Quiz 9: Pricing and Output Decision: Monopolistic Competition and Oligopoly
Given the demand equation: a. The demand schedule is below Price elasticity of demand for interval between $12.50 and $08.00 is less than one. b. Students should not follow the advice of the store manager because the price elasticity is less than one. The percentage decrease in price is not followed by much decrease in demand. Thus they can continue to charge high price and earn higher profits. The optimal price of the book would be the one that covers all the cost of production and gives maximum profits. The optimum price where total revenue is maximum i.e. $9 c. If students decide to charge optimum price, then they should not continue this venture because they have decided to produce 6000 books but at $9 quantity of 9500 should be produced to earn maximum revenue and cover all the cost. d. The store manager advised them to sell at $8.75 because that might be the average price at which books are selling in the store. He advised to reduce price to increase the demand.
Perfect competition is the market structure where there are many sellers and buyers, sellers sell a homogeneous good, buyers and sellers have all relevant information, entry into and exit from the market are easy. Monopolistic competition is the market structure where many producers sell products that are differentiated from one another. Monopolistic competition differs from the perfect competition. These are the differences:- 1) Monopolistic firms have some market power while perfectly competitive firms have not the market power. 2) Product that is produced by monopolistic firms is not identical while perfectly firms produce homogeneous good. 3) Non-price competition exists in monopolistic competition while prefect competition does not have it.
a. The treatment of "miscellaneous cost" as fixed or variable cost would have impact on optimum price. As we know that fixed cost doesn't change with level of output and variable cost varies with level of output. The marginal cost gets affected by change in variable cost. The variable cost directly affects the marginal cost. Thus, miscellaneous cost would affect the optimal price if it is a variable cost. b. The average variable cost would increase with increase in output. The law of diminishing returns plays an important role in increasing AVC. The AVC is the variable cost per unit. AVC increases if the average return falls or are diminishing. c. The average variable cost would decrease if there are increasing returns. As the output is increasing the return per factor is increase and thus the cost per unit of output falls.