# Buổi 4 - Economics - Reading 12: Topics in Demand and Supply Analysis & Reading 13: The Firm and Market Structure

READING 12: TOPICS IN DEMAND AND SUPPLY ANALYSIS

LOS 12.a: calculate and interpret price, income, and cross-price elasticities of demand and describe factors that affect each measure.

Question 12.1: Demand for gasoline (in hundreds of liters) at a particular station, as a function of the price of gasoline and the price of bus travel, is Q = 300 – 14 Pgas + 2 Pbus . If the price of gasoline per liter (P ) is 1.50 euros, and the price of a standardized unit of bus travel (P ) is 12 euros, the cross price elasticity of gasoline demand with respect to the price of bus travel is closest to: A) 0.01. B) 0.08. C) 2.00.

Explanation

B is correct. To calculate the cross price elasticity of the quantity demanded of gasoline with respect to the price of bus travel, we must first calculate the quantity of gas demanded: 300 − 14(1.5) + 2(12) = 303 Question 12.2: The price of milk in a country increases from €1.00 per liter to €1.10 per liter, and the quantity supplied does not change. This suggests the elasticity of the short-run supply of milk in this country is equal to:
A) infinity, and supply is perfectly elastic.
B) zero, and supply is perfectly inelastic.
C) infinity, and supply is perfectly inelastic.
Explanation
B is correct. If quantity supplied does not respond to a change in price, supply is perfectly inelastic. For perfectly inelastic supply, elasticity equals zero.

Question 12.3: Which of the following statements about elasticity is least accurate?
A) Both demand and supply are more elastic in the long run than in the short run.
B) When demand is inelastic, an increase in price will cause a decrease in the total expenditure on a good.
C) When the price of a product increases, consumers will reduce their consumption by a larger amount in the long run than in the short run.
Explanation
B is correct. If demand is inelastic, the percentage change in quantity demanded is smaller than the percentage change in price; quantity demanded is relatively unresponsive to price changes. A price increase increases total expenditures on a good.

LOS 12.c: Distinguish between normal goods and inferior goods.

Question 12.4: An individual sees her income rise from \$80,000 to \$88,000, and along with it, her consumption of Good X has decreased from eight dozen packages per year to six dozen packages per year. Good X should be classified as:
A) a normal good.
B) a Veblen good.
C) an inferior good.
Explanation
C is correct. An inferior good is one that experiences a decline in demand when income rises.
Schweser note
A normal good is one for which the income effect is positive. An inferior good is one for which the income effect is negative.
A Giffen good is an inferior good for which the negative income effect outweighs the positive substitution effect when price falls. A Giffen good is theoretical and would have an upward-sloping demand curve.
A Veblen good is one for which a higher price makes the good more desirable. The idea is
that the consumer gets utility from being seen to consume a good that has high status
(e.g., Gucci bag), and that a higher price for the good conveys more status and increases its
utility.

LOS 12.b: compare substitution and income effects

Question 12.5: With respect to utility theory, the substitution effect for a decrease in the price of a good:
A) will decrease consumption of the good.
B) may increase or decrease consumption of the good.
C) will increase consumption of the good.
Explanation
C is correct. In utility theory, if the price of one good decreases, the substitution effect causes consumption of that good to increase.

Question 12.6: When the price of a good decreases, how do the income effect and the substitution effect change the quantity demanded of the good?
A) Both the income effect and the substitution effect increase the quantity demanded.
B) The income effect increases the quantity consumed, but the substitution effect may increase or decrease the quantity demanded.
C) The substitution effect increases the quantity demanded, but the income effect may increase or decrease the quantity demanded.
Explanation
C is correct. The substitution effect is a shift in consumption toward a larger quantity of a good that decreases in price. A decrease in the price of a good also has an income effect because the old bundle costs less. The income effect may result in consumption of a larger or smaller quantity of the good that has decreased in price, depending on whether it is a normal good or an inferior good.
Schweser note
Based on this analysis, we can describe three possible outcomes of a decrease in the price of
Good X:
1. The substitution effect is positive, and the income effect is also positive—consumption
of Good X will increase.
2. The substitution effect is positive, and the income effect is negative but smaller than
the substitution effect—consumption of Good X will increase.
3. The substitution effect is positive, and the income effect is negative and larger than the
substitution effect—consumption of Good X will decrease.

LOS 12.d: describe the phenomenon of diminishing marginal returns.

