Download Chapter 7 Practice Questions

Chapter 7 Practice Questions
1)
a) Explain the relationship in the short run between the marginal costs of a
firm and its average total costs.
Short run costs of production is inversely proportional to the labor
productive – labor is usually the main variable cost because it can be increased or
decreased immediately. The marginal cost refers the the cost incurred with each
additional unit and is found by dividng the change in total cost with the change in total
output per hour. Average total costs refer to the average cost of each good and is
found by dividing the total cost by the total output per hour.
Marginal costs decline at first, but then increase. This is due to the law of
diminishing returns: “as additional units of a variable resources are added to fixed
resources, beyond a certain point the marginal product of the variable resource will
decline” (Maley & Welker, 2011). The curve of marginal cost intersects the curve of
average total cost at its lower point – after the intersection, the average total cost
starts to increase. This is because at that point the marginal product of the variable
resource has started to decrease; even though the costs for the producer have become
higher, they aren’t able to produce as much to make up for those costs. This explains
why the average total cost eventually increases.
b) Define the law of diminishing returns and assess the likelihood that it will
be experienced by a firm producing a product in a consumer good market.
Like I’ve written in my answer above, the law of diminishing returns says
that as additional units of a variable resources (generally labor) are added to fixed
resources (generally land and capital), beyond a certain point the marginal product of
the variable resource will decline (Maley & Welker, 2011). The likelihood of a firm
experiencing this in a consumer good market is highly probable because in the short
term, the firm is only able to change its variable resources in order to produce more
efficiently. If business is booming for a café, for example, in the short term, they’ll only
be able to change the labor (a variable resource) by hiring more workers or asking the
workers to work longer hours. At first, the marginal product as well as the total
product for each additional worker hired will increase. However, after a while the café
will experience diminishing marginal returns because hiring more workers doesn’t
contribute to more efficient production; in fact, it could even make production less
effective. This is because the fixed resources haven’t changed: the café is still the same
size and has the same tools, but now it has a lot more workers (that may or may not
actually be working efficiently) that all need to be paid a salary.
Chapter 8 Practice Questions
1)
a) Using a suitable diagram, explain the difference between short-run
equilibrium and long run equilibrium in perfect competition.
There is a difference between the short-run equilibrium and the long-run
equilibrium in perfect competition because of the changes that the firm is able to
make.
In the short run, the firm is only able to change its variable resources
(usually labor), so the changes that it can make in supply is small compared to the
changes in market price. However, in the long run, the firm is able to change its fixed
resources (capital, land) as well – this means that the firm can change its supply a lot
more compared to the changes in price. Also in the long-term, firms can leave or enter
the industry and this would affect all of the firms involved.
When firms produce at their short-run equilibrium, they experience
economic profits or losses; when they produce at their long-term equilibrium, all
firms break even. Because there are no barriers to exit or entry, firms are free to enter
or leave the market.
http://www.raybromley.com/notes/equilchange.html
http://justdan93.wordpress.com/2012/07/11/profit-maximization-in-long-run-pure-competitive-market/
If a firm experienced an economic loss in the short run, it is likely to leave
the market. When other firms see that this industry could be lucrative, they are likely
to join the market. Entry of new firms to the industry causes an increase in supply,
which then decrease the equilibrium price. This means that firms that were previously
making a profit would now be breaking even or making a smaller profit. Entry also
causes an increase in competition so that the firms cannot raise their prices (because
then consumers would opt to buy the goods from other firms who offer it for lower
prices), if they want to stay in business. Therefore, in the long term, all firms would be
breaking even.
b) To what extent is the perfectly competitive market likely to exist in the
real world?
In a perfectly competitive market, there are very many firms with no market
power that all produce homogeneous goods. There are also no barriers to entry or
exit. This type of market is not common – in fact, our textbook says that this is “mostly
theoretical.” Other characteristics of perfectly competitive markets are that they don’t
have any shortages or surpluses and they are an example of perfect efficiency. This
makes sense because “efficiency decreases as markets become less competitive”
(Maley & Welker, 2011).
Perfectly competitive markets are so rare because they have no barriers to
entry and exit, and all markets have some type of barriers (even thought they may be
low). However, there are markets that have some of the characteristics of a perfectly
competitive market , such as firms in the agricultural commodities industry.
2)
a) Using a diagram, explain how allocative and productive efficiency will be
achieved in long-run equilibrium in perfect competition.
In a perfectly competitive market, productive efficiency is achieved by
lowering the average cost of production to the minimum. If the firm produces the
quantity at which its marginal cost is equal to its marginal revenue, it is maximizing its
profits; however, it hasn’t achieved maximum efficiency. In order for the firm to
produce as maximum efficiency, it needs to produce the quantity that corresponds to
the minimum average total cost. Allocative efficiency is achieved when the firm’s
marginal cost is equal to the price of the goods. This indicates that the firm is
allocating its resources efficiently (in efficient quantities and combinations), in a way
that is the most favorable to the society.
http://increasing-returns.blogspot.jp/2007/04/allocative-and-productive-efficiency-in.html
The long-run equilibrium is the point at which firms are breaking even; the
point where marginal revenue is equal to marginal cost. This is also the point at which
the average total cost is at its minimum, thus achieving productive efficiency. Because
the market price is equal to average total cost, the firms are have also achieved
allocative efficiency.
b) Evaluate the view that consumers, not producers, are the main
beneficiaries of perfectly competitive market structures.
Consumers, not producers, are the main beneficiaries of perfectly
competitive market structures because in this type of market, the producers are
price-takers – they will supply goods at the price that consumers want. If a firm
decides to sell its goods for a higher price (in a perfectly competitive market), then
ceteris paribus, consumers will purchase the goods from other firms who sell at a
lower price. The consumers are able to do this because in perfectly competitive
markets, the goods are homologous.