Test: Price And Output Determination- 1 - CA Foundation MCQ

The demand curve under perfect competition is a horizontal linear line parallel to x-axis which means that the price of the commodity remains the same and any amount of quantity can be sold at this prevailing price in the market but a little variation in the price will lead to a fall in demand to zero.

In the context of oligopoly, the kinked demand curve hypothesis is designed to explain Price rigidity. The curve is more elastic above the kink and less elastic below it. This means that the response to a price increase is less than the response to a price decrease.

The demand curve of the firm and industry will be the same in the Monopoly form of the market. Explanation: - In a monopoly market, there is only one seller or producer of a particular product or service. This single firm constitutes the entire industry, thus its demand curve is the same as that of the industry. - The monopoly firm has control over the supply of the product or service, allowing it to set prices and restrict output. In this situation, the demand curve faced by the monopoly firm is downward-sloping, indicating that it can charge higher prices for lower quantities of output. - In contrast, in perfect competition and monopolistic competition, there are many firms in the industry, and each firm faces its own downward-sloping demand curve. The industry's demand curve is derived from the horizontal summation of these individual firm demand curves. Thus, the demand curve of individual firms is not the same as the industry demand curve. - In an oligopoly market, there are a few dominant firms, and their demand curves are interdependent due to strategic interactions among them. The industry demand curve is derived from the horizontal summation of these individual firm demand curves, but it is not the same as the demand curve faced by any individual firm.

Historically a prime example of an oligopoly has been the Organization of the Petroleum Exporting Countries (OPEC) where a limited number of countries have dictated oil production and prices to the global economy.

Supernormal profit is also called economic profit, and abnormal profit, and is earned when total revenue is greater than the total costs.

The answer is D: All of the above. Perfect competition is an idealized market structure that serves as a benchmark for analyzing other market structures. It is characterized by the following features: Many Sellers & Buyers: - A large number of both sellers and buyers participate in the market - No single seller or buyer can influence the market price - Each participant is a price taker, meaning they have no control over the market price Homogeneous Product: - The products offered by all sellers in the market are identical or very similar - Buyers have no preference between different sellers' products - This ensures that price is the only factor that influences buyers' decisions Free Entry and Exit: - There are no barriers to entering or exiting the market - Firms can easily enter the market if they believe they can earn a profit - Similarly, firms can exit the market if they are not making a profit - This feature ensures that resources are allocated efficiently and that profits are driven down to a normal level in the long run In summary, perfect competition is characterized by many sellers and buyers, a homogeneous product, and free entry and exit. These features lead to a highly competitive market environment where firms are forced to operate efficiently and provide goods at a price determined by the market.

In the short run, a firm that is operating at a loss (where the revenue is less that the total cost or the price is less than the unit cost) must decide to operate or temporarily shutdown. The shutdown rule states that “in the short run a firm should continue to operate if price exceeds average variable costs. ”

For a firm to achieve long run equilibrium, the marginal cost must be equal to the price and the long run average cost. That is, LMC = LAC = P. The firm adjusts the size of its plant to produce a level of output at which the LAC is minimum.

In the long run, with the entry of new firms in the industry, the price of the product will go down as a result of the increase in supply of output and also the cost will go up as a result of more intensive competition for factors of production. The firms will continue entering the industry until the price is equal to average cost so that all firms are earning only normal profits.

The feature where the Marginal Revenue (MR) curve equals the Average Revenue (AR) curve, which is also the Demand Curve, is characteristic of a Perfect Competition market.

In a perfectly competitive market:

• Each firm is a price taker.
• The demand curve facing each firm is perfectly elastic (horizontal) at the market price.
• The AR curve is the same as the MR curve, as each additional unit sold adds exactly the market price to total revenue.

Explanation: A competitive firm in the short run incurs losses when the market price is less than the firm's average total cost (P < ATC). The firm may continue production in the short run under certain conditions. Conditions for continuing production in the short run: - The firm should continue production if the market price is greater than or equal to the average variable cost (P ≥ AVC). - This is because, at this point, the firm is able to cover its variable costs and make a contribution towards its fixed costs. - If the firm decides to shut down production, it would still have to pay its fixed costs, which it would be unable to do if it cannot cover its variable costs. Option D: P ≥ AVC - This option states that the firm should continue production if the market price is greater than or equal to the average variable cost. - Under this condition, the firm is able to cover its variable costs and contribute towards its fixed costs, which is preferable to shutting down production and incurring the entire fixed cost with no contribution from revenues. - Therefore, the correct answer is option D.