Question 12.7: A plant manager observes the following relationship between hours of labor and units of output:
Labor hours         Units of output
1,400                       140,000
1,500                       150,000
1,600                       165,000
1,700                       175,000
1,800                       180,000
1,900                       170,000
At what quantity of labor hours does this plant first experience diminishing marginal returns to labor?
A) Between 1,400 and 1,500 hours.
B) Between 1,600 and 1,700 hours.
C) Between 1,800 and 1,900 hours.
Explanation
Diminishing marginal returns occur when an additional unit of an input will produce a smaller gain in output than the previous unit of the input. In this case, marginal returns are increasing with up to 1,600 hours of labor input and begin decreasing between 1,600 and 1,700 hours of labor input.

Question 12.8: A manufacturing plant exhibits diseconomies of scale if long-run average cost (LRAC) is:
A) decreasing as output increases, and the plant is at its minimum efficient scale if LRAC is at its lowest level.
B) decreasing as output increases, and the plant is at its minimum efficient scale if LRAC is decreasing over the entire range of output
C) increasing as output increases, and the plant is at its minimum efficient scale if LRAC is at its lowest level.
Explanation
C is correct. Diseconomies of scale are present when long-run average cost increases as output increases. The minimum efficient scale is the plant size that produces the quantity of output for which LRAC is at a minimum.

READING 13: THE FIRM AND MARKET STRUCTURE

LOS 13.a: Describe characteristics of perfect competition, monopolistic competition, oligopoly, and pure monopoly.

Question 13.1: Monopolistic competition differs from pure monopoly in that:
A) monopolistic competitors have low barriers to entry and monopolists do not.
B) monopolists maximize profits and monopolistic competitors do not.
C) monopolistic competitors are price takers and monopolists are not
Explanation
A is correct. Another name for monopolistic competition is a competitive price searcher market. Monopolistic competition refers to a large number of independent sellers, each produces a differentiated product, each market has a low barrier to entry, and each producer faces a downward sloping demand curve.
Kaplan schweser note: Question 13.2: A natural monopoly is most likely to exist when:
A) economies of scale are great.
B) average total cost increases as output increases.
C) a single firm owns essentially all of a productive resource.
Explanation
A is correct. A natural monopoly may exist when economies of scale are great. The large economies of scale mean that a single producer results in the lowest production costs.

LOS 13.b: Explain relationships between price, marginal revenue, marginal cost, economic profit, and the elasticity of demand under each market structure & LOS 13.d: Describe and determine the optimal price and output for firms under each market structure.

Question 13.3: To benefit from price discrimination, a monopolist least likely needs to have:
A) a higher-quality product at a premium price and a lower-quality alternative.
B) a way to prevent reselling between types of consumers.
C) two identifiable groups of consumers with different price elasticities of demand for the product.
Explanation
A is correct. Price discrimination involves a single product, not two alternatives. As long as the company faces a downward-sloping demand curve, can identify at least two groups of customers with different price elasticities of demand, and can prevent reselling between groups, the company can profit from price discrimination.
Schweser note: Price discrimination is the practice of charging different consumers different prices for the same product or service. Examples are different prices for airline tickets based on whether a Saturday-night stay is involved (separates business travelers and leisure travelers) and different prices for movie tickets based on age.

LOS 13.e: Explain factors affecting long-run equilibrium under each market structure.

Question 13.4: If the government regulates a natural monopoly and enforces an average cost pricing, what are the effects on output quantity and price compared to an unregulated natural monopoly?
A) Both are lower under average cost pricing.
B) Both are higher under average cost pricing.
C) One is higher and one is lower under average cost pricing.
Explanation
C is correct. Average cost pricing is meant to force a natural monopolist to reduce price to where the firm's average total cost intersects the market demand curve. This results in higher output and a lower price than would prevail for an unregulated natural monopoly.
Schweser note:
Average cost pricing is the most common form of regulation.
This will:
1. Increase output and decrease price.
2. Increase social welfare (allocative efficiency).
3. Ensure the monopolist a normal profit because price = ATC

Los 13.d: Describe and determine the optimal price and output for firms under each market structure.

Question 13.5: Oligopolists have an incentive to cheat on collusive agreements in order to :
A) avoid competitive practices.
B) increase their individual share of the joint profit.
C) restrict output and put upward pressure on price.
Explanation
B is correct. Colluding restricts output and puts upward pressure on price, but cheating actually increases output and ultimately, if enough cheating occurs, puts downward pressure on the price. Colluders cheat to increase their share of the profits

LOS 13.c: Describe a firm’s supply function under each market structure.

