cost, market, production

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ASSIGNMENT ON MICRO-ECONOMICS

SUBMITTED TO:

Munira Sultana

Lecturer

DEPARTMENT OF BUSINESS ADMINISTRATION

DHAKA CITY COLLEGE

SUBMITTED BY:

GROUP: 1

SECTION: A, 11TH

BATCH BBA

Name of Group

members

Members

ID No.

Md. Faruk Hossain 01

Md. Ariful Haque 21

Md. Arafin Rizvi 31

Rakibul Hasan Kakon 41Rafiqul Alam 51

Farzana Hafiz 61

Date of submission: 06-04-2010



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COST

1. Q: Define short run & long run cost function.

Ans:

Short run cost function: Short run costs are the costs over a period during which some factors of production

are fixed. The function which shows the relation between cost & the variable factors & fixed factors is called

short run cost function. The short run cost function is-

C= f(X, T, P, K)

Here, C= Total Cost

F= Fixed Cost factors

V= Variable costs factors

Long run cost function: Long run costs are the costs over a period long enough to permit the change of all

factors of production. That means in this period there is no fixed factor. The function which shows the relation

between cost & the variable factors is called long run cost function. The long run cost function is-

C= f (V)

Here, C= Total Cost

V= Variable costs factors

In the short run cost curve it can be seen that there are both fixed costs & variable costs. The curve starts from

over the origin. On the other hand, Long run cost curve has no fixed cost. So it starts from the origin.

In the short run cost function, the fixed factors are-

Salaries of administrative staff



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Depreciation of machinery

Expenses of building depreciation & repairs

Expenses for land maintenance & depreciation

Rent of building

In the short run & long run cost functions the variable factors are-

Raw materials

Cost of direct labor

The running expenses of fixed capital such as fuel

Transport cost

2. Q: Identify MC & TC both numerically & graphically.

Ans:

Marginal cost (MC): Marginal means extra. So, marginal cost means the extra or additional cost that is

incurred for producing one extra unit of output. In economics, marginal cost is the change in total cost that

arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a

good. Numerically, MC is the change in total cost divided by change in output. So,

Or, MCn = TCn- TCn-1

Q MC TC AC

1 10 10 10

2 5 15 7.5

3 3 18 6

4 7 25 6.2

5 15 40 8



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Total Cost (TC): Total cost means the sum of all fixed costs & variable costs. So total cost can be defined

numerically as-

TC= Total fixed cost (TFC) + Total variable cost (TVC)

In the short run cost, there are both fixed cost & variable cost. But in the long run cost, there is only variable

cost so for the long run, total cost is

TC= Total variable cost (TVC)

3. Q: Relationship between MC & AC.

Ans: Marginal Cost (MC): Marginal means extra. So, marginal cost means the extra or additional cost that is

incurred for producing one extra unit of output. In economics, marginal cost is the change in total cost that

arises when the quantity produced changes by one unit.

Average Cost: Average cost is the total cost divided by the number of output produced. Average cost implies

cost per output. So average cost is-

Relationship between AC & MC is described for 3 conditions

as bellow-

When MC<AC: When MC is less than AC, AC declines. The

rate of decline in MC is greater than the rate of decline in

AC.

When MC=AC: When MC is equal to AC then AC neither

raises nor declines. AC remains constant. The changing rate of AC is always here equal to the rate of MC.

Q MC TC AC

1 10 10 10

2 5 15 7.5

3 3 18 6

4 7 25 6.2

5 15 40 8



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When MC>AC: When MC is greater than AC, the AC is less than MC. The change rate of MC is greater than the

rate of AC.

In the figure, to the left of the point E, MC is less than AC. So, AC is gradually declining. At the point E, MC=AC.

Here AC is neither raising nor declining. Again, to the right of the point E, MC is greater than AC. Here, AC

gradually increases. The rate of change in MC is greater than AC in all aspects.

4. Q: Why Average Cost (AC) is U shaped?

Ans: Average Cost: Average cost is the total cost divided by the number of output produced. Average cost

implies cost per output. So average cost is-

By constructing a cost schedule & drawing a graph, it can be explained that AC curve is U shaped.

Figure: Average Cost Curve

The explanation can be divided in three stages as-

Primary Stage: In the primary stage, the Average cost curve is declining as the total production is increasing. So

the AC curve is going downward.

