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ECON 1001

ECON 1001. Tutorial 9. Q1) Market power measures the firm’s ability to Under cut its competitors. Resist union wage demands. Raise its price without losing all of its sales. Influence the price its competitors charge. Force consumers to pay prices higher than their reservation prices.

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ECON 1001

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  1. ECON 1001 Tutorial 9

  2. Q1) Market power measures the firm’s ability to • Under cut its competitors. • Resist union wage demands. • Raise its price without losing all of its sales. • Influence the price its competitors charge. • Force consumers to pay prices higher than their reservation prices. Ans: C

  3. This is the way that economists define what market power is. • A firm has more market power if it is able to raise the price of its product more and not losing as many customers. • Firms in a perfectly competitive market do not have any market power at all. • If a firm raises its price in a perfectly competitive market, all its customers will switch to another firm which is selling the same product at the market price.

  4. A firm which is a monopolist has the most market power. • Because it is the only firm selling a certain kind of product, if it raises the price, there will still be some customers staying behind. • Of course, that does not mean when a firm has market power, it will not lose any sales at all. When price rises, quantity demanded inevitably drops (law of demand). • It just mean the firm will not lose all its customers, unlike in the case of perfect competition.

  5. Q2) Suppose a firm increases its labour usage and office space (the only inputs used) by 10% and observes a 13% increase in output. The firm has • Increasing returns to scale. • Constant returns to scale. • Violated the law of diminishing marginal returns. • Increased its average costs. • Reduced its total costs. Ans: A

  6. A firm is said to have constant returns to scale when an x% increase in inputs results in an x% rise in output. • A firm is said to have decreasing returns to scale when an x% increase in inputs leads to a less than x% rise in output. • A firm is said to have increasing returns to scale when an x% increase in inputs causes a more than x% rise in output.

  7. Q3) Imagine that you are an entrepreneur, making designer T-shirts in your garage. Your accountant has estimated that your firm’s total costs are TC = 300+10Q. As you increase production of T-shirts, your AFC ? and your marginal costs ? . • ↓; ↑ • ↑; ↓ • Same, same • Same, ↑ • ↓; same Ans: E

  8. Let’s look at MC first. • The TC function is TC=300+10Q. • MC(Q*) = TC(Q*+1) – TC(Q*) = {300 + 10(Q*+1)} - {300 + 10(Q*)}= 300 + 10Q*+10 - 300 - 10Q*=10 • This is the MC of producing one more unit of the good. • Since MC is a constant on the cost function, it remains the same and does not change with Q.

  9. AFC = Fixed Cost/ Q • Total Fixed Cost is 300. • As Q gets larger, AFC gets smaller. • Mathematically, as the value of the denominator gets larger, the value of the whole fraction becomes smaller. • Hence, the answer is E.

  10. Q4) Suppose that there are just 2 firms in a small market. Acme: TC=100+3Q Generic: TC=500+3Q Which statement is true? • Acme will always have lower MC than Generic. • Acme and Generic have equal MC. • MC at each firm will depend on the output of the firms. • Acme and Generic will always have the same ATC. • Acme has greater economies of scale than does Generic. Ans: B

  11. A Total Cost Function with constant MC generally takes a form like this: TC = Fixed Cost + MC ∙ Q • As the 2 firms have different Fixed Costs, their ATC will NOT be the same. • Hence, option D is wrong.

  12. Both firms’ MC is $30 regardless of how many units of output are produced. • Therefore, Options A and C is also incorrect. • And that makes Option B the correct answer. According to the firms’ cost functions, MCAcme = MCGeneric

  13. Q5) To profit maximise, the firm will choose to produce ? Units and charge a price of ? . • 3.2; $33.50 • 7; $19.30 • 7; $5 • 3.5; $5 • 3.5; $22.50 Ans: E

  14. P • Is the firm a price setter or a price taker? • Price setter (monopolist) • Therefore, we can simplify the diagram into this. MC MR D Q

  15. P • The π-max quantity is where MR=MC. • Therefore, Q*=3.5. • A monopolist will charge the reservation price of Q* according to the Demand schedule. • Therefore, Price will be $22.50 (E) 22.50 MC MR D 3.5 Q

  16. Q6) The socially efficient Price and Output combination is ? . • $5; 7 • $5; 3.5 • $19.30; 7 • $22.50; 3.5 • $33.50; 3.5 Ans: A

  17. P • The Socially Efficient point is where MC meets Demand. • This is the point where all potential surpluses have been extracted. • The respective P and Q are $5 and 7. MC 5 MR D 7 Q

  18. Q7) The difference between CS given the monopoly market structure and CS with socially efficient quantity is the area ? . • LEI • GCEI • 0GI • GJI • GCEL Ans: B

  19. Price • The Socially Eff. Point is where MC meets D. • The CS when it is socially efficient is area GJI. J MC I G D MR Quantity

  20. Price • But if it is a monopoly, P will be higher and Q will be lower. • Q is determined by MR=MC • P is the corresponding reservation price on the Demand curve. J MC E C I G D MR A Quantity

  21. Price • CS under monopoly is area CJE. • The difference between CS (monopoly) and CS (social efficient) is area GCEI. J MC E C I G D MR A Quantity

  22. Q8) Suppose a monopolist produces Good X. He sells one version of X to consumers and another version to businesses. The MC of the consumer version is $5. MC of the business version is $5.75. If resale is impossible, one can infer that • The monopolist will charge 2 different prices and is not practising price discrimination. • The monopolist will charge a uniform price to both consumers and businesses. • The monopolist will charge 2 different prices and is perfectly price discriminating. • The monopolist will charge 2 different prices and is imperfectly price discriminating. • The monopolist will earn more money from sales to business than to consumers. Ans: A

  23. Recall that Price Discrimination is… • A way to reduce inefficiency in a monopoly, and also a way for monopolist to extract consumer surplus. • The practice of charging different buyers different prices for essentially the same good or service.

  24. Is the monopolist in this question charging different buyers different prices? • Yes! • Are the buyers buying the same good? • No! • The versions in the 2 markets are different. The MCs of production of the 2 versions are also different. • Hence, the monopolist is not practising price discrimination. (A)

  25. Q9) Which of the following situations will come closest to perfect price discrimination? • Charging a different price on different days. • Charging a different price at the end of the year. • Negotiating a price with a group of customers. • Negotiating a price with each individual consumer. • Offering instant, in store rebates. Ans: D

  26. Perfect price discrimination is also called ‘First Degree Price Discrimination’. • It is the practice of charging each customer a different price. • The price charged is the maximum or reservation price the customer is willing to pay. • In view of this, Option D is the closest to perfect price discrimination.

  27. Q10) In its efforts to keep medical costs down, the government has decided to impose a $15 price ceiling on a weekly dose of this drug. What is likely to happen? • The firm will produce 400 doses per week causing excess supply of this drug on the market. • This drug will disappear from the market. • The firm will produce 325 doses per week, just meeting consumer demand. • The firm will produce 200 doses per week, the quantity at which price equals MC. • New firms will enter this market due to the high quantity demanded at $15. Ans: B

  28. As there is a price ceiling of $15, the MR of selling a dose is no longer the original MR that is derived from the Demand curve. • The MR is now $15 • Therefore, if the manufacturer is to produce anything, the profit-max quantity would be where MC meets the new MR ($15).

  29. P • Price ceiling is $15. • Profit-max quantity is 220. • However, the AC of each dose is $45. • Therefore, the producer will be making a loss when there is a price ceiling. • It will choose not to produce at all. (B) D $45 ATC $15 MC 220 Q

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