ECO80001 Economics Module 03 (Perfect Competition)

SUGGESTIONS FOR ANSWERING TUTORIAL QUESTIONS FOR MODULE 03

PERFECT COMPETITION & OLIGOPOLY

Note: Questions marked with a [B] are mainly for reviewing “background” and relatively
straightforward material. [E] indicates “extras” questions for deeper learning. The
remaining (unmarked) questions are regarded as “standard”. For assessment, all three
types of questions will be included, but a majority of them will be at the “standard” level.

Answers to Multiple-Choice Questions

1. b 2. d 3. d 4. c
5. d

Suggestions for Answering Short-Answer Questions

1. See table below.

Battlers Pty Ltd

(A perfectly competitive firm)

Quantity Revenue ($) Cost ($) Profit ($)

sold Average Total Marginal Marginal Total Average Average Total Marginal

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
…
10 n.a. n.a.
2,000 10 20,000 20,019.25 10.00963 -0.01 -19.25
10 0.25 9.75
2,001 10 20,010 20,019.50 10.00475 0.00 -9.50
10 0.50 9.50
2,002 10 20,020 20,020.00 10.00000 0.00 0.00
10 1.00 9.00
2,003 10 20,030 20,021.00 9.99551 0.00 9.00
10 1.25 8.75
2,004 10 20,040 20,022.25 9.99114 0.01 17.75

…
10 n.a. n.a.
3,997 10 39,970 35,972.00 8.99975 1.00 3,998.00
10 8.50 1.50
3,998 10 39,980 35,980.50 8.99962 1.00 3,999.50
10 9.51 0.49
3,999 10 39,990 35,990.01 8.99975 1.00 3,999.99
10 9.99 0.01
4,000 10 40,000 36,000.00 9.00000 1.00 4,000.00
10 10.10 -0.10
4,001 10 40,010 36,010.10 9.00027 1.00 3,999.90
10 10.90 -0.90
4,002 10 40,020 36,021.00 9.00075 1.00 3,999.00

…
10 n.a. n.a.
6,000 10 60,000 58,003.00 9.66717 0.33 1,997.00
10 11.50 -1.50
6,001 10 60,010 58,014.50 9.66747 0.33 1,995.50

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ECO80001 Economics Module 03 (Perfect Competition)

a) AR (i.e., the price) is constant, and MR = AR throughout the relevant range.

Both of these suggest that the firm is a price-taker.

b) TR = Q x AR

c) MR = Change in TR

d) MC = Change in TC

e) AC = TC/Q

f) Total profit = TR – TC

g) When MC < AC, AC is falling

When MC > AC, AC is rising

h) When MR > MC, total profit is rising

When MR < MC, total profit is falling

i) Total profit is maximised (= $4,000) when Q = 4,000. In going from Q = 3,999

to Q = 4,000, MR exceeds MC; but going any further will involve MR < MC.

j) Battlers Pty Ltd is making super-normal profit (economic profit). If many other
firms in the industry are also making super-normal profits, potential suppliers will
be encouraged to enter the industry.

Suggestions for Answering Discussion Questions

1. If the firm set a price above the market’s going price, it would not be able to sell any
amount of its product. There are many other sellers, all willing to sell at the going price,
and their products are just as good as that of the firm (indeed, the products of all the firms
in this industry are identical).

2. Draw two appropriate diagrams, one for the industry and the other for the firm
Use the perfect competition model as an approximate description of the banana industry.
Assume that before the cyclone, your plantation was just earning normal profit.
Now analyse the effects of the cyclone, and clearly label these effects on the two
diagrams.
In the national market, the quantity of bananas supplied at any given price will fall, so the
S-curve shifts to the left. Price will rise and quantity traded will fall.
As you are only a small producer, you take the rise in market price as given. This price
rise increases your AR, which is the same as MR for a price-taker. Your output, profit
per unit (AR - AC) and total profit all increase. You now earn super-normal profits, as
shown by the shaded rectangle in the RHS diagram. However, this will be only a
temporary situation.
In the long run, as the weather improves, other plantations will recover, and the industry
S-curve will shift back to the right. P will fall. Output and profit will tend to return to
previous levels. Your plantation will generate just normal profits again.

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ECO80001 Economics Module 03 (Perfect Competition)

3. Looking at the payoff matrix and focusing on self-interest, James would have an incentive
to advertise (i.e. to compete) because that would give him the highest payoff in either

(a) the scenario where Lachlan advertises, or

(b) the scenario where Lachlan does not advertise.

Lachlan would go through the same reasoning process.

Thus if they both focus on self-interest, they will both advertise, thereby making $3
billion each, even though both know that if neither advertises each would make $4 billion.

This predicted outcome is the Nash equilibrium, where each person takes the action that
is in his best interest, given the action of the other person.

Why is it unlikely that James and Lachlan will be able to co-operate, and achieve the
outcome where neither advertises and therefore each makes $4 billion? The main reason
is that each person knows that it is in the other person's interest to “cheat” and advertise,
and so neither will find it easy to trust and rely on the other not to advertise.

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