Optimum stage: At the optimum stage, AC curve stops decreasing. It neither falls nor rises. After this stage, AC

curve starts rising upward. In the cost schedule, 3 no. quantities show the optimum stage where the curve is atthe lowest point.

Post optimum stage: At this stage, AC curve rises as the production increases. Thus the AC curve tends to be

upward.

From the above discussion, it can be said that in normal situation, AC curve is U shaped.

Q TC AC

1 20 20

2 24 12

3 30 10

4 60 15

5 110 220

5

10

15

20

25

0 1 2 3 4 5 6

AC



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5. Explain economies of scale & diseconomies of scale.

Ans: Economies of scale, in microeconomics, are the cost advantages that a business obtains due to

expansion. They are factors that cause a producers average cost per unit to fall as scale is increased.

Economies of scale is a long run concept and

refers to reductions in unit cost as the size of a

facility, or scale, increases. Economies of scale

may be utilized by any size firm expanding its

scale of operation. The common ones are

purchasing (bulk buying of materials through

long-term contracts), managerial (increasing the

specialization of managers), financial (obtaining

lower-interest charges when borrowing from

banks and having access to a greater range of

financial instruments), and marketing

(spreading the cost of advertising over a greater

range of output in media markets). Each of these factors reduces the long run average costs (LRAC) of

production by shifting the short-run average total cost (SRATC) curve down and to the right.

Diseconomies of scale are the opposite.

Diseconomies of scale are the forces that

cause larger firms to produce goods and

services at increased per-unit costs. They are

less well known than what economists have

long understood as "economies of scale", the

forces which enable larger firms to produce

goods and services at reduced per-unit costs.

In general economies of scale are more significant and important for investors, but diseconomies of scale can

occur and are worth considering especially when dramatic expansion or acquisitions are being considered.

6. Discuss the long run average cost curve.



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The long-run average cost curve is the envelope of an infinite number of short-run average total cost curves,

with each short-run average total cost curve tangent to, or just touching, the long-run average cost curve at a

single point corresponding to a single output quantity. The key to the derivation of the long-run average cost

curve is that each short-run average total cost curve is constructed based on a given amount of the fixed input,

usually capital. As such, when the quantity of the fixed input changes, the short-run average total cost curve

shifts to a new location.

The long-run average cost curve can be derived by identifying the factory size (or quantity of capital) that can

produce each quantity of output at the lowest short-run average total cost. For example, The Wacky Willy

Company has one short-run average total cost curve corresponding to a 10,000 square foot factory, another

short-run average total cost curve corresponding to a 10,001 square foot factory, another for a 10,002 square

foot factory, etc. Each of these short-run average total cost curves

incurs the lowest average total cost for the production of a givenquantity of output. The long-run average cost curve is then the

combination of all minimum short-run average total cost values.

We have said that the long run average cost curves are U-shaped.

But empirical studies have shown that the LAC curves are L-

shaped, rather than U-shaped as in the figure. We find that there is

a rather rapid downward slope in the early part of the curve, i.e., in

the initial stages of production.

7 . Definition of TFC, TVC, TC, AC, MC, AFC, AVC.

TOTAL FIXED COST (TFC):

Cost of production that does NOT change with changes in the quantity of output produced by a firm in the

short run. Total fixed cost is one part of total cost. The other is total variable cost. At any and all levels of

output, fixed cost is the same. It includes cost that is not dependent on, or is unrelated to, production. The

best way to identify fixed cost is to produce zero output. Fixed cost is incurred whether or not any output isproduced. A cost measure directly related to total fixed cost is average fixed cost.

Total fixed cost is the opportunity cost incurred in the short-run production that does not depend on the

quantity of output. As the name clearly implies, total fixed cost is fixed. A firm can produce a little output or a

lot, increase or decrease production, or even stop producing altogether, but fixed cost remains unchanged.

Y

LAC

Cost

OutputO X



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Y

XO

Marginal cost

MC

Like most relations found in the study of economics, that between total cost and the quantity of production

can be represented by a curve. The total cost curve is presented in the exhibit to the right.

