Test: Price And Output Determination- 2 - CA Foundation MCQ

Microeconomics focuses on the behaviour of individuals and firms in making decisions regarding the allocation of resources. Key areas include:

• Factor pricing: This involves determining the prices of inputs used in production, such as labour and capital.
• Analysis of consumer behaviour and demand.
• Market structures, including competition and monopoly.

In contrast, broader economic concepts like national income, general price levels, and overall investment fall under macroeconomics.

For a monopolist, the necessary condition for equilibrium is:

• The monopolist sets output where marginal revenue (MR) equals marginal cost (MC).
• This ensures that the cost of producing one more unit is the same as the revenue gained from selling it.
• At this point, the monopolist maximises profits.

Thus, the equilibrium condition is MR = MC.

Paul A Samuelson is a key figure in defining economics through the lens of dynamic growth and development. His contributions include:

• Emphasising the importance of economic growth over time.
• Integrating microeconomic and macroeconomic perspectives.
• Highlighting the role of government in fostering economic progress.

Samuelson's approach has significantly influenced modern economic theory and policy.

Under certain market conditions, firms can earn a normal profit in the long run.

• Perfect competition allows firms to cover their costs and earn normal profits due to the presence of many competitors.
• In a monopoly, a single firm dominates the market, typically leading to higher profits.
• Oligopoly features a few firms that may restrict competition, often resulting in increased profits.
• Thus, in most cases apart from perfect competition, firms do not achieve normal profits.

A study analysing how an increase in the corporate income tax rate impacts the natural unemployment rate falls under the category of:

• Macro Economics: This field focuses on the economy as a whole, examining large-scale economic factors.
• Descriptive Economics: This area describes economic phenomena without making judgments.
• Micro Economics: This focuses on individual and business decision-making processes.
• Normative Economics: This involves value-based perspectives on economic policies.

A mixed economy combines elements of both the private sector and the public sector. Here are some key points about this economic system:

• It allows for private ownership of businesses alongside government control.
• It aims to balance the benefits of free markets with social welfare.
• This system can help address inequalities by providing public services.
• Individuals and businesses operate freely while the state regulates certain sectors.

This approach fosters economic growth while aiming to support those in need.

Economic problems arise from several factors:

• Wants are unlimited, meaning people have endless desires and needs.

• Resources, however, are limited, which constrains our ability to satisfy these wants.

• There are alternative uses for resources, leading to the necessity of making choices.

Therefore, all these factors contribute to the economic problem.

Microeconomics focuses on various aspects of economic behaviour and decision-making, including:

• Consumer behaviours: Understanding how individuals make choices about spending and consumption.
• Product pricing: Analyzing how prices are set based on supply and demand.
• Factor pricing: Examining how factors of production (like labour and capital) are priced in the market.

These components are essential for comprehending the functioning of economies at a smaller scale.

The Kinked demand curve model illustrates price behaviours in certain market structures, particularly in oligopolies. Key characteristics include:

• Price Rigidity: Firms are hesitant to change prices due to the reactions of competitors.
• When one firm lowers its price, others quickly follow, leading to a price war.
• Conversely, if a firm raises its price, others may not follow, resulting in a loss of customers.
• This creates a kink in the demand curve, where the curve is more elastic above the current price and inelastic below it.

This model effectively explains why prices tend to remain stable in an oligopoly, despite changes in costs or demand.

Kinked demand curve:

1. A kinked demand curve occurs when the demand curve is not a straight line but has a different elasticity for higher and lower prices.
2. One example of a kinked demand curve is the model for an oligopoly.
3. This model of oligopoly suggests that prices are rigid and that firms will face different effects for both increasing price or decreasing price.
4. The kink in the demand curve occurs because rival firms will behave differently to price cuts and price increases.

Therefore, the Kinked demand curve is a characteristic of Oligopoly.

Kinked demand curve hypothesis is a concept in economics that explains how market prices and output levels can be influenced by consumer behaviour and competitor actions.

• The hypothesis suggests that firms in an oligopoly face a kinked demand curve.
• This curve is characterised by a rigid price level, where prices tend to be stable despite changes in cost.
• Firms may avoid raising prices due to fear of losing customers to competitors.
• Conversely, they may not lower prices because competitors will likely follow suit, leading to a price war.

The kinked demand curve provides insights into price stability in markets with a few dominant players.

Alfred Marshall was a British economist who proposed the definition of welfare according to which economics should be a science of creation of welfare for both human as well as society believed that the subject studies the creation of materialistic things in the economy for personal gains which is not good for the welfare of the society. Therefore, he proposed a normative definition on economics.

In a perfectly competitive market, the average revenue (AR) of a firm is equal to its marginal revenue (MR). This occurs because:

• Price Taker: Firms are price takers, meaning they accept the market price.
• Constant Revenue: Selling one more unit does not change the price; thus, AR = MR.
• Uniform Pricing: Each firm sells at the same price, leading to equal AR and MR for all units sold.

In contrast, other market structures like monopoly and monopolistic competition typically have differing AR and MR due to pricing power and market control.

