CHAPTER 11PERFORMANCE AND STRATEGY IN COMPETITIVE MARKETS

MULTIPLE CHOICE
1. In competitive market equilibrium, social welfare is measured by:
a. the difference of net benefits derived by consumers and producers.
b. the sum of net benefits derived by consumers and producers.
c. net benefits derived by consumers.
d. net benefits derived by producers.

2. No externalities exist when:

a. private costs exceed social costs.
b. private costs and benefits equal social costs and benefits.
c. private benefits are less than social benefits.
d. private benefits exceed social benefits.

3. A government policy that addresses market failures caused by positive externalities is:
a. patent grants.
b. subsidies for pollution reduction.
c. tax policy.
d. the establishment of operating controls.

4. The burden of a per unit tax on a product will fall primarily on producers when:
a. the tax is collected from customers.
b. demand is highly elastic with respect to price.
c. demand is highly inelastic with respect to price.
d. the tax is collected from producers.

5. A per unit tax will cause output prices to increase least when:
a. marginal cost is constant.
b. marginal cost is falling.
c. average cost is falling.
d. marginal cost is rising.

6. Failure by market structure can occur when:

a. joint products are produced in variable proportions.
b. joint products are produced in fixed proportions.
c. externalities exist.
d. few buyers or sellers are present.

7. In competitive markets:
a. high-wage workers tend to be those that are most productive.
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b. companies earn excess profits by better serving customer needs.

c. fairness is sacrificed in the interest of efficiency.
d. firms dictate the quantity and quality of goods and services provided.

8. Consumer sovereignty reflects:

a. buyer power.
b. failure by market structure.
c. failure by incentive.
d. externalities.

9. Competition in the cable television service industry is furnished by:

a. imports.
b. potential entrants.
c. large numbers of providers in local markets.
d. government regulation.

10. Producer surplus is the:

a. amount paid to sellers above and beyond the value received by consumers.
b. amount paid to sellers above and beyond the required minimum.
c. amount paid to sellers.
d. cost of production.

11. The welfare loss triangle depicts:

a. deadweight losses suffered by consumers.
b. deadweight losses suffered by producers.
c. deadweight losses suffered by consumers and producers.
d. lost profits.

12. Profits stemming from market power reflect:

a. high prices.
b. superior efficiency.
c. exceptional capability.
d. rapid industry growth.

13. Failure by market structure is caused by:

a. positive spillover effects.
b. positive externalities.
c. negative externalities.
d. none of these.

14. Externalities are:

a. differences between social costs and social benefits.
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b. differences between social benefits and private benefits.

c. social costs.
d. social benefits.

15. Undue market power is indicated when buyer influence results in:
a. higher than competitive prices.
b. less than competitive output.
c. less than competitive costs.
d. excess profits.

16. Utility price and profit regulation is designed to address:

a. failure by incentive.
b. failure by market structure.
c. positive externalities.
d. negative externalities.

17. A per unit tax on pollution:

a. results in deadweight loss.
b. raises private benefits.
c. lowers social benefits.
d. lowers private costs.

18. From an economic perspective, imposition of a per unit tax is only advantageous if:
a. the social benefits derived from added tax revenues are sufficient to overcome the social
costs at a risk-adjusted rate of return..
b. the social benefits derived from added tax revenues are sufficient to overcome the private
costs at a risk-adjusted rate of return..
c. the benefits derived from added tax revenues are sufficient to overcome the economic
costs tied to the deadweight loss in social welfare.
d. positive tax revenues are generated.

19. Society's right to a clean environment is asserted through:

a. fines.
b. tradeable emission permits.
c. subsidy policy.
d. price and profit regulation.

20. Who pays the economic cost of a tax is answered at the point of tax:
a. burden.
b. assessment.
c. collection.
d. incidence.

Presented by Suong Jian & Liu Yan, MGMT Panel , Guangdong University of Finance.
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21. The costs of pollution taxes are shared by consumers and producers when:
a. supply is perfectly elastic.
b. supply is perfectly inelastic.
c. demand is perfectly inelastic.
d. none of the above.

