1’ and ‘P1’).
. -ve g ‘MR’ line that goes vertical in line with Q1 line when it meets it, then eventually gets -ve g but steeper then in first place down to x-axis (must be steeper than ‘AR’ line in 1st and 3rd part), it also starts from same point on y-axis as ‘AR’ line.
. +ve g ‘MC1’ curve that crosses the bottom of the ‘MR’ part of Q1 line.
. +ve g ‘MC2’ curve that crosses the top of the ‘MR’ part of Q1 line.
. +ve g ‘MC3 curve that goes through point where ‘AR’ line changes g.
. Equilibrium of ‘MC3’ and ‘MR’ line labelled ‘Q2’, but Q2 line goes above equilibrium until it touches ‘AR’ line, this equilibrium is labelled ‘P2’

Question 18

How do you label and draw diagram, showing joint profit maximisation under oligopoly?

Answer 18

. 2 diagrams.
. X-axis: quantity, Y-axis: price (for both diagrams).
. Left diagram: U shape ‘Firm’s AC’ curve and positive g ‘Firm’s MC’ that cuts through flat part of ‘Firm’s AC’ curve.
. Right diagram: -ve g straight ‘Industry AR=D’ line.
- -ve g straight ‘Industry MR’ line that is to the left to and slightly steeper than ‘AR’ line.
- positive g ‘mc’ curve that goes through MR and AR line.
- MC and AR equilibrium labelled ‘1,000 competitive industry output’ on x-axis and ‘competitive price on y-axis’.
- MR and MC equilibrium labelled ‘750 industry output under cartel’ on x-axis.
. Huge vertical line that starts on right diagram at ‘750 Industry output under cartel’ x-axis, then hits ‘AR’ line and turns horizontal and goes towards y-axis of left diagram (where it hits on y-axis is labelled ‘cartel price’.
- another vertical line comes down from horizontal line around where first part of AC curve is, and is labelled ‘250 quota for firm’ on x-axis.
. Shaded rectangle on left diagram with vertices at equilibrium of AC curve and vertical line, where vertical and horizontal line meet, ‘cartel price’ point and directly to left of AC equilibrium on y-axis.
- area of rectangle= ‘firm’s supernormal profit (AR-AC)q.

Question 19

How do you label and draw diagram, showing short and long run monopoly equilibrium?

Answer 19

. X-axis: ‘quantity’. Y-axis: ‘Cost & revenue’.
. Tick-shaped ‘MC’ curve that crosses through lowest point of U-shaped ‘AC’ curve.
. -ve g straight ‘D=AR’ line.
. -ve g straight ‘MR’ line that is to the left of and slightly steeper than AR curve.
. MC and MR equilibrium is labelled ‘Profit maximising output’.
. Vertical line drawn from point on AR line that is in line with ‘profit maximising output’.
. Shaded rectangle with vertices at point on AR line directly above MC and MR equilibrium, point on AC curve directly under previous point, point on y-axis directly left to previous point and point on x-axis directly left to point on AR line.
- area of rectangle= ‘supernormal profit’.

Question 20

How do you label and draw diagram, showing deadweight loss of welfare in monopoly compared to P.C?

Answer 20

S

Question 21

Market share (%) formula:

Answer 21

(One firm’s sales of a specific product ➗ Total market sales of a specific product) X 100

Question 22

Market share definition (relate to monopoly):

Answer 22

The percentage of total market sales accounted for by one firm. A monopoly has a market share of 100%.

Question 23

At what point is profit maximised?

Answer 23

When the quantity is where marginal revenue= marginal cost

Question 24

At what point is sales revenue maximised?

Answer 24

When the quantity is where marginal revenue = 0

Question 25

At what point is allocative efficiency achieved?

Answer 25

When the quantity is where Price= Marginal Cost

Question 26

At what point is technical efficiency achieved?

Answer 26

When quantity is where Average Cost = marginal Cost (Average cost is minimised)

Question 27

Formula for social cost:

Answer 27

Social cost = private cost + external cost

Question 28

Formula for social benefit:

Answer 28

Social benefit = Private benefit + external benefit

Question 29

Formula for consumer surplus:

Answer 29

Consumer surplus = Price willing to pay - actual price

Question 30

Producer surplus formula:

Answer 30

Producer surplus = Actual price - price willing to supply for

Question 31

How do you label and draw diagram, showing 1st degree or perfect price discrimination?