• In perfect competition, firms are price takers and cannot influence the market price.
• When the price is below the average cost, firms cannot cover their total costs.
• This situation leads to financial losses, as the revenue generated is less than what is needed to sustain operations.
• As a result, firms will either reduce production, exit the market, or seek ways to lower costs to eventually achieve normal profits.

Thus, the correct answer is that the firm would incur losses.

The demand curve is equal to the marginal revenue (MR) curve in a:

• Perfect Competition market structure.
• In this scenario, firms are price takers.
• Each additional unit sold does not affect the market price.

This results in the demand curve being perfectly elastic, meaning it is horizontal at the market price.

Price taker firms do not engage in advertising because they can sell as much as they want at the current market price. This means:

• They are unable to influence the market price through marketing efforts.
• They focus on selling their products without the need for promotional tactics.
• By not advertising, they avoid misleading customers.

Essentially, these firms accept the market price as given and adjust their production accordingly.

The correct option is Option A.

Price discrimination is when the same good is sold at different prices to different consumers.

Price discrimination occur only under imperfect markets such as Monopoly, Oligopoly, Monopolistic competition etc.

It cannot occur under Perfect competition market structure as there are a large number of buyers. So if a firm charges a higher price the consumer will go to the other sellers.

Oligopoly is a market structure characterised by a small number of firms that dominate the market. Here are some key features:

• Firms in an oligopoly are interdependent; the actions of one firm can significantly impact others.
• They often engage in collusion to maximise profits, either explicitly or implicitly.
• Barriers to entry are typically high, making it difficult for new competitors to enter the market.
• Products may be homogeneous (similar) or differentiated (distinct).

OPEC is a prime example of an oligopoly as it consists of a few major oil-producing countries that coordinate their production and pricing strategies.

As you can see above, there are two alternative cases for the determination of Equilibrium in Monopoly:

• With normal profits
• With super-normal profits

In a monopoly, when the elasticity of demand is equal to one, the marginal revenue behaves in a specific way.

• Marginal revenue is affected by the price elasticity of demand.
• When demand is unit elastic (equal to one), any change in price results in no change in total revenue.
• Therefore, the marginal revenue is zero at this point.

In summary, when demand elasticity equals one in a monopoly, marginal revenue will be zero.

• Pure Oligopoly: This occurs when a few firms dominate the market and produce identical products. They have significant control over pricing and market share.
• Imperfect Oligopoly: In this scenario, firms offer differentiated products, leading to less control over prices.
• Price Leadership: A dominant firm sets prices, and others follow, which is common in oligopolistic markets.
• Collusion: Firms may work together to set prices or output levels, reducing competition.

Price discrimination in a monopoly can occur under specific conditions. These include:

• The seller must have control over the price of their product.
• The market must not be uniform; demand must vary across different markets.
• There should be differences in the price elasticity of demand in various markets.
• Uniform price elasticity could hinder effective price discrimination.

Therefore, the ability to discriminate based on price relies heavily on the variations in demand across different segments.

Kinked demand curves are commonly associated with markets characterised by oligopoly. These curves illustrate how firms react to changes in price and demand.

• The kinked curve suggests that if a firm raises its prices, competitors may not follow, leading to a loss of market share.
• Conversely, if a firm lowers its prices, competitors are likely to match the reduction, preventing significant gains.
• This results in a stable price in the market, despite potential shifts in demand.

In perfect competition, free entry and exit of firms ensure that abnormal profits attract new firms, increasing supply and reducing prices. Similarly, losses force some firms to exit, reducing supply and increasing prices. This adjustment continues until firms earn only normal profits in the long run.

Monopolistic competition is a market structure characterised by product differentiation. In this type of market, businesses offer products that are similar but not identical, which allows them to compete on factors other than price. Key features include:

• Product Variety: Each firm provides a unique product, giving consumers choices.
• Brand Loyalty: Customers may prefer certain brands over others due to perceived differences.
• Market Power: Firms can set prices above marginal cost because of differentiation.
• Easy Entry and Exit: New firms can enter the market relatively easily, increasing competition.

This structure contrasts with perfect competition, where products are identical, and firms are price takers.

A monopolist is the sole seller in the market, so the industry demand curve is the firm’s demand curve. This demand curve slopes downward because to sell more units, the monopolist must reduce the price.

The ideal market structure is known as Perfect Competition. In this scenario:

• Many buyers and sellers exist in the market.
• Products offered are identical or very similar.
• No single buyer or seller can influence the market price.
• There are no barriers to entry or exit for businesses.

This market structure ensures efficient resource allocation and promotes competition.

In the long run, the entry of new firms eliminates supernormal profits in monopolistic competition. Equilibrium is achieved when the firm’s price equals average cost (AC). However, price remains greater than marginal cost (MC) due to product differentiation and excess capacity.

The Equilibrium Price is the price at which the quantity demanded by consumers equals the quantity supplied by producers. At this price, there is no surplus or shortage in the market, and the market is in a state of balance. Any price above or below the equilibrium price would lead to either excess supply or excess demand.

In oligopoly, a few large firms dominate the market. Each firm’s pricing and output decision depends on the expected reaction of rival firms, making interdependence the key feature. Unlike perfect competition or monopoly, strategies such as price rigidity and collusion are common in oligopolies.