22. A price ceiling is a costly and seldom used mechanism for:

a. restraining excess supply.
b. restraining excess demand.
c. counteracting the effects of falling productivity.
d. counteracting the effects of rising productivity.

23. A price floor is a costly and commonly used mechanism for:

a. restraining excess supply.
b. restraining excess demand.
c. counteracting the effects of falling productivity.
d. counteracting the effects of rising productivity.

24. Economic rents are profits due to:

a. luck.
b. uniquely productive inputs
c. monopoly power.
d. regulation.

25. Above-normal returns earned in the time interval that exists between when a favorable influence on
industry demand or cost conditions first transpires and the time when competitor entry or growth
finally develops are called:
a. disequilibrium profits.
b. a normal rate of return on investment.
c. disequilibrium losses.
d. economic rents.

PROBLEM
1. Social Welfare Concepts. Indicate whether each of the following statements is true or false, and
explain why.
A. Producer surplus tends to fall as the supply curve becomes more elastic.
B.

Consumer surplus tends to rise as demand becomes more elastic.

C.

The market demand curve indicates the minimum price buyers are willing to pay at each
level of production.
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D. The market supply curve indicates the minimum price required by sellers as a group to bring
forth production.
E.

Consumer surplus is the amount that consumers are willing to pay for a given good or
service above and beyond the amount actually paid.

2. Competitive Market Equilibrium. Suppose demand and supply conditions in the competitive market
for unskilled labor are as follows:
QD = 66.25 - 5P

(Demand)

QS = -27.5 + 10P

(Supply)

where Q is millions of hours of unskilled labor and P is the wage rate per hour.
A. Calculate the industry equilibrium wage/employment combination.
B.

Confirm your answer graphically.

3. Competitive Market Equilibrium. Assume demand and supply conditions in the competitive market
for unskilled labor are as follows:
P = $15 - 0.3QD

(Demand)

P = $0.2QS

(Supply)

where Q is millions of hours of unskilled labor and P is the wage rate per hour.
A. Illustrate the industry equilibrium wage/employment combination both graphically and
algebraically.
B.

Calculate the level of excess supply (unemployment) if the Federal minimum wage is raised
from $5.15 to $6 per hour.

4. Competitive Market Surplus. Suppose demand and supply conditions in the competitive market for
unskilled labor are as follows:
P = $15 - 0.3QD

(Demand)

P = $3 + $0.1QS

(Supply)

where Q is millions of hours of unskilled labor and P is the wage rate per hour.
A. Illustrate the industry equilibrium wage/employment combination both graphically and
algebraically.
B.

Calculate the level of excess supply (unemployment) if the Federal minimum wage is raised
Presented by Suong Jian & Liu Yan, MGMT Panel , Guangdong University of Finance.
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from $5.15 to $7 per hour.

5. Competitive Market Surplus. Assume demand and supply conditions in the competitive market for
unskilled labor are as follows:
QD = 66.25 - 5P

(Demand)

QS = -27.5 + 10P

(Supply)

where Q is millions of hours of unskilled labor and P is the wage rate per hour.
A. Illustrate the industry equilibrium price/output combination both graphically and
algebraically.
B.

How many low-wage workers will get laid off if the Federal minimum wage is raised from
$5.15 to $7.25 per hour?

6. Per Unit Tax and Elastic Demand. Assume that the supply of tickets to an outdoor music festival in
Thousand Oaks, California, is a function of price such that:
QS = 1P

(Supply)

where Q is the number of tickets (in thousands) and P is the ticket price. Also assume that the demand
for such concert tickets is perfectly elastic at a price of $30. This means that the ticket demand curve
can be drawn as a horizontal line that passes through $30 on the Y-axis.
A. Graph the ticket demand and supply curves using the price of tickets as a function of
quantity (Q). On this same graph, draw another ticket supply curve based upon the
assumption that a local municipality imposes a $5 tax on each ticket sold to pay for police
protection and clean-up costs.
B.

Calculate the ticket price and quantity effects of the municipal tax. With perfectly elastic
demand, who pays the economic burden of such a tax?

