ECON 1001

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