Answer 31

. X-axis: Quantity. Y-axis: price.
. +ve g ‘MC’ line that touches y-axis but not the bottom of y-axis.
. -ve g ‘Demand” line that touches y-axis (a lot higher on y-axis than MC line).
. Equilibrium of 2 lines have Q1 and P1.
. Triangle formed by y-axis, ‘MC’ and ‘Demand’ curve shaded and labelled ‘Area of triangle= producer surplus’.

Question 32

How do you label and draw diagram, showing second degree price discrimination?

Answer 32

. X-axis: Output. Y-axis: Price (P) and costs.
. Left of diagram: -ve g ‘MR Off-peak’ line and -ve g ‘Off-peak demand’ line that is to right of MR line and has slightly flatter g than MR line.
. Right of diagram: -ve g ‘MR peak’ line and -ve g ‘Peak demand’ line that is to right of MR line and has slightly flatter g than MR line.
. Whole of diagram: ‘Supply’ line that first goes horizontal from Y-axis then goes vertical when it crosses ‘MR Peak’ line.
. ‘Supply and ‘MR Off-peak’ equilibrium labelled ‘Output Off-Peak’ on x-axis by vertical line.
. This vertical line crosses ‘Off-peak Demand’ line and equilibrium of this labelled ‘Price Off-peak’ on Y-axis.
. . ‘Supply and ‘MR peak’ equilibrium labelled ‘Output Peak’ on x-axis by vertical line.
. This vertical line merges with vertical part of ‘Supply’ line and crosses ‘peak Demand’ line and equilibrium of this labelled ‘Price Peak’ on Y-axis.

Question 33

How do you label and draw diagram, showing third degree price discrimination?

Answer 33

S

Question 34

How do you label and draw diagram, showing limit pricing?

Answer 34

. X-axis: Quantity. Y-axis: Costs.
. U-shaped curve labelled ‘a.c. Existing firm (incumbent)’.
. Steeper U-shaped curve labelled ‘a.c. New entrants’, this curve is above the ‘a.c. Existing firm’ curve.
. Dotted horizontal line that is slightly below lowest point of ‘a.c New entrants’ curve, this curve is labelled’ limit price on it’s y-axis and ‘(just below new entrants ac)’ to the right of it.

Question 35

How do you label and draw diagram, showing satisficing profit?

Answer 35

. 2 diagrams: X-axis: Quantity, y-axis: Profit (for both).
. Left diagram (called ‘Profit Maximising output’): n-shaped steep curve that touches X-axis (not labelled anything).
- The top of this curve is labelled ‘Q1’ on X-axis.
. Right diagram (called ‘Satisficing output range’): n-shaped steep curve that touches X-axis (not labelled anything) that is the exact same shape as the n-shaped curve from left diagram.
. Horizontal line that runs through both diagrams labelled ‘Satisfactory profit’ on Y-axis.
- this line is almost as high as top of 2 n-shaped curves.
. Right diagram: equilibrium of horizontal line and 2 points on n-shaped curve labelled ‘q’ (for left part of n-shaped curve) on x-axis and ‘q1’ (for right part of n-shaped curve) on x-axis.

Question 36

How do you label and draw diagram, showing ‘revenue maximisation (Mr=0)’ Vs ‘profit maximising (Mr=MC)’ Price and Output?

Answer 36

. 2 diagrams: X-axis: Output, Y-axis: Cost and Rev (for both diagrams).
. Left diagram: n-shaped ‘TR’ curve that starts from origin but doesn’t quite end on x-axis.
- ‘TC’ curve that starts on y-axis, goes really steep then goes flat then gets steeper then continues at a sort of high gradient but the g stays the same from there.
- Highest point of ‘TR’ curve labelled ‘Rev Maximisation’ on x-axis.

Question 37

Give two features of monopolistic competition:

Answer 37

. Many firms offering differentiated products.

. Each firm has a small market share.

Question 38

Give 3 features of oligopolies:

Answer 38

. Market dominated by a small number of firms, each with a large market share.
. Tend to compete on non-price factors, including advertising.
. Potentially anti-competitive, if consumers collude on price.

Question 39

Give a list of goals for firms (PIGSMESS):

Answer 39

Profit, Image, Growth, Sales revenue maximisation, Managerial utility maximisation, Environment and social goals, Satisicing, survival

Question 40

Where is productive efficiency on a diagram (not ppf)?

Answer 40

Where AC=MC

Question 41

How is x-efficiency shown on a diagram?

Answer 41

When the lowest a.c. curve on the diagram is showing.

Question 42

What point is allocative efficiency on a diagram?

Answer 42

P= mc

Question 43

Define N firm concentration ratio:

Answer 43

N firm Concentration ratio is the aggregated market share of the largest N firms.