Under monopolistic competition, the cross elasticity of demand for the product of a single firm would be zero. Here's an explanation for this answer: Monopolistic Competition: - Monopolistic competition is a market structure where many firms sell products that are similar but not identical. - Each firm has some degree of market power, which means they can set prices to some extent, instead of being price takers like in perfect competition. - Firms in monopolistic competition differentiate their products through branding, quality, design, or other factors that make their products unique compared to competitors. Cross Elasticity of Demand: - Cross elasticity of demand measures the responsiveness of the quantity demanded of one good to a change in the price of another good. - It is calculated as the percentage change in quantity demanded of one good divided by the percentage change in the price of another good. Zero Cross Elasticity of Demand: - In monopolistic competition, each firm's product is unique and differentiated from the products of other firms. - As a result, consumers do not perceive the products of different firms as close substitutes. - This means that a change in the price of one firm's product will not have a significant impact on the quantity demanded for another firm's product. - Therefore, the cross elasticity of demand for the product of a single firm in monopolistic competition is zero.

A monopolist is able to maximize its profits by setting the price at the level that will maximize its per-unit profit.setting output at MR = MC and setting price at the demand curve's highest point. producing maximum output where price is equal to its marginal cost.

Answer: B: Two equal parts Explanation: The MR curve (Marginal Revenue curve) is a significant concept in microeconomics, especially when studying the behavior of firms in perfect competition and monopolies. When the MR curve cuts the horizontal line between the Y-axis and the demand curve, it results in: - Two equal parts: In the case of a linear demand curve (a straight line with a constant slope), the MR curve is also a straight line with a slope that is twice as steep as the demand curve. When the MR curve intersects the horizontal line between the Y-axis and the demand curve, it divides the horizontal line into two equal parts. - This division occurs because, in a linear demand curve, the MR curve passes through the midpoint of the horizontal line between the Y-axis and the demand curve, effectively dividing it into two equal segments. - This observation holds true for both perfect competition, where the MR curve coincides with the demand curve, and monopolies, where the MR curve lies below the demand curve. In summary, when the MR curve cuts the horizontal line between the Y-axis and the demand curve, it divides the horizontal line into two equal parts. This observation is consistent with the behavior of firms in both perfect competition and monopolies.

 In an oligopolistic market, the kinked demand curve hypothesis states that the firm faces a demand curve with a kink at the prevailing price level. The curve is more elastic above the kink and less elastic below it. This means that the response to a price increase is less than the response to a price decrease.

Explanation: In a market, the price and output equilibrium is determined on the basis of the interaction between the marginal revenue (MR) and marginal cost (MC) of a firm. This can be explained through the following points: - Marginal Revenue (MR): It is the additional revenue generated by selling an additional unit of a product or service. In other words, it is the change in total revenue resulting from selling one more unit of output. - Marginal Cost (MC): It is the additional cost incurred by producing an additional unit of a product or service. In other words, it is the change in total cost resulting from producing one more unit of output. - Equilibrium Condition: The price and output equilibrium occurs when the marginal revenue equals marginal cost (MR = MC). This is because, at this point, the firm maximizes its profit as the additional revenue generated by selling an additional unit is equal to the additional cost incurred in producing that unit. - Profit Maximization: If the marginal revenue is greater than the marginal cost (MR > MC), the firm can increase its profit by producing and selling more units. On the other hand, if the marginal revenue is less than the marginal cost (MR < MC), the firm should decrease its production as it is incurring losses on additional units produced. In conclusion, the price and output equilibrium in a market is determined on the basis of the interaction between marginal revenue and marginal cost, as it helps the firm maximize its profit.

The correct option is Option D.

If the demand of nachos goes up when the price of cheese goes down, nachos and cheese are complements.

Answer: B - Monopoly Price discrimination is best exercised by the seller in a monopoly market structure. Here's why: 1. Market Power: - In a monopoly, there is only one seller, which means the firm has significant market power and can control the price. - This allows the monopolist to charge different prices to different consumers based on their willingness to pay. 2. Barriers to Entry: - Monopoly markets have high barriers to entry, which prevents new firms from entering the market and competing with the monopolist. - This allows the monopolist to exercise price discrimination without the fear of losing customers to competitors. 3. Differentiated Demand: - In a monopoly, the seller can identify and segment consumers based on their demand and price elasticity. - This enables the monopolist to charge different prices to different consumer segments, maximizing profit. 4. Limited Consumer Information: - In a monopoly, consumers may not have complete information about the product or its pricing. - This makes it easier for the monopolist to engage in price discrimination without customers being aware of the different prices charged. In contrast, oligopoly, monopolistic competition, and perfect competition market structures have multiple sellers, making it more difficult for any single firm to engage in price discrimination without facing competition or losing customers to other firms.

