Important Questions: Market Equilibrium

Very Short Answer Type Questions

Q1: What is a price-taker firm?
Ans: A firm that accepts the market price because it is too small to influence that price is called a price taker. Such a firm must sell at the price determined by industry-wide supply and demand.
Q2: What does "normal profit" mean?
Ans: Normal profit is the minimum return an entrepreneur needs to keep resources in the current business. It represents the opportunity cost of the owner's time and capital and is the level of profit that makes staying in the business worthwhile.
Q3: Describe the cooperative oligopoly.
Ans: A cooperative oligopoly exists when a few large firms in an oligopolistic market collaborate-formally or informally-to fix prices or output. This cooperation (often called collusion) reduces competition and helps firms maintain higher profits.
Q4: What is a price maker firm?
Ans: A price maker is a firm with sufficient market power to influence the price of its product. Such a firm faces a downward-sloping demand curve and can raise or lower price without immediately losing all customers.
Q5: If a single business cannot affect the market price in a situation of perfect competition, who can alter the market price?
Ans: In perfect competition, no single firm can change the market price; only the industry as a whole can influence price by changing total output supplied to the market.
Q6: Explain advertising costs.
Ans: Advertising costs are the expenses a firm incurs to promote its goods or services. These include spending on media such as television, radio, newspapers, magazines and digital platforms to increase awareness and sales.

Short Answer Type Questions

Q7: Describe two characteristics of a monopoly market.
Ans: The two most important traits of a monopoly market are as follows:

• Sole Seller: Only one firm supplies the product, so it has considerable control over price. Buyers have no close substitutes and must purchase from the sole seller if they want the product.
• High Entry Barrier: Significant obstacles-such as legal protections (patents), high initial costs, or control of essential resources-prevent new firms from entering, allowing the monopolist to earn abnormal profits in the long run.

Q8: Briefly describe why a company operating in perfect competition is a price taker rather than a price maker.
Ans: A firm in perfect competition is a price taker because:
- There are a very large number of firms, each producing a homogeneous product.
- Buyers can switch between sellers without cost, so no single firm can influence market price.
- Price is determined by overall market supply and demand (equilibrium price), and each firm must accept that price and sell its output accordingly.
Q9: Why is there a small number of businesses in an oligopoly? Explain.
Ans: An oligopoly has a small number of firms because of high entry barriers. These barriers include large start-up costs, control over essential raw materials, patents, economies of scale and legal restrictions. Such obstacles limit new entrants, so only a few large firms come to dominate the market.
Q10: Describe the effects of the following:

• Oligopolistic firm interdependence
• A perfect competition with many sellers. 

Ans: The consequences of the aforementioned characteristics are as follows:
A market dominated by a few large firms leads to interdependence. Each firm's decisions about price, output, advertising or investment affect rivals, who then react strategically. This mutual dependence often results in careful monitoring of competitors, price rigidity, and frequent non-price competition.
In perfect competition, there are many buyers and sellers, each too small to affect market price. Individual transactions are insignificant relative to total market supply or demand, so firms are price takers and competition is mainly on cost and efficiency rather than on price manipulation.

Long Answer Type Questions

Q11: How would an increase in the consumers' income influence the equilibrium price and equilibrium quantity of a common good or service?
Ans: For a normal good, an increase in consumers' income shifts the demand curve to the right because buyers are willing to purchase more at each price. With supply unchanged in the short run, this leads to a higher equilibrium price and a larger equilibrium quantity. Over time, higher prices encourage producers to increase output, which may shift the supply curve rightward until a new equilibrium is reached; however, the immediate effect of a rise in income is higher price and higher quantity demanded.

Q12: An equilibrium exists in the market for a commodity. Both the supply of commodities and their demand are rising at the same time. Describe how it affects the market price.
Ans: When both demand and supply increase, the change in equilibrium price depends on their relative magnitudes. There are three cases:

• When demand growth equals supply growth: If the rightward shifts of demand (D1D1 → D2D2) and supply (S1S1 → S2S2) are of the same proportion, the new equilibrium (E2) has a larger quantity but the price remains unchanged (OP1).
• When demand growth surpasses supply growth: If demand shifts right by more than supply, the new equilibrium (E2) results in both a higher price (OP1 → OP2) and a higher quantity (Oq1 → Oq2).
• When supply growth surpasses demand growth: If supply shifts right by more than demand, the new equilibrium (E2) has a larger quantity (Oq1 → Oq2) but a lower price (OP1 → OP2).