As might be expected the total cost curve has a positive slope. As the quantity of output produced increases,

so too does total cost. However, the slope of the total cost curve is not constant. It is relatively steep for small

quantities, flattens for intermediate levels of production, and then once again steepens for the largest

quantities. The shape of the total cost curve is based on short-run production returns, especially the law of

diminishing marginal returns.

Another observation is that the total cost curve does not go through the origin, but rather begins at a positive

value on the vertical axis. In other words, if the quantity of output is zero, total cost is positive. This vertical

intercept indicates fixed cost.

Total cost=total fixed cost + total variable cost

Marginal cost:

Marginal cost is the amount of additional cost to be incurred

on the production of an additional unit of product.

In other words, marginal cost is the ratio between changes in

total cost and changes in the number of production. Thus

here MC=marginal cost, TC=total cost, q=quantity of

production.

The change in total cost (or total variable cost) resulting from

a change in the quantity of output produced by a firm in the

short run. Marginal cost indicates how much total cost

changes for a give change in the quantity of output. Because changes in total cost are matched by changes in

total variable cost in the short run (remember total fixed cost is fixed), marginal cost is the change in either

total cost or total variable cost. Marginal cost, usually abbreviated MC, is found by dividing the change in total

cost (or total variable cost) by the change in output.

Average Cost (AC):

Average cost is the per unit cost of production determined by dividing, the total cost with the number of units

produced.



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Average cost is a general notion of the per unit cost incurred in the production of a good or service. It is

specified as the total cost divided by the quantity of output. Average cost plays a key role in the short-run

production decision by a firm when evaluated against the price, which is per unit revenue. A comparison

between per unit revenue (price) and per unit cost (average cost) indicates whether a firm is making a profit,

incurring a loss, or should shut down production operations.

A generic formula for calculating average cost is specified as:

Average Fixed Cost (AFC):

Average fixed cost is per unit fixed cost determined by dividing the total fixed cost with the quantity of

production.

Average fixed cost is the total fixed cost per unit of output incurred when a firm engages in short-run

production. It can be found in two ways. Because average fixed cost is total fixed cost per unit of output, it can

be found by dividing total fixed cost by the quantity of output. Alternatively, because total fixed cost is the

difference between total cost and total variable cost, average fixed cost can be derived by subtracting average

variable cost from average total cost.

The standard method of calculating average fixed cost is to divide total fixed cost by the quantity of output,

illustrated by this equation:

An alternative specification for average fixed cost is found by subtracting average variable cost from average

fixed cost:

Average Variable cost (AVC):

For any output level is calculated by dividing total variable cost (TVC) by that output (Q).

Average variable cost is the total variable cost per unit of output incurred when a firm engages in short-run

production. It can be found in two ways. Because average variable cost is total variable cost per unit of output,

it can be found by dividing total variable cost by the quantity of output. Alternatively, because total variable



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cost is the difference between of total cost and total fixed cost, average variable cost can be derived by

subtracting average fixed cost from average total cost.

In general, average variable cost decreases with additional production at relatively small quantities of output,

then eventually increases with relatively large quantities of output. This pattern is illustrated by a U-shaped

average variable cost curve.

The Average Variable Cost Curve

The relation between average variable cost and the quantity of

production can be represented by a curve, such as the one

conveniently presented in the exhibit to the right.

The key feature of this average variable cost is the shape. It is U-

shaped, meaning it has a negative slope for small quantities of

output, reaches a minimum value, then has a positive slope for

larger quantities. This U-shape is indirectly attributable to the law

of diminishing marginal returns.

Total Variable Cost (TVC):

Cost of production that does change with changes in the quantity of output produced by a firm in the short

run. Total variable cost is one part of total cost. The other is total fixed cost. Variable cost depends on the level

of output. If a firm produces more output, then variable cost is greater. If a firm produces no output, then

variable cost is zero. A cost measure directly related to total variable cost is average variable cost.

Total cost=total fixed cost + total variable cost

Total variable cost is the opportunity cost incurred in the short-run production that depends on the quantity of

output. As the name clearly implies, total variable cost is variable, it changes. If a firm produces a little output,

then total variable cost is less. If a firm produces a lot of output, then total variable cost is more.

A firm can avoid variable cost in the short run by reducing production to zero. This bit of information often

comes in handy when the price received by a firm is so low that it falls short off covering variable cost at any

positive quantity of production. As such, the firm might find it most "profitable" to cut losses by shutting down

production and avoiding variable cost, until the price increases.

