THE UNIVERSITY OF ZAMBIA

SCHOOL OF HUMANITIES AND SOCIAL SCIENCES

DEPARTMENT OF ECONOMICS

QUIZ 1 29th January, 2017

ECN 9125: INDUSTRIAL ORGANISATION

TIME: 50 Minutes
INSTRUCTIONS:
ANSWER ALL QUESTIONS IN SECTION A
ANSWER ONLY ONE QUESTION IN SECTION B.
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SECTION A: [10 Marks]

Indicate whether the following are TRUE, FALSE or UNCERTIAN, briefly JUSTIFY.
(Any correct Answer without justification will NOT be rewarded)

1. According to the Structural Conduct performance Approach, the market structure

directly determines both firm behavior and market performance. [1 Mark]

FALSE: Market structure only DIRECTLY determines firm behavior

2.The Structural Conduct Performance Paradigm became unpopular solely because of

advancements in Game Theory. [1 Mark]

FALSE: It was ALSO due to reducing existence of evidence to back up the theory.

3. According to the New Industrial Organization Approach, firm behavior directly

determines both market structure and market performance. [1 Mark]
TRUE: Both the market structure and Market performance are DIRECTLY determined
by firm behavior.

4. If a firm has marginal profits of - K50,000 its marginal cost will be greater than the
price it is charging. [1 Mark]

UNCERTAIN: This is TRUE under prefect competition where P = MC, But FALSE
under other market structures where MR = MC but MR ≠ P. If the Market structure is not
given MR = MC and thus, Negative Marginal profits would mean Marginal cost is
greater than Marginal revenue.

5. If the firm demand function is given by P = K500, There will be Pareto optimality in
the market regardless of how much output an individual firm produces. [1 Mark]

TRUE: Only a perfectly competitive firm faces a horizontal demand curve. In which case
Pareto optimality would be achieved regardless of how much one individual firm
produces. Other firms in the market will still produce the optimal output in the market.

6. If John is making zero economic profits after investing K10,000 in a business with a
total revenue of K15,000. Opportunity costs are greater than K5,000. [1 Mark]

FALSE: In this case opportunity cost would be 15,000-10,000 = 5,000, equal and not
GREATER!

7. If the prevailing competitive market price is K120 while the price minimum is K125,
it is advisable to shut-down production in the long-run. [1 Mark]

TRUE: A firm needs to shut-down production in short-run when Price is less than price
minimum, it which case it will also shut-down in the long-run since price is less than
average total cost.

8. Sunk costs are those costs which have already been incurred but cannot be recovered.

[1 Mark]
TRUE: Examples are Rental costs and Mineral Exploration costs when minerals are not
found. Once they have been incurred, they cannot be recovered.

9. Quasi-Rent will be equal to profits if the average avoidable cost (AAC) is equal to the
average total cost (ATC). [1 Mark]

TRUE: Since Quasi-Rents rents = (P - ACC)Q while Profit = ( P - ATC)Q ,

When ACC = ATC, Quasi-Rents will be equal to profits.

10. In a perfectly competitive market, Total surplus is maximized when output is

produced where willingness to pay is equal to marginal revenue. [1 Mark]

FALSE: , Total surplus is maximized when output is produced where willingness to pay
(Demand curve) is equal to MARGINAL COST (Supply curve)

SECTION B: Answer ONLY one Question in this section

Question 1 [15 Marks]
ZESCO is the only supplier of Electricity in Zambia, After a country wide survey, the
sales team found that the market Demand curve is
( )= − and that = = ,
where P(Q) is the price charged for Q units of electricity, ATC is the average total cost
and MC is marginal cost.
(a) Find ZESCO's price and Output [2 Marks]
Output = 19 units of electricity Price = K 105 per/unit
(b) Calculate the Socially optimal Quantity and price [2 Marks]
Output = 38 units of electricity Price = K 10
(c) Find the Deadweight loss attributed to ZESCO pricing [2 Marks]
Deadweight Loss = 0.5 ( ∆P ) ( ∆Q ) = K 902.5
(e) Find the Value of the Consumer Surplus [2 Marks]
Consumer Surplus = 0.5 (200 - 105) 19 = K 902.5
(f) Define and Explain the concept of Pareto Optimality [4 Marks]
A combination is said to be Pareto optimal if there exits not more combinations which are
either PPI or PI. (Explain and give examples)
(g) Explain the difference between Naked and Ancillary Price fixing agreements
[3 Marks]
The objective and effect of Naked agreements is to fix prices so has to restrict
competition while the objective and effect of Ancillary agreements is not to fix prices but
to achieve some other legitimate business objective. (Explanations required)
Question 2 [15 Marks]
(a) What is Market Power? [3 Marks]
A Firm has market power if it finds it PROFITABLE to raise the price above the
marginal cost. (Explanation required)
(b) Explain the two forms of Public Policies aimed at remedying the exercise and
extension of Market Power [4 Marks]
Regulations and Anti-Trust Laws (Explanations required)
Missing Question:
(c) Sate and Explain three limitations of using Total Surplus as a measure of Efficiency
[3 Marks]
1. Consumer surplus is not an accurate monetary measure of consumer welfare-does not
fully capture compensation variations when income effects are large.

2. Total surplus does not take into account or incorporate the gains or losses due to
externalities of trade and production.

3. Total surplus ranked allocations do not analyze the distribution of gains or losses of
trade but only focus on their magnitudes.

(d) Lafarge Zambia is one of the leading Cement suppliers in the country. The Business
development manager, Mr. Alex Dundumwezi , recently conducted a research and got the
following information:

Town Lerner index Marginal Cost Price

Lusaka 0.41176 K 40 K68
Ndola 0.36 K 48 K75
 Chipata 0.2875 K 57 K80

= =

(i) Is Lafarge Zambia acting like a perfectly competitive firm? [1 Mark ]

NO! It is not setting price equal to Marginal cost
(ii) Find the Lerner index for Ndola [2 Marks]
L = ( P - MC) / P = ( 75- 48)/75 = 0.36
(ii) Find the Price charged in Chipata
0.2875 = (P-57) / P , P = K 80 [3 Marks]
(iii) In which town would will find the most responsive consumers of Cement?
[2 Marks]
Lusaka elasticity = 1 / 0.41176 = 2.4286
Ndola elasticity = 1 / 0.36 = 2.7778
Chipata elasticity = 1 / 0.2875 = 3.4782

The Town with the most responsive consumers is Chipata

END
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All the Best
C.B