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Test: The Theory of the Firm under Perfect Competition- Case Based Type Questions - Commerce MCQ


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5 Questions MCQ Test Economics Class 11 - Test: The Theory of the Firm under Perfect Competition- Case Based Type Questions

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Test: The Theory of the Firm under Perfect Competition- Case Based Type Questions - Question 1

Direction: Read the following passage and answer the questions that follows:

Market structure is best defined as the organisational and other characteristics of a market. We focus on those characteristics which affect the nature of competition and pricing – but it is important not to place too much emphasis simply on the market share of the existing firms in an industry.

Key Summary on Market Structures

Traditionally, the most important features of market structure are:

  • The number of firms (including the scale and extent of foreign competition)

  • The market share of the largest firms (measured by the concentration ratio)

  • The nature of costs (including the potential for firms to exploit economies of scale and also the presence of sunk costs which affects market contestability in the long term)

  • The degree to which the industry is vertically integrated-vertical integration explains the process by which different stages in production and distribution of a product are under the ownership and control of a single enterprise. A good example of vertical integration is the oil industry, where the major oil companies own the rights to extract from oil fields, they run a fleet of tankers, operate refineries and have control of sales at their own filling stations.

  • The extent of product differentiation (which affects cross-price elasticity of demand)

  • The structure of buyers in the industry (including the possibility of monopsony power)

  • The turnover of customers (sometimes known as "market churn") i.e. how many customers are prepared to switch their supplier over a given time period when market conditions change. The rate of customer churn is affected by the degree of consumer or brand loyalty and the influence of persuasive advertising and marketing.

Q. In which market, there is the highest market churn?

Detailed Solution for Test: The Theory of the Firm under Perfect Competition- Case Based Type Questions - Question 1
Monopolistic competition characterizes an industry in which many firms offer products or services that are similar, but not perfect substitutes. Barriers to entry and exit in a monopolistic competitive industry are low, and the decisions of any one firm do not directly affect those of its competitors.
Test: The Theory of the Firm under Perfect Competition- Case Based Type Questions - Question 2

Direction: Read the following passage and answer the questions that follows:

The biggest reason why oligopolies exist is collaboration. Firms see more economic benefits in collaborating on a specific price than in trying to compete with their competitors. By controlling prices, oligopolies are able to raise their barriers to entry and protect themselves from new potential entrants into the market. This is quite important, as new firms may offer much lower prices and thus jeopardize the longevity of the colluding firms’ profits.

In most markets, antitrust laws exist that aim to prevent price collusion and protect consumers. Nonetheless, firms have devised ways to achieve price collusion without being detected by regulators. For example, firms might elect a price leader that is tasked with leading changes in prices before other firms follow suit in order to “react to competition”. Firms may also agree to change their prices on specific dates; in such cases, the changes may be seen as merely a reaction to economic conditions such as fluctuations in inflation.

How do oligopolies work?

It is important to note that in real-life oligopolies, the games (instances of collusion) are sequential; meaning that one firm’s behaviour in one game may influence the game’s outcome in future periods. In this scenario, we see that the optimal outcome that generates the most cumulative profits occurs if both firms collude. This situation would be the best long-run equilibrium situation that would provide the most benefit to all the firms.

Nonetheless, in this equilibrium, firms have an incentive to cheat and not collude. For example, if both firms agree to set a price of $10, but Firm A cheats and sets prices at $5, Firm A will essentially capture the entire market (assuming little to no differentiation). While this may result in high profits for Firm A in this game, Firm B now knows that Firm A is a cheater and thus will never collude again.

Therefore, the new equilibrium would be the one where neither firm collude and achieve profits that would occur under perfect competition (which is significantly less profitable than colluding). Thus, to realize the best long-run profits, firms in an oligopoly choose to collude.

Q. Why do firms agree to collude?

Detailed Solution for Test: The Theory of the Firm under Perfect Competition- Case Based Type Questions - Question 2
Collusion is a way for firms to make higher profits at the expense of consumers and reduces the competitiveness of the market.
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Test: The Theory of the Firm under Perfect Competition- Case Based Type Questions - Question 3

Direction: Read the following passage and answer the questions that follows:

More specifically, a price ceiling (in other words, a maximum price) is put into effect when the government believes the price is too high and sets a maximum price that producers can charge; this price must lie below the equilibrium price in order for the price ceiling to have an effect.