7. Percentage Tariff and Elastic Demand. Assume that the supply of imported personal computers
(PCs) from China is given by the expression:
QS = 0.03125P

(Supply)

where Q is the number of PCs sold (in thousands) and P is the PC price. Given the availability of PCs
on the Internet, assume that the demand for PCs is perfectly elastic at a price of $800. This means that
the PC demand curve can be drawn as a horizontal line that passes through $800 on the Y-axis.
A. Graph the PC demand and supply curves using price as a function of quantity (Q). On this
same graph, draw another supply curve based upon the assumption imports form China are
subject to an 25% import tariff (tax) that is not imposed on imports from other countries.
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B.

Calculate the PC price and quantity effects of the 25% import tariff. With perfectly elastic
demand, who pays the economic burden of such a tax?

8. Sales Tax and Elastic Demand. Assume that the supply of a best-selling book at local book stores
throughout the United States is a function price such that:
QS = -50 + 5P

(Supply)

where Q is the number of books sold (in thousands) and P is the book price. Given the availability of
this book on amazon.com for $20, demand is perfectly elastic at a price of $20.
A. Derive the book supply curve where price is expressed as a function of output. Calculate the
equilibrium level of output and local bookstore sales revenue.
B.

Derive a second book supply curve based upon the assumption local sales are subject to an
8% sales tax that is not imposed on Internet sales. Calculate the book price and quantity
effects of the local 8% sales tax. With perfectly elastic demand, who pays the economic
burden of such a tax?

9. Recycling Fee and Elastic Demand. Assume that the weekly supply of 16-ounce bottles of soda at
convenience stores in the Twin Cities of Minneapolis and St. Paul is a function of price such that:
QS = -20 + 80P

(Supply)

where Q is the number of sodas sold in convenience stores (in thousands) and P is the soda price.
Assume demand is perfectly elastic at a price of $1.
A. Derive the soda supply curve where price is expressed as a function of output. Calculate the
equilibrium level of output and convenience store sales revenue.
B.

Derive a second curve based upon the assumption convenience store sales become subject to
a 5 cent recycling fee. Calculate the price and quantity effects of the recycling fee. With
perfectly elastic demand, who pays the economic burden of such a fee

10. Franchise Tax and Inelastic Demand. Assume the supply of broadband services in the City of
Williamsburg can be described as:
QS = 1P

(Supply)

where Q is thousands of homes served per month with broadband service, and P is the price per month.
Also assume that broadband service demand is perfectly inelastic at a quantity of 30(000). This means
that the broadband demand curve can be drawn as a vertical line that passes through 30(000) on the
X-axis.
A. Graph the broadband demand and supply curves using price as a function of the quantity of
service demanded (Q). On this same graph, draw another supply curve based upon the
assumption that the City of Williamsburg imposes a franchise tax that increases provider
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costs by $5 per customer every month.

B.

Calculate the price and output effects of the City of Williamsburg franchise tax. With
perfectly inelastic elastic demand, who pays the costs of this tax?

11. Franchise Tax and Inelastic Demand. Assume the supply of sewer and water services in the City of
Portland can be described as:
QS = -20 + 0.5P

(Supply)

where Q is thousands of homes served per month with sewer and water service, and P is the price per
month. Also assume that sewer and water service demand is perfectly inelastic at a quantity of 25(000).
This means that the sewer and water demand curve can be drawn as a vertical line that passes through
25(000) on the X-axis.
A. Graph the sewer and water demand and supply curves using price as a function of the
quantity of service demanded (Q). On this same graph, draw another supply curve based
upon the assumption that the City of Portland imposes a franchise tax that increases provider
costs by $10 per customer every month.
B.

Calculate the price and output effects of the City of Portland franchise tax. With perfectly
inelastic demand, who pays the costs of this tax?

12. Franchise Tax and Inelastic Demand. Assume the supply of sewer and water services in the City of
Greenville, North Carolina, can be described as:
QS = -150 + 2P

(Supply)

where Q is thousands of homes served per month with sewer and water service, and P is the price per
month. Also assume that sewer and water service demand is perfectly inelastic at a quantity of
50(000).
A. Derive the sewer and water service supply curve where price is expressed as a function of
output. Calculate the equilibrium level of output and sewer and water utility sales revenue.
B.

