ECO 101 Problem set 4 spring 2019Directions: Answer all questions...

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ECO 101                Problem set 4                    spring 2019Directions:  Answer all questions completely yet concisely.  I will award credit based on the quality of your explanations. All of your answers must be type written.  I will not accept hand written problem sets.   Graphs may be hand drawn.  1.  Fully explain why a perfectly competitive firm will maximize its profits by producing a level of output where MR = MC.2.  Show graphically and explain how an increase in the technology that augments the fixed factor of production of perfectly competitive firms affects the price, output and profits of a representative firm in both the short-run and in the long-run.3.  Can a profit maximizing firm with monopoly power ever produce at a level of output where there is allocative efficiency?  Explain why or why not.4.  Is the welfare generated by a single-price monopolist greater to, less than, or equal to the welfare generated by a monopolist that practices 1st degree price discrimination?5.  2 firms, A and B, face the choice of advertising or not advertising their product.  The game theory payoff matrix that they face is shown below.   Find any Nash equiliia that exist in this game.

Dr. Smita · Accepted Answer

Micro Economics
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Micro Economics		[Type the document subtitle]		[Pick the date]		Student Name	
1.  Fully explain why a perfectly competitive firm will maximize its profits by producing a level of output where MR = MC.
Solution: 
The markets under perfect competition work on the principle of productive efficiency and allocative efficiency. This implies that the firms operating under perfectly competitive markets will optimize production at a point where marginal revenue equates marginal cost.
Productive efficiency refers to the allocation of resources in such a way that the economy cannot produce any more of one good without sacrificing the production of another good. This means that productive efficiency occurs when a good or service is produced at the lowest possible cost.
Producer’s equilibrium is often explained in terms of marginal revenue (MR) and marginal cost (MC) of production. Profit is maximized (or a producer strikes his equilibrium) when two conditions are satisfied – 
(i) MR = MC
(ii) MC is rising 
(iii) When Marginal Cost  Marginal Revenue, then for each extra unit produced, the cost will be higher than revenue so that you will create less.
Thus, optimal quantity produced should be at MC = MR
Any deviation from this point would either cause losses or will have a scope for more profits. Perfectly competitive firms will always operate on the marginal principle where marginal costs equal marginal revenues.
2.  Show graphically and explain how an increase in the technology that augments the fixed factor of production of perfectly competitive firms affects the price, output, and profits of a representative firm in both the short-run and in the long-run.
Solution:
Perfect competition is characterized by the presence of a large number of buyers and a large number of sellers in the market. The buyer possesses complete knowledge about the products and the products sold in the market are of homogeneous nature.
  
Technological Change
· Technological improvements lower the average cost of production.
· Most technological improvements cannot be implemented without investment in new plant and equipment.
· This means it takes time for a technological advance to spread through an industry.
· Hence, the short run would 
Technological Change and Equilibrium Price
· A technological improvement that affects all firms will shift the industry supply curve down and to the right.
· This lowers equilibrium price and raises output.
Technological Change and Equilibrium Profit
· Implementing a technological improvement causes the marginal cost curve for each firm to shift.
· Economic profits may not be affected in the long run.
· In the long run, the firms that survive will be those that adopted the new technology early.
Hence, it can be stated that any technological improvements that augment the fixed factors of production will lower the cost of production, specifically the average fixed cost. A lower fixed cost in the short run would be like an invitation to the new firms to enter the market. But investment in fixed factors of production would take time and such adjustments would not be made that easily. In the long run investments in a fixed factor of production would bring in incentives and there would be new firms entering the markets. New firms and augmented productive capacities would lower the price and finally, the equilibrium will be reached at a high production and lower prices.
3.  Can a profit-maximizing firm with monopoly power ever produce at a level of output where there is allocative efficiency?  Explain why or why not.
Solution:
Monopoly power refers to the exclusive control on the market due to which the firm can exploit consumers.
Firms operating with Monopolistic powers maximize their profit levels at a point when they produce at a level where its marginal costs equal its marginal revenues. But, the individual firm’s demand curve is downward sloping, reflecting market power, the price these firms will charge will exceed their marginal costs. Due to how products are priced in this market, consumer surplus is not attained. The market suffers from deadweight loss. The suppliers in this market will also have excess production capacity. 
Deadweight loss and loss of consumer surplus is the characteristic feature of monopoly firms. Therefore, they are regarded as an inefficient market structure and is known to exploit consumers.
4.  Is the welfare generated by a single-price monopolist greater to, less than, or equal to the welfare generated by a monopolist that practices 1st-degree price discrimination?
Solution:
Price Discrimination is the practice of charging different prices for different quantities of units sold.
First-degree price discrimination, alternatively known as perfect price discrimination, occurs when a firm charges a different price for every unit consumed.
The firm is able to charge the maximum possible price for each unit which enables the firm to capture all available consumer surpluses for it.
A single price monopoly is a firm that sells the goods at a single price to all consumers
Under the first-degree price discrimination model, at each unit sold monopolist eats up the consumer surplus leaving no room for consumer welfare whereas the single price monopolist is characterized by reducing consumer welfare and creating deadweight losses, but the degree of exploitation is less than that of price discriminatory monopolist.
5.  2 firms, A and B, face the choice of advertising or not advertising their product.  The game theory payoff matrix that they face is shown below.   Find any Nash equilibria that exist in this game.  
Solution:  Nash equilibrium is a stable state of equilibrium that involves several participants and no participant can gain by the change of strategy till the time other players continue with the same strategy. It determines the optimal solution in a noncooperative game in which each player lacks the incentive to change their initial strategy.
In the above example, Nash equilibrium exists at the point where both firm A and firm B decides to advertise and enjoy gains from advertising. Though the gains enjoyed by firm A are more than from B, it is profitable to advertise.
Initially, when both the firms do not advertise, A is selling 10 units and B is selling 2 units. If only A advertises it is able to sell 15 units and B sells 0 units. If only B advertises it sells 8 units and A sells 6 units. Hence, both firm A and B will advertise.
REFERENCES:
1. Koutsoyiannis, A. (1979). Monopoly. 10.1007/978-1-349-16077-8_6.
2. Markham, J.W.. (1965). Market Structure, Business Conduct, and Innovation. American Economic Review. 55. 323-332.
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ECO 101 Problem set 4 spring 2019 Directions: Answer all questions completely yet concisely. I will award credit based on the quality of your explanations. All of your answers must be type written. I...

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