Compared to other markets, why do economists consider perfect competition to be the most efficient market structure? Perfect competition is the most efficient market structure because, in the long run, each firm in the market will be producing at its minimum average cost, or per-unit. This means that consumers get desired goods and services at the lowest possible prices, and also that the firms are economizing on society’s scarce resources to the greatest extent possible.

What is the difference between the concepts of diseconomies of scale, and the law of diminishing return? (4 marks)

Law of diminishing return occurs in the short-run when one factor is fixed. If the variable factor of production is increased, there comes a point where it will become less productive and therefore there will eventually be a decreasing marginal and then average product.

When long-run average total cost rises as output increases, there are said to be diseconomies of scale.

a. Sally owns a ceiling fan company. Last year, she sold 1000 ceiling fans at $50 each, and each fan cost her $20. Before going into the ceiling fan business, she worked as a fan-dancer at $25,000 a year. She used her own money to buy the fans by withdrawing the money from her savings account where it was earning five percent annual interest. Calculate Sally’s economic profit and her accounting profit. Should Sally continue with her ceiling fan business? Explain. (6 marks)

If her economic profit is at least zero, Sally should stay in business. Her TR = $50,000 and her total accounting cost is $20,000, for an accounting profit of $30,000. She forgoes interest on savings of $20,000 (.05) = $1,000 as well as forgone earnings of $25,000. This leaves $4,000 in economic profit, so she should stay in business.

Bob Edwards owns a bagel shop. Bob hires an economist who assesses the shape of the bagel shop’s average total cost (ATC) curve as a function of the number of bagels produced. The results indicate a U-shaped average total cost curve. Bob’s economist explains that ATC is U-shaped for two reasons. The first reason is the existence of diminishing marginal product, which causes it to rise. What is the second reason? Explain your answer. Assume that the marginal cost curve is linear. (4 marks)

Average fixed cost always declines as output rises because fixed cost is being spread over a larger number of units, thus causing the average total cost curve to fall.

a. Provide two circumstances in which monopoly may offer efficiency advantages over competition. (4 marks)

A monopolist might be better positioned to exploit economies of scale leasing to an equilibrium which gives a higher output and a lower price than under competitive conditions.

As firms are able to earn abnormal profits in the long run there may be a faster rate of technological development that will reduce costs and produce better quality products for consumers. This is because the monopolist will invest profits into research and development to promote dynamic efficiency.

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Explain the practice of tying and discuss why it is controversial. (5 marks)

Tying is the practice of bundling goods for sale. It is controversial because it is perceived as a tool for expanding the market power of firms by forcing consumers to purchase additional products. However, economists are skeptical that a buyer’s willingness to pay increases just because to products are bundled together. In other words, simply bundling two products together doesn’t necessarily add any value. It is more accurately believed to be a form of price discrimination.

Describe the source of tension between cooperation and self-interest in a market characterized by oligopoly. Use an example of an actual cartel arrangement to demonstrate why this tension creates instability in cartels. (5 marks)

The source of the tension exists because total profits are maximized when oligopolists cooperate on price and quantity by operating as a monopolist. However, individual profits can be gained by individuals cheating on their cooperative agreement. This is why cooperative agreements among members of a cartel are inherently unstable.

a. If the average total cost curve is falling, what is necessarily true of the marginal cost curve? If the average total cost curve is rising, what is necessarily true of the marginal cost curve? (5 marks)

When average total cost curve is falling it is necessarily above the marginal cost curve. If the average total cost curve is rising, it is necessarily below the marginal cost curve.

Describe the difference between average revenue and marginal revenue. Why are both of these revenue measures important to a profit-maximizing firm? (5 marks)

Average revenue is total revenue divided by the amount of output. Marginal revenue is the change in total revenue from the sale of each additional unit of output. Marginal revenue is used to determine the profit-maximizing level of production and average revenue is used to help determine the level of profits.

Describe the process by which the market for capital and the market for land reach equilibrium. As part of your description, elaborate on the role of the stock of the resource versus the flow of services from the resource. (6 marks)

Equilibrium in the markets for land and capital are governed by the value of marginal product for these factors relative to their supply. One difference between these markets and the market for labor is the distinction between rental value (flow) and purchase price (stock). This difference is reconciled by noting that in efficient markets, the purchase price should reflect the value of the stream of services provided by the land or capital (or the sum of rental values appropriately discounted).

a. List and explain two conditions necessary for firms to be able to successfully practice price discrimination. (2 marks)

Differences in price elasticity of demand between markets: There must be a different price elasticity of demand from each group of consumers. The firm is then able to charge a higher price to the group with a more price inelastic demand and a relatively lower price to the group with a more elastic demand. By adopting such a strategy, the firm can increase its total revenue and profits. To profit maximize, the firm will seek to set marginal revenue = to marginal cost in each separate (segmented) market.

Barriers to prevent consumers switching from one supplier to another: The firm must be able to prevent “market seepage” or “consumer switching” – defined as