The correct answer is C: Homogeneous products. Explanation: Imperfect competition is a market structure where some of the assumptions of perfect competition, such as identical products and numerous sellers, do not hold true. The features of imperfect competition include: - Product differentiation: Firms in imperfect competition offer products that are differentiated from each other. This can be in the form of physical differences, branding, or perceived quality. - Few sellers: In imperfect competition, the number of sellers is limited, and each seller has a significant market share. This allows them to have some control over the prices they charge. - Price wars: Due to the presence of a limited number of sellers and differentiated products, firms in imperfect competition often engage in price wars, where they compete by lowering their prices to gain market share. However, homogeneous products are a feature of perfect competition, not imperfect competition. In perfect competition, all products are identical, and customers have no preference for one product over another. In imperfect competition, products are differentiated, and customers may prefer one product over another due to various factors such as branding, quality, or features.

Explanation: The incorrect statement is: D: Competitive firm always seeks to discriminate prices Here's why the other statements are correct: A: Competitive firms are price takers and not price makers - In a perfectly competitive market, individual firms have no control over the market price. - They must accept the market price as given and adjust their output levels accordingly. B: Price discrimination is possible in monopoly only - Price discrimination occurs when a firm charges different prices to different consumers for the same good or service. - This is possible in a monopoly because the firm has market power and can control the price of the product. - In competitive markets, firms cannot practice price discrimination as they have no control over the market price. C: Duopoly may lead to monopoly - A duopoly is a market structure where there are only two firms dominating the market. - If one firm acquires the other or if the two firms collude to act as a single entity, the market structure can transition into a monopoly.

Answer: A. Perfectly elastic demand curve Explanation: A perfectly competitive firm faces a perfectly elastic demand curve due to the following reasons: - Large number of firms: In a perfectly competitive market, there are a large number of firms producing identical products. This means that the individual firm's output is just a small portion of the total market output, and thus, it has no control over the market price. - Homogeneous products: All firms in a perfectly competitive market produce identical (homogeneous) products. This means that the products of all firms are perfect substitutes for each other, and consumers have no preference for any particular firm's product. As a result, any attempt by a firm to raise its price above the market price will result in the loss of all its customers, as they will switch to other firms offering the same product at a lower price. - Price takers: Each firm in a perfectly competitive market is a price taker, which means that it has no control over the market price and must accept the prevailing market price for its product. This is because the firm's output is too small compared to the total market output, making it unable to influence the market price. - Perfect information: In a perfectly competitive market, all firms and consumers have perfect information about the prices and products available in the market. This means that consumers are aware of the market price and would not buy from a firm charging a higher price. Given these characteristics, a perfectly competitive firm faces a perfectly elastic demand curve, which is a horizontal line at the market price. This means that the firm can sell any quantity of its product at the market price, but it cannot sell anything at a price higher than the market price.

A shutdown point is a level of operations at which a company experiences no benefit for continuing operations, and therefore decides to shut down temporarily (or in some cases permanently). It results from the combination of output and price where the company earns just enough revenue to cover its total variable costs. Conventionally stated the shutdown rule is: "in the short run a firm should continue to operate if price exceeds average variable costs." Restated, the rule is that to produce in the short run a firm must earn sufficient revenue to cover its variable costs.

Answer: D. Inelastic Explanation: A monopolist can fix the price of goods with an elasticity of demand that is inelastic. This is because: - Inelastic demand: When the price elasticity of demand for a good is less than 1, it is considered inelastic. This means that the percentage change in quantity demanded is smaller than the percentage change in price. In other words, consumers are not highly sensitive to price changes for inelastic goods. - Price-setting power: A monopolist has the ability to set the price of a good since they are the sole seller in the market. This price-setting power allows them to maximize their profits by charging a higher price for goods with inelastic demand. - Higher profits: When demand is inelastic, consumers will continue to purchase the good even if the price increases. This allows a monopolist to raise the price without causing a significant decrease in quantity demanded, leading to higher profits. - Examples of inelastic goods: Goods with inelastic demand typically have few substitutes or are considered necessities. Examples include utilities (e.g., water, electricity), life-saving medications, and essential food items. In conclusion, a monopolist can fix the price of goods with inelastic demand because consumers are not highly sensitive to price changes for these goods. This allows the monopolist to maximize their profits by charging a higher price without causing a significant decrease in quantity demanded.