Question 13.6: The short-run supply curve for a firm under perfect competition is the firm's:
A) marginal cost curve above average total cost.
B) marginal cost curve above average variable cost.
C) average variable cost curve above marginal revenue.
Explanation
B is correct. The supply curve for a firm under perfect competition is its marginal cost curve above average variable cost. As long as price exceeds AVC, the firm will produce up to the quantity where MC = Price, which is also MR in this case.
Schweser note:
The short-run supply function for a firm under perfect competition is its marginal cost curve
above its average variable cost curve, as described earlier. The short-run market supply curve
is constructed simply by summing the quantities supplied at each price across all firms in the
market. In markets characterized as monopolistic competition, oligopoly, and monopoly, there is no well-defined supply function.

LOS 13.b: Explain relationships between price, marginal revenue, marginal cost, economic profit, and the elasticity of demand under each market structure

Question 13.7: Which of the following most likely describes a loss that consumers suffer under an unregulated monopoly compared to a competitive market?
A) Monopolies produce less goods than a competitive market would.
B) Costs of production are higher with monopolies.
C) Monopolists charge the maximum price.
Explanation
A is correct. A reduction in output and increase in price under monopoly decrease consumer surplus and welfare compared to perfect competition. A natural monopoly may have lower costs than several competitive suppliers. Monopolists charge the profit maximizing price, not the "maximum price."
Schweser note:
Compared to the quantity produced under perfect competition, the quantity produced by a monopolist reduces the sum of consumer and producer surplus by an amount represented by the triangle labeled deadweight loss (DWL). Consumer surplus is educed not only by the decrease in quantity but also by the increase in price relative to perfect competition. Monopoly is considered inefficient because the reduction in output compared to perfect competition reduces the sum of consumer and producer surplus.

LOS 13.f: Describe pricing strategy under each market structure

Question 13.8: Which model of pricing strategy under imperfect competition requires that firms be able to identify groups of customers that have different elasticities of demand?
A) Nash equilibrium.
B) Price discrimination.
C) Kinked demand curve
Explanation
B is correct. For a price discrimination strategy to increase a firm's profits, the firm must face a downward-sloping demand curve, have at least two identifiable groups of customers that have different price elasticities of demand, and be able to prevent these customers from reselling
the product to each other.
Schweser note:
Kinked demand curve: This assumes competitors will match a price decrease but not a
price increase. Firms produce the quantity for which marginal revenue equals marginal
cost. However, the marginal revenue curve is discontinuous (there’s a gap in it), so for
many cost structures the optimal quantity is the same, given they face the same kinked
demand curve

LOS 13.d: Describe and determine the optimal price and output for firms under each market structure.

Question 13.9: Compared to a competitive market result, a single-price monopoly will most likely:
A) adopt a marginal cost pricing strategy, which will decrease consumer surplus.
B) result in a higher price, less consumer surplus, and more producer surplus.
C) result in lower output, deadweight loss, and less producer and consumer surplus.
Explanation
B is correct. A firm in a monopoly position will reduce output to where MC = MR, which will increase price, decrease consumer surplus, and increase producer surplus. A marginal cost pricing strategy refers to regulation which requires a firm to set price equal to marginal cost.

LOS 13.g: Describe the use and limitations of concentration measures in identifying market structure

Question 13.10: An advantage of the Herfindahl-Hirschman Index (HHI) over the N-firm concentration ratio as a summary measure of the market structure of an industry is that the HHI is more sensitive to:
A) mergers.
B) barriers to entry.
C) elasticity of demand.
Explanation
A is correct. The HHI is more sensitive to the effects of mergers compared to the N-firm concentration ratio. Neither measure accounts for elasticity of demand or barriers to entry.
Schweser note:
One limitation of the N-firm concentration ratio is that it may be relatively insensitive to
mergers of two firms with large market shares. This problem is reduced by using an
alternative measure of market concentration, the Herfindahl-Hirschman Index (HHI). The
HHI is calculated as the sum of the squares of the market shares of the largest firms in the
market

LOS 13.h: Identify the type of market structure within which a firm operates.

Question 13.11: A market has the following characteristics: a large number of independent sellers, each producing a differentiated product; low barriers to entry; producers facing downward sloping demand curves; and demand that is highly elastic. This description most closely describes:
A) an oligopoly.
B) pure competition.
C) monopolistic competition.
Explanation
C is correct. These conditions characterize monopolistic competition. By contrast, monopolies and oligopolies have high barriers to entry and involve either a single seller (monopoly) or a small number of interdependent sellers (oligopoly). Similar to monopolistic competition, pure competition involves a large number of independent sellers. With pure competition, products are homogeneous (not differentiated), no barriers to entry exist (not low barriers to entry), and the demand schedule is horizontal (not downward sloping) and perfectly elastic (not highly elastic).