Managerial Economics Study Set 10

Business

Quiz 8 :

Pricing and Output Decisions: Perfect Competition and Monopoly

Quiz 8 :

Pricing and Output Decisions: Perfect Competition and Monopoly

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You may wish to consult Appendix 8A if you need help answering the more algebraic problems. Use the following equation to demonstrate why a firm producing at the output level where MR = MC will also be able to maximize its total profit (i.e., be at the point where marginal profit is equal to zero). P = 170 - 5 Q TC = 40 + 50 Q + 5 Q 2
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Profit are maximized when marginal revenue equal to marginal cost and marginal cost rising. Therefore, in order to obtain the equilibrium output we equate MC =MR.
img img In equilibrium,  MC =MR
img Total profit gets when total revenue minus total cost.
img Substituting Q  = 8
img We take derivative of MC to fulfillment of second order condition i.e. MC is rising.
img The positive sign of the second derivative of TC implies that MC is rising.

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Explain why the demand curve facing a perfectly competitive firm is assumed to be perfectly elastic (i.e., horizontal at the going market price).
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Demand curve shows the relationship between price and quantity of product. If quantity demanded is infinite at the prevailing price, but any rise in price will cause quantity demanded to fall to zero, is said to be perfectly elastic demand. Symbolically,
img img In perfect competition, the demand curve for the product by a firm is perfectly elastic at market price. The firm can sell all of the output at this price because its output is so small in comparison with the entire market of product. As a price taker, the firm cannot charge a higher price and lower price at the prevailing price.
Demand curve and marginal revenue curve are the same for a perfectly competitive firm.
img

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Explain the relationship between P AVC and a firm's contribution margin.
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Contribution margin is the amount of revenue that a firm earns above its total variable cost. A firm incurs a loss may continue operating in the short run if it has a positive contribution margin. A firm experiencing a negative contribution margin must shut down its operation because its revenue cannot cover its variable costs of operation.
If
img it means that price is greater than average variable cost. It also indicates positive contribution margin. It is explained the following figure:-
img In the figure
img and positive contribution are the same.