Average Variable Cost Curve



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MARKET

1.Define market, Discuss different forms of market.

Definition of market:

A market is a mechanism to each the goods and services are traded between buyers and sellers, on the other

words, a market is a public place where provisions and other objectives were exposed for sale, but the word

has been generalized no as to mean any body of persons who are in intimate business relations and carry on

extensive transaction in any commodity.

Classification of marker:

There are mainly two types of market. Those are perfect market and imperfect market.

Perfect Market:

A market is said to be perfect when all the potential sellers and buyers are promptly aware of the prices at

which transaction take place and all the offers made by other seller and buyers and when any buyer can

purchase from any seller and conversely.

Imperfect Market:

A market is said to be imperfect when some buyer of seller or both are not aware of the offers being made by

the offers. Naturally, therefore different prices come to prevail for the same commodity at the same time in an

imperfect market. There are five types of imperfect market. They are as follows-

Market

Perfectmarket

Imperfectmarket

Monopoly Monopolistic Oligopoly Duopoly Monopsony



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Monopoly market

Monopolistic market

Oligopoly Market

Duopoly Market

Monophony market

3.Relationship between AR and MR of different market.

Average Revenue (AR):

Average revenue is the per unit revenue earned by a firm out of selling individual unit of product to be

determined average revenue by dividing the total revenue the number of unit sale.

Marginal Revenue (MR):

Marginal revenue may be defined as the amount of revenue to be earned by a firm by way of selling an

additional unit of output or product.

Relationship between AR and MR in different market:

Relationship between AR and MR in different market are given below with the help of a table.

Number of Units AR(Average Revenue) TR(Total Revenue) MR(Marginal Revenue

1 22 22 22

2 21 42 20

3 20 60 18

4 19 76 16

5 18 90 14

6 17 102 12

7 16 112 10

8 15 120 8

9 14 126 6

10 13 130 4



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Similarly, it can be shown that if e1, MR is positive and if e<1, MR is negative.

The relationship can be illustrated by the

following diagram.

In this diagram DD is a straight line demand

curve or AR curve, MR is the marginal revenue

curve and OD is the total revenue curve. At the

middle point C of AR curve elasticity is one

(e=1). On its lower half it is less than one (e<1).

Referring to the formula given

above, we can say that marginal revenue

corresponding to the middle point C of the

demand curve is zero. This is shown by the fact

that MR curve cuts the X axis at N which corresponds to the point C on the AR curve. If the quantity is greater

than ON, it will correspond to that portion of the AR curve where e<1 marginal revenue is negative because

MR goes below the X Axis.

Likewise, for a quantity less than ON, e>1 and the marginal revenue is positive this means that if quantity

greater than ON is sold, the total revenue will be diminishing and for a quantity less than ON the total revenue

TR will be increasing.

Thus the total revenue (TR) will be maximized at the point H where elasticity is equal to one, and marginal

revenue is zero.

5.Discuss the features of perfect competitive & monopoly, monopolistic, oligopoly,

Features of perfect competitive market:

Generally, a perfectly competitive market exists when every participant is a "price taker," and no participant

influences the price of the product it buys or sells. Specific characteristics may include:

Y

X

DTR

N DOMR

C

H



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y Infinite Buyers/Infinite Sellers Infinite consumers with the willingness and ability to buy the product

at a certain price, Infinite producers with the willingness and ability to supply the product at a certain

price.

y Zero Entry/Exit Barriers It is relatively easy to enter or exit as a business in a perfectly competitive

market.

y Perfect Information - Prices and quality of products are assumed to be known to all consumers and

producers.

y Transactions are Costless - Buyers and sellers incur no costs in making an exchange [Perfect mobility].

y Firms Aim to Maximize Profits - Firms aim to sell where marginal costs meet marginal revenue, where

they generate the most profit.

y Homogeneous Products The characteristics of any given market good or service do not vary across

suppliers.

Some subset of these conditions is presented in most textbooks as defining perfect competition. More

advanced textbooks try to reconcile these conditions with the definition of perfect competition as equilibrium

price taking; that is whether or not firms treat price as a parameter or a choice variable. It should be noted

that a general rigorous proof that the above conditions indeed suffice to guarantee price taking is still lacking

(Keeps 1990, p. 265).

