POSSIBLE SOLUTION

1. Market structure is best defined as the organizational and other characteristics of a market. This implies the market form that best describes the state of the market in relation to pricing, supply, competition, barriers of entry and efficiency. Factors considered as determinant factors of a market structure would include:
a. Freedom of entry and exit.
b. Nature of the product (homogeneous – identical or differentiated)
c. Control over supply/output.
d. Control over price – (price taker & price setter)
e. Barriers to entry.

2. For profit maximization , a firm should produce in the short-run if it can realize either a profit or a loss lesser than its fix costs (minimizing loss). In case of an economic loss; Eco Loss = TFC + (AVC-P) X Q
a. Shut Down**
b. Produce in the short-run
c. Shut down
d. Produce in the short-run

3. Graphical Approach - discussed separately.

4. In a Perfect Competitive (PC) market, a firm may sell any quantity of output it chooses at the market price. They cannot influence the market price because its production is an insignificant part of the total market. So the Demand Curve for a PC is a horizontal line at the market price, the same as the Marginal Revenue. For Monopolistic, after product differentiation, they are the market’s only supplier. So in relevance to the “Law of Demand” they will reflect a downward sloping demand curve. The fact that the monopolist faces a downward-sloping demand curve implies that the price a monopolist can expect to receive for its output will not remain constant as the monopolist increases its output.

5. Marginal Revenue (MR) is the change in total revenue that occurs as a firm changes its output. For a Monopolistic, they must lower their price in order for them to sell more units (even though they seems to be influencing the price; because in this situation the law of demand is predominant). Consequently, when a monopolist sells an extra unit, the price falls, not only for the extra unit, but for all the units it sells influencing the Average Revenue (AR) for Monopolistic to fall below the MR. Simply the AR is their Demand Curve. So AR will not only be less than the MR but have a downward sloping as well. Whereas for PC firms, face a perfectly elastic demand curve, indicating that they can sell additional units of its output without lowering its price. Thus, each additional unit has a marginal revenue equal to the prevailing market price. Since the individual firm cannot influence the market price they can produce any quantity but will only be demanded at the market price, which is their MR. A monopolist’s MR curve can coincide with its demand curve if the firm is practicing perfect price discrimination—selling each unit for a different price.

6. Calculation
a. Producer & Consumer Surplus in Monopolistic will be:
i. CS >> .5(.70-.50) x 50 = 5
ii. PS >> ((.5-.16) x 50) + .5(.16) x 50) = 21
b. PS & CS for Perfectly Competitive condition
i. CS>> .5(.7-.31) x 80 = 15.6
ii. PS>> .5(.31) x 80 = 12.4
c. Would advice the Monopolistic to set a price where MR = MC and greater than the ATC and also produce where MR=MC.

7. In this portion of the demand curve demand is inelastic with respect to price. When demand is inelastic, a decrease in price actually reduces total revenue in spite of the increased unit sales. Thus, marginal revenue is negative. In addition, total cost is higher since output is increased, so profit must fall. Therefore, a firm will never produce where marginal revenue is negative. However, firm might be producing with government subsidies and producing at where MC = D which is the inelastic portion of the Demand Curve.

8. The monopolist's Marginal Revenue (MR) from each unit sold does not remain constant. Consequently, his Average Revenue Curve also faces a downward sloping. So the price that the monopolist can get for each additional unit of output must fall as the monopolist increases its output. Consequently, the monopolist's MR will also be falling as the monopolist increases its output. If it is assumed that the monopolist cannot discriminate price, that is, charge a different price for each unit of output it produces, then the monopolist's MR from each additional unit produced will not equal the price (AR) that the monopolist charges. In fact, the MR that the monopolist receives from producing an additional unit of output will always be less than the price that the monopolist can charge for the additional unit causing him to have no control of the current price.

9. Monopolistic & Perfectly Competitive Firms (PCF)
a. In the LR, Monopolistic firms have zero Economic Profit (minimize loss) where MR=MC and LR price would be where ATC= D. In this situation there is no restriction of entry to other firms. With PCF, they still maximize profit (minimize loss) where D=S. You will see that under this situation; PCF will still produce more (or have a less equilibrium) in relative to Monopolistic firms.
b. In the LR normal Economic Profits for perfect competition are at the minimum point of its ATC curve whereas in monopolistic competition they are at the point of diminishing marginal costs thus reflecting excess capacity. What this means is that they are producing below its efficient scale. However, another factor to consider is that the PCF have a horizontal Demand Curve whereas the Monopolistic don’t. PCF has a flat demand curve and the reason why this happens is due to one of the key assumptions that exist under perfect competition and not under monopolistic competition and that is product homogeneity. This product homogeneity forces firms to price all products the same because they can only compete on the basis of price. Charging higher than the market price is impossible and charging lower would mean they are making losses, thus in perfect competition, average revenue is constant and equal to price.
c. Strictly speaking in regards to output, the benefits that we may consider for monopolistic competitive results, thou the excess capacity for Monopolistic might be considered as inefficiency for their part, it is important to understand that it reflects a trade-off between lower costs and greater choice and thus we can’t make such an assessment with absolute certainty (or horizontal demand curve with homogeneous products)

Solution

Question 3 MC S1


A. As illustrated above, the market starts out in the long-run competitive equilibrium.
Initially, there is no incentive for firms to enter or exit the market. With a decrease in
consumer income, the demand for normal good will decrease resulting in the left ward
shift in the demand curve that is from (D0-D1). Thus quantity falls and the market
experience economic loss. Due to the change in market condition, individual firms will
make necessary adjustments to keep its economic loss at a minimum, that is to keep at
MC=P0. Due to the adjustment, the market is now in short run equilibrium but not longrun
equilibrium. An economic loss is a signal for some firms to exit the market. As firms
leave the short run market supply will decrease, which results in a leftward shift from (S0-
S1). With decrease in market supply, the market price rises as indicated by the arrows
along D1. At a higher market price, firm’s profit maximizing output is greater so the firms
remaining increases market output. Thus, each firm slides up its MC or supply curve.
That is due to exit of some firms, market output falls, and individual firms output
increases. Eventually, enough firms leave the market for the market supply to have
shifted to S1. For that, the market price has returned to its original level, P0.
B. Since firms are now making zero economic profit, no firms will be induced to enter or exit
the market. Therefore, the market supply remains at S1 and output at Q2. The market is
again in long run equilibrium.