Derive a second sewer and water service supply curve based upon the assumption that every
month the City of Greenville imposes a $25 per customer franchise tax. Calculate the
equilibrium level of output and sewer and water utility sales revenue with the tax. With
perfectly inelastic demand, who pays the economic burden of such a tax?

13. Percentage Tax and Inelastic Demand. Assume the supply of cable TV services in the City of San
Marcos, Texas, can be described as:
QS = -5 + 0.5P

(Supply)

where Q is thousands of homes served per month with cable TV service, and P is the price per month.
Also assume that cable TV service demand is perfectly inelastic at a quantity of 25(000).
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A. Derive the cable TV service supply curve where price is expressed as a function of output.
Calculate the equilibrium level of output and cable TV utility sales revenue.
B.

Derive a second cable TV service supply curve based upon the assumption that every month
the City of San Marcos imposes a 25% of revenues franchise tax on the local cable TV
company. Calculate the equilibrium level of output and cable TV sales revenue with the tax.
With perfectly inelastic demand, who pays the economic burden of such a tax?

14. Regulation Costs. Kingston Components, Inc., produces electronic components for cable TV systems.
Given vigorous import competition, prices are stable at $4,500 per unit in this dynamic and very
competitive market. Kingston's annual total cost (TC) and marginal cost (MC) relations are:
TC = $7,000,000 + $500Q + $0.5Q2
MC = TC/Q = $500 + $1Q
where Q is output.
Suppose the Occupational Health and Safety Administration (OSHA) has recently ruled that the
company must install expensive new shielding equipment to guard against worker injuries. This will
increase the marginal cost of manufacturing by $100 per unit. Kingston's fixed expenses, which
include a required return on investment, will be unaffected.
A. Calculate Kingston's profit-maximizing price/output combination and economic profits
before installation of the OSHA-mandated shielding equipment.
B.

Calculate the profit-maximizing price/output combination and economic profits after

Kingston has met OSHA guidelines.

C.

Compare your answers to parts A and B. Who pays the economic burden of meeting OSHA
guidelines?

15. Compulsory Benefit Costs. Columbia Federal Savings & Loan, Inc. offers low-cost home mortgage
refinancing services on the Internet. Each refinancing brings the company $250 in fees, and these fees
are stable given the competitive nature of Internet marketing. Columbia's relies upon independent
contractors (sales associates) who work on a commission-only basis. Weekly total cost (TC) and
marginal cost (MC) relations are:
TC = $200,000 + $50Q + $0.05Q2
MC = TC/Q = $50 + $0.1Q
where Q is thousands of refinancing applications processed.
Suppose the US Department of Labor recently ruled that Columbia's sales associates must be
considered employees entitled to benefits under the Employee Retirement Income Security Act
(ERISA). As a result, Columbia's marginal cost of doing business will rise by $25 per unit. Columbia's
fixed expenses, which include a required return on investment, will be unaffected.
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A. Calculate Columbia's profit-maximizing price/output combination and economic profits

before meeting DOL guidelines.
B.

Calculate the profit-maximizing price/output combination and economic profits after

Columbia has met DOL guidelines.

C.

Compare your answers to parts A and B. Who pays the economic burden of meeting DOL
guidelines?

16. Compulsory Benefit Costs. The Telemarketing Louisianan Company generates leads for a major
credit card company using over-the-phone solicitations. Each lead generated brings TLC $10 in fees,
and these fees are stable given the competitive nature of the telemarketing business. TLC's relies upon
independent contractors (sales associates) who work on a commission-only basis. Weekly total cost
(TC) and marginal cost (MC) relations are:
TC = $50,000 + $0.0005Q2
MC = TC/Q = $0.001Q
where Q is thousands of refinancing applications processed.
Suppose the US Department of Labor recently ruled that TLC's sales associates must be considered
employees entitled to benefits under the Employee Retirement Income Security Act (ERISA). As a
result, TLC's marginal cost of doing business will rise by $1 per unit. TLC's fixed expenses, which
include a required return on investment, will be unaffected.
A. Calculate TLC's profit-maximizing price/output combination and economic profits before
meeting DOL guidelines.
B.

Calculate the profit-maximizing price/output combination and economic profits after TLC
has met DOL guidelines.