In the short term, perfectly-competitive markets are productively inefficient as output will not occur where

marginal cost is equal to average cost, but electively efficient, as output will always occur where marginal costis equal to marginal revenue, and therefore where marginal cost equals average revenue. In the long term,

such markets are both electively and productively efficient.

Under perfect competition, any profit-maximizing producer faces a market price equal to its marginal cost.

This implies that a factor's price equals the factor's marginal revenue product. This allows for derivation of the

supply curve on which the neoclassical approach is based. (This is also the reason why "a monopoly does not

have a supply curve.") The abandonment of price taking creates considerable difficulties to the demonstration

of existence of a general equilibrium except under other, very specific conditions such as that of monopolistic

competition.

Features of monopoly market:

In economics, monopoly is a pivotal area to the study of market structures, which directly concerns normative

aspects of economic competition, and sets the foundations for fields such as industrial organization and

economics of regulation. There are four basic types of market structures under traditional economic analysis:



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perfect competition, monopolistic competition, oligopoly and monopoly. A monopoly is a market structure in

which a single supplier produces and sells the product. If there is a single seller in a certain industry and there

are no close substitutes for the goods being produced, then the market structure is that of a "pure monopoly".

Sometimes, there are many sellers in an industry and/or there exist many close substitutes for the goods being

produced, but nevertheless firms retain some market power. This is called monopolistic competition, whereas

in oligopoly the main theoretical framework revolves around firm's strategic interactions.

y Single Seller: In a monopoly there is one seller of the monopolized good who produces all the output.

Therefore, the whole market is being served by a single firm, and for practical purposes, the firm is the

same as the industry. In a competitive market (that is, a market with perfect competition) there are an

infinite number of sellers each producing an infinitesimally small quantity of output.

y Market Power: Market Power is the ability to affect the terms and conditions of exchange so that the

price of the product is set by the firm (price is not imposed by the market as in perfectcompetition).Although a monopoly's market power is high it is still limited by the demand side of the

market. A monopoly faces a negatively sloped demand curve not a perfectly inelastic curve.

Consequently, any price increase will result in the loss of some customers.

Features of monopolistic market:

The term Monopolistic Market is derived from the Greek words moons which means alone or single and

pollen which means to sell. It is defined as a situation in which a single company owns all or nearly all of the

market for a given type of product or service.This would happen in the case that there is a barrier to entry into the industry that allows the single company

to operate within competition (for example, vast economies of scale, barriers to entry, or governmental

regulation). In such an industry structure, the producers will often produce a volume that is less than the

amount which would maximize social welfare. It is also explained as the exclusive power; or privilege of selling

a commodity; the exclusive power, rights, or privilege of dealing in some articles, or of trading in some market,

sole command of the traffic in anything, however obtained; as the proprietor of a patented article in given a

monopoly of its sale for a limited time.

1. Exclusive possession or control of one firm/company to produce and sell a commodity or a service.

2. The firm is an industry, since the distinction between firm and industry doesnt exist.

3. Contradicts a perfect competition market.

4. No close substitute of the product/service is available in the market.

5. The sellers are the price makers and not price takers, since they are the sole suppliers.



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6. High entry barriers for the other firms, thus restricting competition.

7. The entry barriers can be legal, technological, economical or natural. As rightly said by Milton Friedman that

monopoly frequently arises from government support or from collusive agreements among individuals.

8. The firm faces a downward sloping demand curve for its product; since the firm is an industry. It means it

cant sell more output unless the price is lowered.

Features of oligopoly market:

Oligopoly competition can give rise to a wide range of different outcomes. In some situations, the firms may

employ restrictive trade practices (collusion, market sharing etc.) to raise prices and restrict production in

much the same way as a monopoly. Where there is a formal agreement for such collusion, this is known as a

cartel. A primary example of such a cartel is OPEC which has a profound influence on the international price of

oil.

Profit maximization conditions: An oligopoly maximizes profits by producing where marginal revenue equals

marginal costs.

Ability to set price: Oligopolies are price setters rather than price takers

Entry and Exit: Barriers to entry are high. The most important barriers are economies of scale, patents, access

to expensive and complex technology, and strategic actions by incumbent firms designed to discourage or

destroy nascent firms.