Answer: D. Oligopoly Explanation: Price rigidity refers to a situation where the prices of goods and services in a market do not change easily or quickly in response to changes in supply or demand. This phenomenon is typically observed in an oligopoly market structure. The reasons for price rigidity in an oligopoly include: - Interdependence: In an oligopoly, there are only a few firms that dominate the market. These firms are aware of their interdependence and are cautious about changing their prices. A price change by one firm may lead to retaliatory price changes by the other firms, resulting in a price war, which can be harmful to all firms involved. - Price leadership: Oligopolies often have a firm that acts as a price leader, setting the market price for the industry. Other firms in the market follow the price set by the leader to avoid price wars and maintain stability. - Collusion: Oligopolistic firms may engage in explicit or implicit collusion to maintain price stability in the market. In explicit collusion, firms may form cartels and agree on prices, while in implicit collusion, firms may follow a common pricing strategy without any formal agreement. - Non-price competition: Oligopolistic firms often compete on factors other than price, such as product differentiation, advertising, and customer service. This reduces the need for price competition and contributes to price rigidity. In contrast, price rigidity is not common in perfect competition, monopoly, or monopolistic competition market structures. In perfect competition, there are many firms, and prices are determined by supply and demand. In a monopoly, there is only one firm, which has control over the price. In monopolistic competition, there are many firms with differentiated products, and each firm has some control over its own prices, but they are still subject to competitive pressures.

In a perfectly competitive market individual firms are price takers. The market demand curve slopes downward, while the firm's demand curve is a horizontal line. The firm's horizontal demand curve indicates a price elasticity of demand that is perfectly elastic.

Answer: A. Pure Oligopoly A pure oligopoly is a market structure where: - A small number of large firms dominate the market. - These firms produce identical or homogeneous products. - There is a high degree of interdependence among firms in terms of decision-making, pricing, and other strategies. - Barriers to entry exist, making it difficult for new firms to enter the market. - Firms may engage in non-price competition, such as advertising and product differentiation, to increase their market share. In contrast, other types of oligopolies include: B. Collusive Oligopoly: - Firms in the market cooperate and set prices together, often through cartels or other agreements. - This cooperation allows firms to increase their profits and maintain market stability. - Collusive behavior is often illegal and can lead to antitrust investigations. C. Independent Oligopoly: - Firms in the market do not actively cooperate with each other and make decisions independently. - They may still be influenced by the actions of their competitors, but they do not engage in explicit collusion. D. None of these: - This option is incorrect because pure oligopoly is the correct answer.

The correct answer is D: Existence of large number of firms. Explanation: An oligopoly market is a market structure characterized by a few dominant firms, each having significant control over the market. The key features of an oligopoly market include: A: Interdependence of the firms in decision making - In an oligopoly, the actions of one firm directly impact the other firms in the market. As a result, firms must consider the potential reactions of their competitors when making decisions, such as setting prices or launching new products. B: Price rigidity - Oligopolistic firms tend to avoid significant price changes to prevent a price war with their competitors. As a result, prices in an oligopoly market tend to be rigid or sticky, meaning they do not change frequently. C: Group behavior - Firms in an oligopoly market may engage in group behavior, such as forming cartels or engaging in collusion, to maximize their profits collectively. This can result in practices that restrict competition, such as price fixing or limiting production. D: Existence of large number of firms - This is not a feature of an oligopoly market. In an oligopoly, there are only a few dominant firms, as opposed to a large number of firms. This concentration of market power among a few firms is a key characteristic of oligopoly markets. In contrast, a large number of firms is a characteristic of a competitive market structure, such as perfect competition or monopolistic competition.

Correct Answer :- C

Explanation : The doctrine of excess (or unutilised) capacity is associated with monopolistic competition in the long- run and is defined as “the difference between ideal (optimum) output and the output actually attained in the long-run.”

A monopolistic competitive industry has the following features:

Many firms.

Freedom of entry and exit.

Firms produce differentiated products.

Firms have price inelastic demand; they are price makers because the good is highly differentiated

Firms make normal profits in the long run but could make supernormal profits in the short term

Firms are allocatively and productively inefficient.

The correct answer is C: Fulfillment of the assumption that a price cut is followed by others and a price increase by a firm is not followed by others. Explanation: In an oligopoly, the kink on the demand curve is a result of the following factors: 1. Price cut followed by others: When a firm in an oligopoly market lowers its price, other firms in the market are likely to follow suit in order to remain competitive. This means that the demand for the firm's product remains relatively elastic, as consumers are responsive to the price change. 2. Price increase not followed by others: On the other hand, if an oligopoly firm decides to increase its price, other firms in the market are unlikely to follow. This is because they can maintain their market share by keeping their prices constant or even lowering them. As a result, the firm that increased its price will experience a significant decrease in demand, as consumers will shift their consumption to the products of firms that have maintained or decreased their prices. This makes the demand curve relatively inelastic. The kink on the demand curve in an oligopoly market is thus due to the fulfillment of these two assumptions.