Tayyab Ismat

QUESTION:1

Classify the following markets as perfectly competitive, monopolistic, or monopolistically competitive, and explain your answers?

a. wooden #2 pencils

b. bottled water

c. copper

d. local telephone service

e. peanut butter

f. lipstick

A:

Wooden 2 pencils:

• The market for 2 pencils is perfectly competitive since pencils by any manufacturer are identical and there are a large number of manufacturers.

B:

Bottled water:

• The market for bottled water is monopolistically competitive because of consumers' concerns about quality As a result, each producer has a slightly different product.

C:

copper:

• The market for copper is perfectly competitive, since all copper is identical and there are a large number of producers.

D:

local telephone service:

• The market for local telephone service is monopolistic because it is a natural monopoly—it is cheaper for one firm to supply all the output.

E:

peanut butter:

• The market for peanut butter is monopolistically competitive because different brand names exist with different quality characteristics

F:

Lipstick:

• The market for lipstick is monopolistically competitive because lipstick from different firms differs slightly, but there are a large number of firms who can enter or exit without restriction.

QUESTION:2

For each of the following, say whether it describes a perfectly competitive firm, a monopolistically competitive firm, both, or neither.

• Charges a price equal to marginal cost.

• Has marginal revenue equal to price.

• Faces barriers to entry.

• Produces a product that is identical to that of its competitors.

• Earns zero economic profit in the long run.

• Produces where marginal revenue is greater than marginal cost.

1:

Charges a price equal to marginal cost?

A firm in perfect competition charges a price equal to marginal cost.

2:

Has marginal revenue equal to price?

A firm in perfect competition has marginal revenue

Equal to price.

3:

Faces barriers to entry?

Neither a firm in monopolistic competition nor in perfect competition faces barriers to entry.

4:

Produces a product that is identical to that of its competitors?

A firm in perfect competition produces a product that is identical to that of its competitors.

5:

Earns zero economic profit in the long run?

Both a firm in monopolistic competition and a firm in perfect competition earn zero economic profit in the long run.

6:

Produces where marginal revenue is greater than marginal cost?

Neither a firm in monopolistic competition nor in perfect competition produces where marginal revenue is greater than marginal cost.

QUESTION:3

For each of the following characteristics, say whether it describes a monopoly firm, a monopolistically competitive firm, both, or neither.• Faces a downward-sloping demand curve.

• Has marginal revenue less than price.

• Faces the entry of new firms selling similar products.

• Earns economic profit in the long run.

• Equates marginal revenue and marginal cost.

• Produces the socially efficient quantity of output.

1:

Faces a downward-sloping demand curve?

Both a firm in monopolistic competition and a monopoly firm face a downward-sloping demand curve.

2:

Has marginal revenue less than price

Both a firm in monopolistic competition and a monopoly firm have marginal revenue that is less than price.

3:

Faces the entry of new firms selling similar products?

A firm in monopolistic competition faces the entry of new firms selling similar products.

4:

Earns economic profit in the long run?

A monopoly firm earns economic profit in the long run

5:

Equates marginal revenue and marginal cost?

Both a firm in monopolistic competition and a monopoly firm equate marginal revenue and marginal cost.

6:

Produces the socially efficient quantity of output?

Neither a firm in monopolistic competition nor a monopoly firm produce the socially efficient quantity of output.

QUESTION:4

You are hired as the consultant to a monopolistically competitive firm. The firm reports the following information about its price, marginal cost, and average total cost. Can the firm possibly be maximizing profit? If the firm is profit maximizing, is the firm in a long-run equilibrium? If not, what will happen to restore long-run equilibrium?

A: P < MC, P > ATC

I would think that the firm can’t possible be maximizing profit. The firm should raise price, so that price is greater than MC.Since the firm isn’t profit maximizing the firm should raise price, so that price is equal to ATC but greater than MC.

B: P > MC, P < ATC

The firm is maximizing profit. The firm is not in long-run equilibrium since the price is less than ATC.

C: P = MC, P > ATC

The firm is maximizing profit. The firm is not in long-run equilibrium since the price is greater than ATC.

D: P > MC, P = ATC

The firm is maximizing profit. The firm is in long-run equilibrium since the price is equal to ATC.

A:• The profit maximizing point is determined by the

quantity at which marginal cost and marginal revenue are equal. Take that quantity and see what consumers are willing to pay for it (follow a vertical line to the demand curve.) That is the profit maximizing price, which will be higher than marginal cost.

B:

•That shows P (price) > (is greater than) MC (marginal cost)It always will be.

C:

• If that price happens to be higher then the ATC (average total cost) then the firm is making an economic profit. If this happens, then other firms will begin to offer substitutes to attempt to capture part of that profit. As this competition increases market supply will increase and the equilibrium price will fall until none of the firms are making economic profit. They will probably be making accounting profit but when you factor in opportunity cost into the equation then they could do no better elsewhere.

D:

• In D P (price) = ATC (average total cost). This means that the amount of market supply makes the price too low for new competitors to be falling all over themselves to get in. The company is making zero economic profit also known as normal economic profit.