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You may wish to consult Appendix 8A if you need help answering the more algebraic problems. Following is the graphical representation of a short-run situation faced by a perfectly competitive firm. Is this a good market for this firm to be in Explain. What do you expect will happen in the long run Explain. img
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Explain the importance of free entry and exit in the perfectly competitive market. That is, if free entry and exit did not exist, what impact would this have on the allocation of resources and on the ability of firms to earn above-normal profits over time
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The perfectly competitive model is not very useful for managers because very few markets in the U.S. economy are perfectly competitive." Do you agree with this statement Explain. Regardless of whether you agree, what lessons can managers learn by studying perfectly competitive markets
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You may wish to consult Appendix 8A if you need help answering the more algebraic problems. A manufacturer of electronics products is considering entering the telephone equipment business. It estimates that if it were to begin making wireless telephones, its short-run cost function would be as follows: img a. Plot the average cost, average variable cost, marginal cost, and price on a graph. b. Suppose the average wholesale price of a wireless phone is currently $50. Do you think this company should enter the market Explain. Indicate on the graph the amount of profit (or loss) earned by the firm at the optimal level of production. c. Suppose the firm does enter the market and that over time increasing competition causes the price of telephones to fall to $35. What impact will this have on the firm's production levels and profit Explain. What would you advise this firm to do
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Explain why the P = MC rule is the same as the MR = MC rule for perfectly competitive firms.
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You may wish to consult Appendix 8A if you need help answering the more algebraic problems. 2. Indicate whether each of the following statements is true or false and explain why. a. A competitive firm that is incurring a loss should immediately cease operations. b. A pure monopoly does not have to worry about suffering losses because it has the power to set its prices at any level it desires. c. In the long run, firms operating in perfect competition and monopolistic competition will tend to earn normal profits. d. Assuming a linear demand curve, a firm that wants to maximize its revenue will charge a lower price than a firm that wants to maximize its profits. e. If P AVC, a firm's total fixed cost will be greater than its loss. f. When a firm is able to set its price, its price will always be less than its MR. g. A monopoly will always earn economic profit because it is able to set any price that it wants to.
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What are the main characteristics of a perfectly competitive market that cause buyers and sellers to be price takers Explain.
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You may wish to consult Appendix 8A if you need help answering the more algebraic problems. 10. "In a perfectly competitive market, a firm has to be either good or lucky. " Explain what is meant by this statement. Illustrate your answer with the use of the diagrams shown in Figures. Figure MR - MC Approach to Maximizing Economic Profit (using Table) img Using Marginal Revenue (or Price) and Marginal Cost to Determine Optimal Output: The Case of Economic Profit img Figure Normal Profit ( a Using Table) and Economic Loss ( b Using Table) img Table Using Marginal Revenue (or Price) and Marginal Cost to Determine Optimal Output: The Case of Normal Profit img Table Using Marginal Revenue (or Price) and Marginal Cost to Determine Optimal Output: The Case of Economic Loss img Figure Contribution Margin img
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You may wish to consult Appendix 8A if you need help answering the more algebraic problems. Overheard at the water cooler: "The demand and cost estimates that were provided at the meeting are very useful [ Q = 90 - 6.5 P and TC = 150 + 3.5 Q ]. Unfortunately, what we didn't realize at the time was that our fixed costs were underestimated by at least 30 percent. This means that we'll have to adjust our price upward by at least 30 percent to cover the added fixed cost. In any case, there is no way in the world that we can survive by charging less than $9 for our product ." a. Comment on this statement. Do you agree with the speaker Explain. Illustrate your answer with the use of a graph indicating the firm's short-run cost structure. b. What price do you think this firm should charge if it wants to maximize its short-run profit
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You may wish to consult Appendix 8A if you need help answering the more algebraic problems. This same manufacturer of electronics products has just developed a handheld computer. Following is the cost schedule for producing these computers on a monthly basis. Also included is a schedule of prices and quantities that the firm believes it will be able to sell (based on previous market research). img a. What price should the firm charge if it wants to maximize its profits in the short run b. What arguments can be made for charging a price higher than this price If a higher price is indeed established, what amount would you recommend Explain. c. What arguments can be made for charging a lower price than the profit-maximizing level If a lower price is indeed established, what amount would you recommend Explain.
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Why do economists consider zero economic profit to be "normal"
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You may wish to consult Appendix 8A if you need help answering the more algebraic problems. 6. The manufacturer of high-quality flatbed scanners is trying to decide what price to set for its product. The costs of production and the demand for the product are assumed to be as follows: TC = 500,000 + 0.85 Q + 0.015 Q 2 Q = 14,166 - 16.6 P a. Determine the short-run profit-maximizing price. b. Plot this information on a graph showing AC, AVC, MC, P, and MR.
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Explain why the demand curve facing a monopolist is less elastic than one facing a firm that operates in a monopolistically competitive market (all other factors held constant).
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"Economic profit" is a theoretical concept used to help explain the behavior of firms in competitive markets. Suggest ways in which this concept can actually be measured.
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You may wish to consult Appendix 8A if you need help answering the more algebraic problems. 7. The demand and cost function for a company are estimated to be as follows: P = 100 - 8 Q TC = 50 + 80 Q - 10 Q 2 + 0.6 Q 3 a. What price should the company charge if it wants to maximize its profit in the short run b. What price should it charge if it wants to maximize its revenue in the short run c. Suppose the company lacks confidence in the accuracy of cost estimates expressed in a cubic equation and simply wants to use a linear approximation. Suggest a linear representation of this cubic equation. What difference would it make on the recommended profit-maximizing and revenue-maximizing prices
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Use the model of perfect competition described in this chapter to explain, illustrate, or elaborate on the following statements. a. "Increasing competition from new firms entering the market is good because it means one is in a good business." b. "One important difference between an entrepreneur and a manager is that the former gets into a market before demand increases, while the latter gets into the market after the shift."
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Kelson Electronics, a manufacturer of DVRs, estimates the following relation between its marginal cost of production and monthly output: MC = $150 + 0.005 Q a. What does this function imply about the effect of the law of diminishing returns on Kelson's short-run cost function b. Calculate the marginal cost of production at 1,500, 2,000, and 3,500 units of output. c. Assume Kelson operates as a price taker in a competitive market. What is this firm's profit-maximizing level of output if the market price is $175 d. Compute Kelson's short-run supply curve for its product.
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