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Problem Set 3 Theory of a Firm Part A: Short Answer 1. Using a suitable diagram, predict what is likely to happen to efficiency when a competitive industry is monopolized. Perfect competition is a market structure in which there is large number of firms in the industry. Each firm has no control over the price at which it sells its product because of the large number of firms; each firm's output is a very small fraction of the total output of the industry, so it cannot influence price. All firms in the industry sell an undifferentiated product; from the consumers' point of view it makes no difference from which firm they buy the product, as it is exactly the same in all firms; and there are no brand names. There are no barriers to entry into the industry; any firm that would like to enter the industry and begin producing and selling the good or service can do so freely. Lastly, there is perfect knowledge in perfect competition; thus all firms and all consumers have complete information regarding products, prices, resources and methods of production. This assumption ensures that no firm has access to information not available to all others that would allow it to produce at a lower cost compared to its competitors. Monopoly is a market structure in which there is a single firm in the industry. That firm has significant control over the price at which its product is sold in the market. The firm produces and sells a unique good or service, which cannot be purchased elsewhere. Moreover, if a new firm likes to enter the industry, it cannot do so due to the high barriers to entry in the industry. The lower output and higher price of the monopolist have important implications for consumer and producer surplus. The perfectly competitive industry is economically efficient because the sum of consumer and producer surplus is maximum. ...read more.


and non-collusive (oligopolistic firms do not agree, whether formally or informally, to fix prices or collaborate in some way) oligopoly. b) Competition in economics is a term that encompasses the notion of individuals and firms striving for a greater share of a market to sell or buy goods and services. Many people believe that the more competition there is within each industry the better. Competition has different impacts on consumers in different market structures; positive or negative. For example, competition between firms under monopolistic competition puts a downward pressure on costs as firms compete with each other; these competitive pressures may force less efficient firms to leave the industry. The absence of competition in monopoly does not exact such a downward pressure on costs. Also, free entry and exit under monopolistic competition drives economic profits down to zero in the long run, and allows prices to be lower for the consumer than is possible under monopoly, where barriers to entry allow the firms to maintain profits over the long run. Oligopolistic firms usually engage in intense non-price competition. In other words, in these firms there are product differentiation, advertising, and branding. Oligopolistic firms try to make their goods more attractive to gain money. In order to make their goods more attractive they increase the quality and try to minimize the price for those goods. As a result, competition provides better products than no competition and consumers benefit from the competition. Governments encourage competition because they want their citizens to gain the most utility they can from procuring differentiated products. 6. "Monopoly price is higher and output smaller than is socially ideal. The public is the victim." a) A comparison of monopoly with perfect competition at the level of the industry reveals that price is higher in quantity of output produced lower in monopoly than in a perfectly competitive industry. The graphs below shows the long-run equilibrium positions of a perfectly competitive industry, composed of many small firms, and of a monopoly, which is the entire industry. ...read more.


In the long run the loss-making firm can shut down its plant completely and stop incurring any costs at all. When you do not have any fixed costs, you can shut down your business. 11. Using the text and your knowledge of economic theory, explain why the Japanese government is trying to solve the problems of the taxi industry through deregulation. Deregulation is the removal or simplification of government rules and regulations that constrain the operation of market forces (Wikipedia definition). Economic efficiency occurs when firms produce the particular combination of goods and services that consumers mostly prefer. It is achieved when MB=MC; since MB=P, condition can be restated as P=MC. * Marginal benefit (MB) is the marginal utility of a good or service is the utility gained of a good or service. * Marginal cost (MC) is the change in cost arising from one additional unit of output. Productive efficiency occurs when firms produce at the lowest possible cost. The condition for production efficiency is the following. It is achieved when P=minimum ATC. The Japanese government is aiming to improve the economic efficiency of the taxi industry by deregulation. The stated rationale for deregulation is often that fewer and simpler regulations will lead to a raised level of competitiveness, therefore higher productivity, more efficiency and lower prices overall. The use of deregulation to expose economic activity to greater market forces, resulting in shorter run unemployment, business failure and falling prices, but greater efficiency and stability in the long run. Both allocative and productive efficiency are achieved by the perfectly competitive firm when it is at its lower run equilibrium position. At the point of production determined by MR=MC, price is equal to marginal cost, and therefore society's scarce resources are being allocated efficiently. Also, at the point of production P= minimum ATC, and therefore the lowest possible costs are being achieved; hence there is no waste of resources. The achievement of economic (allocative and productive) efficiency by the firm when it is in long-run equilibrium is summarized by: P=MC=minimum ATC. ...read more.

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