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ECON 2X03 Chapter Notes - Chapter 8.7: Marginal Revenue, Marginal Cost, Economic Equilibrium

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School
McMaster University
Department
Economics
Course
ECON 2X03
Professor
Krishnakali Sen Gupta

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Document Summary

In the long-run analysis, we need to distinguish between established firms (those already in the market) and potential firms or entrants (those not yet in existence). No-exit, no-entry, and long-run equilibrium: there are two requirements, or conditions, of long-run equilibrium, no-exit condition: in long-run equilibrium, no established firm wants to exit the. Implies that the long-run equilibrium price pe must be high enough that each established firm makes at least zero profit: no-entry condition: in long-run equilibrium, no potential firm wants to enter the industry. industry. a. a. Implies that pe must be low enough that no potential entrant could earn positive profit: positive profit is a signal that induces entry, or the allocation of additional resources to the industry. The no-exit and no-entry conditions imply that the long-run competitive equilibrium price is equal to minimum average cost. The no-exit condition is violated for any price less than c", the minimum average cost.

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Related Questions


1.
If firms in a monopolistically competitive market are earningpositive profits,
A) firms will likely be subject to regulation.
B) barriers to entry will be strengthened.
C) some firms must exit the market.
D) new firms will enter the market.
2.

Panel c in the set of figures shown is consistent with a firm in amonopolistically competitive market that is


A) earning profit and is in both short-run and long-runequilibrium.
B) earning economic profit and is in short-run equilibrium, but notlong-run equilibrium.
C) earning profit and is in long-run equilibrium, but not short-runequilibrium.
D) earning a negative profit and is not in equilibrium.
3.
When a profit-maximizing firm in a monopolistically competitivemarket is producing the long-run equilibrium quantity,
A) its marginal revenue will exceed its marginal cost.
B) its average revenue will equal its marginal cost.
C) it will be earning positive economic profits.
D) its demand curve will be tangent to its average-total-costcurve.
4.
Monopolistic competition differs from perfect competition becausein monopolistically competitive markets
A) each of the sellers offers a somewhat different product.
B) strategic interactions between firms is vitally important.
C) there are barriers to entry.
D) all firms can eventually earn economic profits.
5.
The free entry and exit of firms in a monopolistically competitivemarket guarantees that
A) economic losses can persist into the long run, but not economicprofits.
B) both economic profits and economic losses can persist into thelong run.
C) economic profits can persist into the long run, but not economiclosses.
D) both economic profits and economic losses disappear in the longrun.
6.


Panel (a) shows a profit-maximizing monopolistically competitivefirm that is

A) All answers are correct
B) earning a zero profit.
C) charging a price that is equal to average total cost.
D) in long-run equilibrium.
7.
Since a firm in a monopolistically competitive market faces a
A) perfectly elastic demand curve, it will always operate withexcess capacity.
B) downward-sloping demand curve, it will always operate atefficient scale.
C) perfectly inelastic demand curve, it will always operate atefficient scale.
D) downward-sloping demand curve, it will always operate withexcess capacity.
8.
In a monopolistically competitive market,
A) firms can enter or exit the market without restriction.
B) each firm takes the price of its product as given.
C) each firm produces a product that is essentially identical tothe products of other firms in the market.
D) there are only a few sellers.
9.
The fact that there is a great deal of advertising of men’s shavingproducts indicates that
A) it costs firms very little to produce those products.
B) the market for those products is perfectly competitive.
C) those products are highly differentiated.
D) All answers are correct
10.
A profit-maximizing firm in a monopolistically competitive marketdiffers from a firm in a perfectly competitive market because thefirm in the monopolistically competitive market
A) has no barriers to entry.
B) faces a downward-sloping demand curve for its product.
C) faces a horizontal demand curve at the market clearingprice.
D) is characterized by market share maximization.

Consider the following market game: An incumbent firm, called firm 3, is already in an industry. Two potential entrants, called firms 1 and 2, can each enter the industry by paying the entry cost of 10. First, firm 1 decides whether to enter or not. Then, after observing firm 1's choice, firm 2 decides whether to enter or not. Then, after observing firm 1's choice, firm 2 decides whether to enter or not. Every firm, including firm 3, observes the choices of firms 1 and 2. After this, all of the firms in the industry (including firm 3) compete in a Cournot oligopoly, where they simultaneously and independently select quantities. The price is determined by the inverse demand curve p = 12 − Q, where Q is the total quantity produced in the industry. Assume that the firms produce at no cost in this Cournot game. Thus, if firm i is in the industry and produces qi, then it earns a gross profit of (12 − Q)qi in the Cournot phase. (Remember that firms 1 and 2 have to pay the fixed cost of 10 to enter).

(a) Compute the subgame perfect equilibrium of this market game. Do so by first finding the equilibrium quantities and profit in the Cournot subgames. Show your answer by designating optimal action on the tree and writing the complete subgame perfect equilibrium strategy profile. [Hint: In an n-firm Cournot oligopoly with demand p = 12 − Q and 0 costs, the Nash equilibrium entails each firm producing the quantity q = 12/(n + 1).]

(b) In the subgame perfect equilibrium, which firms (if any) enter the industry?

Cray Computer, Inc., located in Colorado Springs, Colorado, is a privately-held producer of high-speed electronic computers with immense storage capacity and computing capability. Although the Crays market is restricted to industrial users and a few large government agencies (e.g., Department of Health, NASA, National Weather Service, etc.), the company has profitably exploited its market niche.

Glen Cray, founder and research director, has recently announced his retirement, the timing of which will, unfortunately, coincide with the expiration of several patents covering key aspects of the Cray computer. Your company, a potential entrant into the market for supercomputers, has asked you to evaluate the short- and longer-run potential of this market. Based on data gathered from your company's engineering department, user surveys, trade associations, and other sources, the following market Demand and cost information has been developed:

P = $54 - $1.5Q

TC = $200 + $6Q + $0.5Q2

where P is the price, Q is units measured by the number of supercomputers, TC is total costs, including a normal rate of return and all figures are in millions of dollars.

A. Assume that these demand and cost data are descriptive of Cray's historical experience.

i.Calculate the profit-maximizing output, price, and economic profit earned by Cray Computer as a monopolist.

ii. What is the point price elasticity of demand at this output level?

 

B. After the patents expire and barriers to entry are eliminated, the market structure changes.

i.If the new entrants have the same total cost structure as Cray, and a competitive equilibrium results.

ii. What will the output of one firm be after all adjustment has taken place; and what will the price be in the market?

iii. What will one firm's profits be?

C. Assume as in B that barriers to entry are eliminated and all entrants have the same cost conditions; however, firms are able to differentiate their products in the eyes of their customers.

i. What will the output of one firm be after all adjustments have taken place?

ii. What will the price be? (Assume that entry causes a parallel shift in the demand curve, as in the monopolistic competitive market).

iii. What will the firm's profits be?

D. Assume that the point price elasticity of demand calculated in part A is a good estimate of the relevant arc price elasticity. What are the estimates for the potential overall market size (i.e., total quantity demanded in the market) for super-computers in B and C?

E.If no other near-term entrants are anticipated, should your company enter the market for supercomputers using the estimates of the market size in D? Why or why not? (Hint: Criterion for entry: if in the longer-run equilibrium the total quantity demanded in the market is greater or equal to the sum of the amounts produced by two firms. There is room for another firm.)