So this shows they are in the long term equilibrium

QUESTION:5

Sparkle is one firm of many in the market for toothpaste, which is in long-run equilibrium.

Draw a diagram showing Sparkle’s demand curve, marginal-revenue curve, average-total-cost curve, and marginal-cost curve. Label Sparkle’s profit maximizing output and price.

What is Sparkle’s profit? Explain.

On your diagram, show the consumer surplus derived from the purchase of Sparkle toothpaste. Also show the deadweight loss relative to the efficient level of output.

If the government forced Sparkle to produce the efficient level of output, what would happen to the firm? What would happen to Sparkle’s customers?

A:

•Draw a diagram showing Sparkle’s demand curve, marginal-revenue curve, average-total-cost curve, and marginal-cost curve. Label Sparkle’s profit maximizing output and price.

Figure 1 illustrates the market for Sparkle toothpaste in long-run equilibrium. The profit-maximizing level of output is QM and the price is PM.

B:

What is Sparkle’s profit? Explain.

•Sparkle’s profit is zero, because at quantity QM, price equals average total cost.

C:On your diagram, show the consumer surplus derived from the purchase of Sparkle toothpaste. Also show the deadweight loss relative to the efficient level of output?

The consumer surplus from the purchase of Sparkle toothpaste is areas A + B. The efficient level of output occurs where the demand curve intersects the marginal-cost curve, at QC. The deadweight loss is area C, the area above marginal cost and below demand, from QM to QC.

D:

If the government forced Sparkle to produce the efficient level of output, what would happen to the firm? What would happen to Sparkle’s customers?

If the government forced Sparkle to produce the efficient level of output, the firm would lose money because average total cost would exceed price, so the firm would shut down. If that happened, Sparkle’s customers would earn no consumer surplus

QUESTION:6

•The chapter states that monopolistically competitive firms send Christmas cards to their coustomers, what do they accomplish by this? Explain in words and with a diagram?

By sending Christmas cards to their customers, monopolistically competitive firms are advertising themselves. Since they are in a position in which price exceeds marginal cost, they would like more customers to come in, as shown in Figure 5. Since the price, PM, exceeds marginal cost, MCM, any additional customer who pays the existing price increases the firm's profits.

QUESTION:7

For each of the following pairs of firms, explain explain which firm would be more likely to engage in advertising:

• a A family owned farm or a family owned restaurant.

• b A manufacturer of forklifts or a manufacturer of cars.

• c A company that invented a very reliable watch or a company that invented a less reliable watch that costs the same amount to make.

PART:A

•A family owned restaurant would be more likely to advertise than a family owned farm because the output of the farm is sold in a perfectly competitive market, in which there is no reason to advertise, while the output of the restaurant is sold in a monopolistically competitive market.

PART:B

•A manufacturer of cars is more likely to advertise than a manufacturer of forklifts because there is little difference between different brands of industrial products like forklifts, while there are greater perceived differences between consumer products like cars. The possible return to advertising is greater in the case of cars than in the case of forklifts.

PART:C

•A company that invented a reliable watch is likely to advertise more than a company that invented a less reliable watch that costs the same amount to make because the company with the reliable watch will get many repeat sales over time to cover the cost of the advertising, while the company with the less reliable watch will not.

QUESTION:8

Thirty years ago, the market for chicken was perfectly competitive. Then Frank Perdue began marketing chicken under his name.

• How do you suppose Perdue created a brand name for chicken? What did he gain from doing so?

• What did society gain from having brand-name chicken? What did society lose?

A:How do you suppose Perdue created a brand name for chicken? What did he gain from doing so?

• As I recall he fed them food that made them have a slightly yellow color, then advertised heavily claiming yellow chickens were "better" than pasty white ones. At some point Purdue chickens lost their color and are now pasty white like other chickens

B:What did society gain from having brand-name chicken? What did society lose?

•Some people find utility in thinking they are buying a superior product. Since generic chickens are still available at a lower price, I can't see much loss.

QUESTION:9

The makers of Tylenol pain reliever do a lot of advertising and have loyal customers. In contrast, the makers of generic acetaminophen do no advertising, and their customers shop only for the lowest price. Assume that the marginal costs of Tylenol and generic acetaminophen are the same and constant?

A:Draw a diagram showing Tylenol’s demand, marginal-revenue, and marginal-cost curves. Label Tylenol’s price and markup over marginal cost.

B:Repeat part a) for the producer of generic acetaminophen. How do the diagrams differ? Which company has the bigger markup? Explain

• DIAGRAM shows the demand, marginal revenue, and marginal cost curves for a maker of acetaminophen. The diagrams differ in that the acetaminophen maker faces a horizontal demand curve, while the maker of Tylenol faces a downward-sloping demand curve. The acetaminophen maker has no markup of price over marginal cost, while the maker of Tylenol has a positive markup, because it has some market power.

Acetaminophen:

C: Which company has the bigger incentive for careful quality control? Why?

• The maker of Tylenol has a bigger incentive for careful quality control, because if quality were poor, the value of its brand name would deteriorate, sales would decline, and its advertising would be worthless.