05 Jun Question ECO 555 Final Exam Perfect Competition (45 points)
Question
ECO 555
Final Exam
Perfect Competition (45 points)
1. (27 points) A perfectly competitive firm has the short-run marginal cost function,
MC = 3 + 6Q + 3Q2
Where K (capital) is fixed and L (labor)is variable. PK (price of capital) = $3 and P (price of output) = $48
a. What is the profit maximizing level of Output? Show your work.
b. Write the equation for Total Costs (TC).
c. What is TC when profit is maximized?
d. What is Total Revenue when profit is maximized?
e. What is Total Profit when profit is maximized?
f. Approximately, what is Q when ATC is minimized?
g. Will firms enter or exit in the long-run? (explain your answer)
h. (6 points) Graph the P, MC, MR, AR and ATC curves in P/Q space to correspond to your answers above. Make sure to label the values (with the numbers you have calculated above) for optimal Q and where the curves intersect optimal Q and where the curves intersect the vertical axis. Make sure to indicate/label profit/loss.
2. (4 points) Describe the mechanism that adjusts the market to its long-run equilibrium.
3. (4 points) Describe how a demand shock in a long-run constant cost industry results in a market long-run supply function that is horizontal.
4. (6 points) In a perfectly competitive market, economic profit for each firm is supposed to be zero in the long-run. There are some industries in which positive economic profits seem necessary in order for these firms to survive in the long run (e.g., banking and pharmaceuticals – assume theses are perfectly competitive, even though they are not). What makes these industries special? Use one of them as a specific example. Should this economic profit be considered part of the cost curves? Give a reason for doing this. If this profit is subsumed into the cost curves, would economic profit be zero in the long run?
5. (4 points) Explain why a perfectly competitive market is socially desirable.
Monopoly (32 points)
1. (24 points) A monopolistic firm has the short-run marginal cost function,
MC = 20 + 4Q
Where K (capital) is fixed and L (labor)is variable. PK (price of capital) = $10 and
Average Revenue is given by
P= 180-2Q
a. What is the profit maximizing level of Output? Show your work.
b. Write the equation for Total Costs (TC).
c. Write the equation for Total Revenue (TR)
d. Write the expression for the market demand function.
e. What is TC when profit is maximized?
f. What is Total Revenue when profit is maximized?
g. What is Total Profit when profit is maximized?
h. Graph the P, MC, MR, AR and ATC curves in P/Q space to correspond to your answers above. Make sure to label the values (with the numbers you have calculated above) for optimal Q and where the curves intersect optimal Q and where the curves intersect the vertical axis. Make sure to indicate/label profit/loss.
2. (2 points) What assumption is relaxed on the perfectly competitive market to obtain a monopolistic market?
3. (2 points) Explain why a monopoly is not socially desirable.
4. (4 points) What is a natural monopoly? Why do governments allow the operation of natural
monopolies? Why do governments impose regulations on natural monopolies?
Monopsony (5 points)
1. (2 points) Briefly describe the conditions for monopsony.
2. (3 points) Show that L (quantity of labor) is lower and PL is higher than in the perfectly competitive labor market.
Monopolistic Competition (18 points)
1. (8 points) Explain monopolistic competition. Include in your explanation the characteristics that determine the degree of monopolistic competition.
2. (10 points) Discuss Khalid’s proposed business in terms of a competitive market and in terms of a monopolistic competitive market. Which type of market structure (competitive or monopolistic competitive) might he hope develops? Why? Does that development depend on him? Explain.
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