Number of firms: "Few"a "handful" of sellers. There are so few firms that the actions of one firm can

influence the actions of the other firms.Long Run Profits: Oligopolies can retain long run abnormal profits. High barriers of entry prevent sideline firms

from entering market to capture excess profits.

Product differentiation: Product may be standardized (steel) or differentiated (automobiles).

Perfect Knowledge Assumptions about perfect knowledge vary but the knowledge of various economic actors

can be generally described as selective. Oligopolies have perfect knowledge of their own cost and demand

functions but their inter-firm information may be incomplete. Buyers have only imperfect knowledge as to

price, cost and product quality.

Interdependence: The distinctive feature of an oligopoly is interdependence. Oligopolies are typically

composed of a few large firms. Each firm is so large that its actions affect market conditions. Therefore the

competing firms will be aware of a firm's market actions and will respond appropriately. This means that in

contemplating a market action, a firm must take into consideration the possible reactions of all competing

firms and the firm's countermoves. It is very much like a game of chess or pool in which a player must



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In panel (a) of the figure, the monopolistic competitor will make a profit. However, like a monopoly, a

monopolistic competitor is not guaranteed to make a profit in the short run. The firm may make a loss in the

short run; its profitability will depend on the demand. This is shown in panel (b).

To more fully understand price and output determination in monopolistic competition, try the following Active

Graph exercise:

Price and output determination in monopolistic market under long run:

The action in a monopolistically competitive market occurs when the market moves to the long run. Since

other competitors selling a similar good can enter the market, two changes will occur:

y Firm demand will decrease.

y Firm demand will become more elastic.

As more firms enter the market, the demand for any one firm will decrease, since the firm is now sharing the

market with other firms.

A decrease in demand implies a leftward shift in the demand curve. Since the entering firms are producing

substitutes for the existing firms good, the demand for the existing good will become more elastic. An

increase in elasticity implies the demand curve is getting flatter. By combining these effects, as a

monopolistically competitive market moves from short-run profits to the long run, the firms demand curve

will move to the left and get flatter. Furthermore, the demand curve will continue to move until there are no

more firms entering the market. Firms will

stop entering the market when profits are

zero.

This occurs when the demand curve just

barely touches (i.e., is tangent to) the ATC

curve, as shown in the figure above. Once

the demand curve is tangent to the ATC

curve, the profit-maximizing price is equal

to the average total cost, and thus, profits

are zero. In the long run, competition will

drive monopolistically competitive markets



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to make zero profits. The goal of the firm is to try to maintain as much short-run profit as possible by

differentiating its product. Eventually, though, in the long run, economic profits will be zero.

If a monopolistic competitor is losing money in the short run, the opposite holds true. If the market is not

profitable, firms will leave as the market moves towards the long run. When firms leave, there are fewer

substitutes, so demand becomes more inelastic and increases since market demand is split up among more

firms. The demand curve keeps getting steeper and moving to the right until it is tangent to the ATC curve,

where profits become zero and no other firms want to leave the market. (This would occur at point A in panel

(b) of the earlier figure.)

7 .Distinguish between perfect & monopoly, monopoly & monopolistic, perfect &

monopolistic, monopoly & monopolistic market.

Distinguish between monopoly and monopolistic:

Monopoly means a market situation in which there is only a single seller and large no. of buyers. Whereas

monopolistic competition is a market situation in which there is large no. of sellers and large no. of buyers.in

monopolistic competition, close substitutes are there in the sense that products are different in terms of size,

colour, packaging, brand, price etc. as in case of soap, toothpaste etc.but in monopoly, there is no close

substitute of the good, if any, it will be a remote substitute like in India, Indian railways has its monopoly but

its remote substitutes are present like bus and air service.in monopolistic competition, there is aggressive

advertising but in monopoly, there is no advertising at all or a very little.in monopolistic competition, demand

curve faced by the firm is more elastic because of availability of close substitutes. it means if a firm raises its

price, it will loose its large market share as customers in large will shift to close substitutes present in the

market. but in monopoly, the demand curve faced by the firm is less elastic because of no close substitutes. if

means if the firm raises its price, demand will not fall in a large quantity as it is only one in the market.