C.

Compare your answers to parts A and B. Who pays the economic burden of meeting DOL
guidelines?

17. Tariffs. The Manchester Shoe Corporation is an importer and distributor of foreign-made footwear
that is sold at popular prices in leading discount retailers. The U.S. Commerce Department recently
informed the company that it will be subject to a new 25% tariff on the import cost of rubberized
footwear originating from China. The company is concerned that the tariff will slow its sales growth,
given the highly competitive nature of the footwear market where wholesale prices are stable at $5 per
unit. Relevant total cost (TC) and marginal cost (MC) relations for this product are:
TC = $100,000 + $0.00005Q2
MC = TC/Q = $0.0001Q
A. Calculate the optimal price/output combination and economic profit prior to imposition of
the tariff.
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B.

Calculate the optimal price/output combination and economic profit after imposition of the
tariff.

C.

Compare your answers to Parts A and B. Who pays the economic burden of the import
tariff?

18. Outsourcing Tariffs. The Seattle Software Company develops, manufactures, licenses, and supports a
wide range of software products. Its software products include operating systems for servers, personal
computers (PC), and intelligent devices; and server applications for distributed computing
environments. To cut costs, the company has begun to outsource to various Asian markets a significant
amount of code checking and software verification. The global code checking and software
verification service market is fiercely price competitive with prices stable at $25 per hour for services
provided by trained and experienced software engineers. Relevant total cost (TC) and marginal cost
(MC) relations for a typical foreign supplier of code checking and software verification services (Q)
are:
TC = $1,500,000 + $0.00005Q2
MC = TC/Q = $0.0001Q
A. Calculate the optimal price/output combination and economic profit for a typical foreign
supplier prior to imposition of the tariff.
B.

Calculate the optimal price/output combination and economic profit for a typical foreign
supplier after imposition of the tariff.

C.

Compare your answers to parts A and B. Who pays the economic burden of the import
tariff?

19. Price Floors and Consumer Surplus. The U. S. wheat crop averages about 2 billion bushels per year,
and is about 10 percent of the 20 billion-bushel foreign wheat crop. Typically, the market has a
relatively good estimate of the wheat crop from the United States and Canada, but wheat crops from
the Southern Hemisphere are much harder to predict. Argentina's wheat acreage varies dramatically
from one year to another, for example, and Australia has hard-to-predict rainfall in key wheat
production areas. To illustrate some of the cost in social welfare from agricultural price supports,
assume the following market supply and demand conditions for wheat:
P = $2 + 0.001QS

(Market Supply)

P = $4,80 - $0.0004QD

(Market Demand)

where Q is output in bushels of wheat (in millions), and P is the market price per bushel.
A. Graph and calculate the equilibrium price/output solution.
B.

Use this graph to help you algebraically determine the loss in consumer surplus due
imposition of a $4.40 per bushel price support program. Explain.

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20. Price Floors and Producer Surplus. The U. S. wheat crop averages about 2 billion bushels per year,
and is about 10 percent of the 20 billion-bushel foreign wheat crop. Typically, the market has a
relatively good estimate of the wheat crop from the United States and Canada, but wheat crops from
the Southern Hemisphere are much harder to predict. Argentina's wheat acreage varies dramatically
from one year to another, for example, and Australia has hard-to-predict rainfall in key wheat
production areas. To illustrate some of the cost in social welfare from agricultural price supports,
assume the following market supply and demand conditions for wheat:
QS = -2,000+ 1,000P

(Market Supply)

QD = 12,000 - 2,500P

(Market Demand)

where Q is output in bushels of wheat (in millions), and P is the market price per bushel.
A. Graph and calculate the equilibrium price/output solution. Use this graph to help you
algebraically determine the amount of surplus production the government will be forced to
buy if it imposes a support price of $4.40 per bushel.
B.

Use this graph to help you algebraically determine the gain in producer surplus due to the
price support program. Explain.