The price ceiling is usually instituted via law and is typically applied to necessary goods like food, rent, and energy sources in order to ensure that everyone has access to them.

Benefits and Downsides:

Price ceilings are beneficial to society, and are often necessary, in that they make sure that essential goods are financially accessible to the average person, at least in the short run. By lowering costs, price ceilings also have the beneficial effect of helping to stimulate demand, which can contribute to the health of an economy.

However, there can also be downsides to price ceilings. While they stimulate demand, price ceilings can also cause shortages. Where the ceiling is set, there is more demand than at the equilibrium price. This means that the amount of the good or service supplied is less than the quantity demanded.

For example, in agriculture, medicine, and education, many governments set maximum prices to make the needed goods or services more affordable. Producers may respond to such an economic situation by rationing supplies, decreasing production levels or lowering the quality of production, making the consumer pay extra for otherwise free elements of the good (features, options, etc.), and more.

Q. How do the producers respond to the situation of price ceiling?

Detailed Solution for Test: The Theory of the Firm under Perfect Competition- Case Based Type Questions - Question 3
A price ceiling is a government- or group-imposed price control, or limit, on how high a price is charged for a product, commodity, or service. Governments use price ceilings ostensibly to protect consumers from conditions that could make commodities prohibitively expensive.
Test: The Theory of the Firm under Perfect Competition- Case Based Type Questions - Question 4

Direction: Read the following passage and answer the questions that follows:

More specifically, a price ceiling (in other words, a maximum price) is put into effect when the government believes the price is too high and sets a maximum price that producers can charge; this price must lie below the equilibrium price in order for the price ceiling to have an effect.

The price ceiling is usually instituted via law and is typically applied to necessary goods like food, rent, and energy sources in order to ensure that everyone has access to them.

Benefits and Downsides:

Price ceilings are beneficial to society, and are often necessary, in that they make sure that essential goods are financially accessible to the average person, at least in the short run. By lowering costs, price ceilings also have the beneficial effect of helping to stimulate demand, which can contribute to the health of an economy.

However, there can also be downsides to price ceilings. While they stimulate demand, price ceilings can also cause shortages. Where the ceiling is set, there is more demand than at the equilibrium price. This means that the amount of the good or service supplied is less than the quantity demanded.

For example, in agriculture, medicine, and education, many governments set maximum prices to make the needed goods or services more affordable. Producers may respond to such an economic situation by rationing supplies, decreasing production levels or lowering the quality of production, making the consumer pay extra for otherwise free elements of the good (features, options, etc.), and more.

Q. When does the government put price ceiling?

Detailed Solution for Test: The Theory of the Firm under Perfect Competition- Case Based Type Questions - Question 4
Price ceiling is a situation when the price charged is more than or less than the equilibrium price determined by market forces of demand and supply. It has been found that higher price ceilings are ineffective.
Test: The Theory of the Firm under Perfect Competition- Case Based Type Questions - Question 5

Direction: Read the following passage and answer the questions that follows:

A price floor is the lowest legal price that can be paid in a market for goods and services, labour, or financial capital. Perhaps the best-known example of a price floor is the minimum wage, which is based on the normative view that someone working full time ought to be able to afford a basic standard of living. The federal minimum wage at the end of 2014 was $7.25 per hour, which yields an income for a single person slightly higher than the poverty line. As the cost of living rises over time, Congress periodically raises the federal minimum wage.

Price floors are sometimes called price supports because they support a price by preventing it from falling below a certain level. Around the world, many countries have passed laws to create agricultural price supports. Farm prices, and thus farm incomes, fluctuate—sometimes widely. So even if, on average, farm incomes are adequate, some years they can be quite low. The purpose of price supports is to prevent these swings.

The most common way price supports work is that the government enters the market and buys up the product, adding to demand to keep prices higher than they otherwise would be.

Q. Read the following statements–Assertion (A) and Reason (R).

Assertion (A): Price floor is also known as price support.

Reason (R): Price floor supports a price from falling the certain level

Select the correct alternative from the following:

Detailed Solution for Test: The Theory of the Firm under Perfect Competition- Case Based Type Questions - Question 5
Price floors are sometimes called “price supports,” because they support a price by preventing it from falling below a certain level.
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