Difference between Perfect Competition & Monopolistic

Monopolistic Competition

A type of competition within an industry where:

1. All firms produce similar yet not perfectly substitutable products.

2. All firms are able to enter the industry if the profits are attractive.

3. All firms are profit maximizes.

4. All firms have some market power, which means none are price takers.



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2. Along a few features, each of which has a wide possible range of (continuous or discrete) values;

3. Across a large number of features, each of which has only a presence/absence "flag".

In the second and third cases, it is possible to find out a product that is better than another one according to

one criterion but worse than it in respect to another feature.

Vertical differentiation is a property of the supplied goods but, as it is maybe needless to say, the perceived

difference in quality by different consumer will play a crucial role in the purchase decisions.

In particular, potential consumers can have a biased perception of the features of the good (say because of

advertising or social pressure).

Consumer decision rules when the product is differentiated are presented in this paper.

When evaluating a real market, a good starting point is a top-down grid of interpretation; we shall present first

in 3 segments.

class Price Crucial feature

Low Low The price is low, the product simply works

Middle Middle Use of the good is comfortable. Most people use it. Mass market brand.

High High Quality, exclusivity, durability

(= low life-long price),

To this basic classification, one should add two intermediate classes:

Class Price Crucial feature

Middle-low Low The cheapest nation-wide brand

Middle-high Middle The cheapest product of high quality

Two extreme classes should finally be added:

Class Price Crucial feature

Extremely low Low It usually does not work, it does not last, and it has important defects

Extremely High High Exclusivity, non practical, status symbol

In this way, you can vertically position different brands and product versions, also using clues from advertising

campaigns.



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If you compare widely different goods fulfilling the same (highly-relevant) need, you may distinguish at the

extreme of your spectrum necessity goods and at the other luxury goods. In other cases, what makes this

difference is, instead, the nature of the need fulfilled.

As a general rule, better products have a higher price, both because of higher production costs (more noble

materials, longer production, more selective tests for throughput...) and bigger expected advantages for

clients, partly reflected in higher margins.

Thus, the quality-price relationship is typically upwards sloped. This means that consumers without their own

opinion nor the capability of directly judging quality may rely on the price to infer quality. They will prefer to

pay a higher price because they expect quality to be better.

This important flaw in knowledge and information processing capability - an instance of bounded rationality -

can be purposefully exploited by the seller, with the result that not all highly priced products are of good

quality .Through this mechanism, the demand curve - that in the neoclassical model - is always downward sloped, can

instead turn out to be in the opposite direction.

Horizontal differentiation

When products are different according to features that can't be ordered, a horizontal differentiation emerges

in the market. A typical example is the ice-cream offered in different tastes. Chocolate is not "better" than

lemon. Horizontal differentiation can be linked to differentiation in colors (different color version for the same

good), in styles (e.g. modern / antique), in tastes. This does not prevent specific consumers to have a stable

preference for one or the other version, since you should always distinguish what belongs to the supply

structure and what is due to consumers' subjectivity.

It is quite common that, in horizontal differentiation, the supplier of many versions decide a unique price for

all of them. Chocolate ice-creams cost as much as lemon ones.

When consumers don't have strong stable preferences, a rule of behavior can be to change often the chosen

good, looking for variety itself. An example is when you go to a fast food and ask for what you haven't eaten

the previous time.

Fashion waves often emerge in horizontally-differentiated markets with imitation behaviors among consumers

and specific styles going "in" and "out".



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9.What is Barriers to entry?

BARRIERS TO ENTRY

In economics and mostly especially in the theory of competition, barriers to entry are obstacles in the path of afirm that make it difficult to enter a given market.

[1]

Barriers to entry are the source of a firm's pricing power - the ability of a firm to raise prices without losing all

its customers.

The term refers to hindrances that an individual may face while trying to gain entrance into a profession or

trade. It also, more commonly, refers to hindrances that a firm (or even a country) may face while trying to

enter a market, industry or trade grouping. Barriers to entry restrict competition in a market.

George Stigler defined an entry barrier as A cost of producing which must be borne by a firm which seeks to

enter an industry but is not borne by firms already in the industry.[2]

A barrier to entry is anything that prevents entry when entry is socially beneficial

Franklin M. Fisher(Diagnosing Monopoly 1979)[3]

,

Barriers to entry enable market control by limiting the number of competitors and thus the availability of close

substitutes. Barriers that limit entry into the supply side of market mean that buyers have fewer buying

alternatives, which give the sellers greater market control. Barriers that limit entry into the demand side of

market means that seller have fewer seller options which give the buyers greater market control.

