ECW1101

Tutorial 11
Perfect Competition & Monopoly

Question 1

The Infinity Warm Sdn. Bhd., faces costs of production as follows:

Q TFC TVC

0 $100 $0

1 100 50

2 100 70

3 100 90

4 100 140

5 100 200

6 100 360

a) Calculate the company’s average fixed cost, average variable cost, average total cost,
and marginal cost at each level of production.

b) The price of a unit of production is $50. Vaguely remember his introductory economics
course, the chief financial officer tells the CEO it is better to produce 1 unit of product,
because marginal revenue equals marginal cost at that quantity. What is the firm’s
profit/loss at that level of production? Was this the best decision? Explain.

c) Seeing that he can’t make a profit, the chief executive officer (CEO) decides to shut
down operations. What is the firm’s profit/loss? Was this a wise decision? Explain.

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Question 2

(a) Amy owns a photo developing shop. She also does contract photography. If she takes on a
contract, she cannot develop photos in that time and her customers go to her competitors.
Suppose Amy rejects a contract to photograph a wedding. This would have been a five-
hour job and Amy charges $500 per hour. She spent those five hours developing photos.
Her chemicals and paper cost $1250. She earned $3500 in sales.

(i) What is Amy’s accounting profit from development photos?

(ii) What is Amy’s economic profit from development photos?

(iii) Based on your answers in (i) and (ii), is it a wise decision for her to reject the
contract to photograph a wedding? Explain your answer.

(b) Ahmad’s business is a profit-maximising, perfectly competitive firm. He mows lawns for
$20 each. His total cost each day is $220, of which $40 is a fixed cost. He mows 10 lawns a
day. What can you say about Ahmad’s short-run decision regarding shutdown and his long-
run decision regarding exit?

(i) What is Ahmad’s profit/loss per day if he shuts down?

(ii) What is Ahmad’s profit/loss per day if he does not shut down?

(iii) What can you say about Ahmad’s short-run decision regarding shutdown? Explain
your answer.

(iv) What is his long-run decision regarding exit?

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Question 3

DC firm operates in an industry that is perfectly competitive and is currently in the long-run
equilibrium.

(a) Draw a diagram to illustrate the long-run equilibrium in the market.

(b) Draw a diagram to show DC firm’s price and marginal cost and average total cost.
Note: diagram for (a) and (b) should be linked
(c) What is DC firm’s profit in long-run equilibrium? Fully explain your answer.
Suppose a change in government policy leads to a sudden drop in the market demand.

(d) In the short run, what will happen to the price? How will “DC” respond to this change over
the short term and in the longer term?
(e) What changes will occur in the industry in the longer term? What is the long-run change in
price due to the government policy?

Question 4

The Table below shows the total demand for cable TV subscriptions for a monopoly. Assume
that the monopolist incurs an annual fixed cost of $100,000 and that the marginal cost of
providing an additional subscription is always $100.

Quantity Price (per year)

0 $400
2,000 $350
4,000 $300
6,000 $250
8,000 $200
10,000 $150
12,000 $100
14,000 $50
16,000 $0

What is the profit maximising level of quantity and price? What is the profit at this level of
output? Explain your answers using the concept of marginal revenue and marginal cost.

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Question 5

(a)Graphically
depict the deadweight loss caused by a monopoly. How is this similar to the
deadweight loss from taxation?

(b)One solution to the problems of marginal-cost pricing of a regulated natural monopolist is

average cost pricing. In this model, the monopolist is allowed to price its production at
average total cost. How does average-cost pricing differ from marginal-cost pricing? Does
this solution maximize social well-being?

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