21. Regulation Costs. Finlandia, Inc., manufacturers molded plastic products used to improve industrial
productivity. Suppose the Occupation Health and Safety Administration (OSHA) has required the firm
to enhance the durability of its popular safety helmet at a cost of $10 per unit. Prior to these costs,
Finlandia's annual manufacturing costs of this item are:
TC = $225,000 + $20Q + $0.001Q2
MC = TC/Q = $20 + $0.002Q
where Q is units produced per year and TC includes a normal rate of return on investment.
A. Calculate Finlandia's profit at the profit-maximizing activity level if prices in the industry
are stable at $50 per unit, and therefore P = MR = $50.
B.

Calculate Finlandia's optimal price, output, and profit levels if the OSHA mandated cost
increase can be fully passed onto customers.

C.

Determine the effect on output and profit if Finlandia is not able to pass onto consumers any
of the projected cost increase, and must instead absorb it.

22. Regulation Costs. Ottawa Construction, Ltd., is a medium-sized housing contractor located in eastern
Ontario. The company is adversely affected by new local regulations requiring it to pay $10,000 to
cover sewer and water hook-up charges for each new apartment Ottawa builds. Before such expenses,
Ottawa's construction costs are described as:
TC = $100,000 + $50,000Q + $2,500Q2

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MC = TC/Q = $50,000 + $5,000Q

where Q is the number of apartment units built per year and TC includes a normal rate of return on
investment.
A. Calculate Ottawa's profit at the profit-maximizing activity level if prices in the industry are
stable at $100,000 per unit, and therefore P = MR = $100,000.
B.

Calculate Ottawa's optimal price, output, and profit levels if the new regulation-induced cost
increase can be fully passed onto customers.

C.

Determine the effect on output and profit if Ottawa is not able to pass onto consumers any of
the projected cost increase.

23. Costs of Regulation. The Appalachian Coal Company sells coal to electric utilities in the southeast.
Unfortunately, Appalachian's coal has high particulate content and, therefore, the company is
adversely affected by state and local regulations governing smoke and dust emissions at its customer's
electricity-generating plants. Appalachian's total cost and marginal cost relations are:
TC = $250,000 + $5Q + $0.0002Q2
MC = TC/Q = $5 + $0.0004Q
where Q is tons of coal produced per month and TC includes a normal rate of return on investment.
A. Calculate Appalachian's profit at the profit-maximizing activity level if prices in the industry
are stable at $25 per ton, and therefore P = MR = $25.
B.

Calculate Appalachian's optimal price, output, and profit levels if a new state regulation
results in a $300,000 fixed cost increase that cannot be passed onto customers.

24. Competitive Strategy. Carry Underwood runs Tax Preparation Services, Inc., a small firm that offers
timely tax preparation services in Oklahoma City. Given the large number of competitors, the fact that
tax preparers rely heavily upon standard tax-preparation software, and the lack of entry barriers, it is
reasonable to assume that the tax form preparation market is perfectly competitive and that the average
$150 price equals marginal revenue, P = MR = $150. Assume that TPS's annual operating expenses are
typical of several such firms operating in the local market, and can be expressed by the following total
and marginal cost functions:
TC = $830,000 + $10Q + $0.005Q2
MC = $10 + $0.01Q
where TC is total cost per year, MC is marginal cost, and Q is the number of clients served. Total costs
include a normal profit and allow for Underwood's employment opportunity costs.
A. Calculate TPS's profit-maximizing output level.
B.

Calculate TPS's economic profits at this activity level. Is this activity level sustainable in the
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long run?

25. Competitive Strategy. Bob Ice owns and operates Bob's Music Center, Ltd., a small firm that offers
music lessons in Huntsville, Alabama. Given the large number of competitors and the lack of entry
barriers, it is reasonable to assume that the market for music lessons is perfectly competitive and that
the average $60 per hour price equals marginal revenue, P = MR = $60. Assume that Bob's annual
operating expenses are typical of several such firms and individuals operating in the local market, and
can be expressed by the following total and marginal cost functions:
TC = $100,000 + $10Q + $0.005Q2
MC = $10 + $0.01Q
where TC is total cost per year, MC is marginal cost, and Q is the number lessons given. Total costs
include a normal profit and allow for Bob's employment opportunity costs.
A. Calculate Bob's profit-maximizing output level.
B.

Calculate Bob's economic profits at this activity level. Is this activity level sustainable in the
long run?

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