The four primary barriers to entry are: (1) resource ownership, (2) patents and copyrights, (3) government

restrictions, and (2) start-up cost.

Barriers to entry and market structure

1. Perfect competition: Zero barriers to entry.

2. Monopolistic competition: Low barriers to entry.

3. Oligopoly: High barriers to entry.

4. Monopoly: Very High to Absolute barriers to entry

10. Price discrimination of monopoly market.

price discrimination

Practice of selling goods or services at different prices to different buyers, even though sales costs are the

same for all the transactions. Buyers may be discriminated against on the basis of income, ethnicity, age, or



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11. What is Shut down condition of perfect competitive market? When it occurs?

The shutdown point

When a firm is making a loss, it will have to decide whether to continue production or not. This decision will, in

fact, depend on the different total costs levels and whether the firm is operating in the short run or in the long

run.

If the firm is in the short run, and is making a loss whereby:

y Total costs (TC) is greater than total revenue (TR)

y and whereby total revenue is greater or equal to total variable cost (TVC)

it is advisable for the firm to continue production. If it fails to achieve these conditions, it is advised to close

down so that the only costs the firm will have to pay will be the fixed costs.

Even if the firm stops producing, it will have to continue to meet the level of fixed costs. Since whether the

firm produces or not, it will have to pay fixed costs, it is better for it to continue production in an attempt to

decrease total costs and increase total revenue, thus making profits. This can be done by:

y Increasing productivity. The most obvious methods involve automation and computerization which

minimize the tasks that must be performed by employees. All else constant, it benefits a business to

improve productivity, which over time lowers cost and (hopefully) improves ability to compete and

make profit.

y Adopting new methods of production like Just in Time or lean manufacturing in an attempt to reduce

costs and wastages.

In the long run, the condition to continue producing requires the price P to be higher than the ATC, i.e. the line

representing market price should be above the minimum point of the ATC curve.

If P is equal to ATC, the firm is indifferent between shutting down and continuing to produce. This case is

different from the short run shut down case because in long run there's no longer a fixed cost (everything is

variable).

12. Describe Dead weight loss.

Deadweight loss:

In economics, a deadweight loss (also known as excess burden or allocative inefficiency) is a loss of economic

efficiency that can occur when equilibrium for a good or service is not Pareto optimal. In other words, either

people who would have more marginal benefit than marginal cost are not buying the product, or people who

would have more marginal cost than marginal benefit are buying the product.



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Causes of deadweight loss can include monopoly

pricing (see artificial scarcity), externalities, taxes

or subsidies (Case and Fair, 1999: 442), and binding

price ceilings or floors. The term deadweight loss

may also be referred to as the "excess burden" of

monopoly or taxation. For example, consider a

market for nails where the cost of each nail is 10

cents and the demand will decrease linearly from a

high demand for free nails to zero demand for nails

at $1.10. In a perfectly competitive market,

producers would have to charge a price of 10 cents

and every customer whose marginal benefitexceeds 10 cents would have a nail. However if

there is one producer who has a monopoly on the

product, then they will charge whatever price will yield the greatest profit. For this market, the producer

would charge 60 cents and thus exclude every customer who had less than 60 cents of marginal benefit. The

deadweight loss is then the economic benefit forgone by these customers due to the monopoly pricing.

Conversely, deadweight loss can also come from consumers buying a product even if it costs more than it

benefits them. To describe this, let's use the same nail market, but instead it will be perfectly competitive, with

the government giving a 3 cent subsidy to every nail produced. This 3 cent subsidy will push the market price

of each nail down to 7 cents. Some consumers then buy nails even though the benefit to them is less than the

real cost of 10 cents. This unneeded expense then creates the deadweight loss: resources are not being used

efficiently.

13. Excess capacity of monopolistic market.

Ans:

Discussion of monopolistic competition by Chamberlin and Joan Robinson has shown that firms under

imperfect competition operate with excess capacity. According to these economists a firm under monopolistic

competition produces on output in the long run equilibrium, which is less than socially optimum or ideal

output.

cost, market, production

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