Market Structures, Costs and Revenue: practice questions

Question 1

A market for a standard grade of raw cotton is often treated as a real-world approximation to the theoretical model of perfect competition, since there are many small growers, an identical product, and freedom of entry and exit for new producers.

In the long-run equilibrium of a perfectly competitive market such as this, which outcome is correct?

Accepted Answer

B

Question 2

Hearthside Furniture makes bespoke wooden garden benches in a single workshop with a fixed number of woodworking machines. In the short run, only the number of workers it employs can vary. Total fixed cost is $60 per week. The table shows total variable cost (TVC) at different w…

Accepted Answer

((a)) Marginal cost of the 4th bench =124-108=16 (i.e. $16) and marginal cost of the 5th bench =150-124=26 (i.e. $26)  ((b)) Average cost at 3 benches =108÷3=36 (i.e. $36) and average cost at 6 benches =186÷6=31 (i.e. $31)  ((c)) Marginal cost is lowest at an output of 3 benches per week ($12); beyond this output, each additional worker adds less extra output than the last (diminishing marginal returns to the fixed workshop and machines), so each extra bench needs more extra variable cost to produce, pus…  ((d)) Average cost is lowest at an output of 5 benches per week ($30); average cost keeps falling as long as marginal cost is below it, and only starts rising once marginal cost has risen above it, which happens between 5 and 6 benches in this table

Question 3

EconoSoft is the only firm producing a specialised accounting app licensed to small businesses in a particular country, so, unlike a firm in perfect competition, it faces the whole downward-sloping market demand for the app rather than a single price fixed by the market. Its fix…

Accepted Answer

((a)) TR = 100, 180, 240, 280, 300, 300 (for Q = 1 to 6) and MR = 100, 80, 60, 40, 20, 0  ((b)) MC = 20, 30, 35, 40, 70, 110 (for Q = 1 to 6)  ((c)) The profit-maximising output is 4 licences per month, where MC = MR = $40; profit at this output = TR - TC =280-175=105, i.e. $105  ((d)) EconoSoft faces the entire downward-sloping market demand curve, so to sell one more licence it must lower the price on all units sold, not just the extra one, making marginal revenue less than price at every output beyond the first unit; a perfectly competitive firm's output is…

Question 4

BrightBake is a bakery business deciding how large a plant to build. The table shows its estimated long-run average cost (LRAC) of production at different possible plant sizes, measured by monthly output. Monthly output (thousand loaves) 10 20 30 40 50 60 LRAC ($ per loaf) 0.25…

Accepted Answer

((a)) BrightBake experiences economies of scale as output rises from 10,000 to 30,000 loaves per month, since LRAC keeps falling over this range; it experiences diseconomies of scale as output rises from 40,000 to 60,000 loaves per month, since LRAC rises over this range  ((b)) Minimum efficient scale is the lowest level of output at which a firm first reaches the minimum point of its long-run average cost curve; for BrightBake this is 30,000 loaves per month, the smallest output at which LRAC first reaches its lowest value of $0.17 per loaf  ((c)) Internally, a larger plant lets BrightBake spread the cost of large, indivisible equipment (such as an industrial oven) over a greater number of loaves, lowering the fixed cost per loaf; externally, as the baking industry as a whole grows in the area, specialist flour suppliers…  ((d)) Beyond 40,000 loaves per month, BrightBake's plant may become so large that management struggles to coordinate and supervise every part of the business effectively, leading to slower decision-making, communication problems between departments, and a loss of control over quality…

Question 5

A government is reviewing whether to allow a merger that would turn a perfectly competitive industry of many small producers into a single dominant monopoly supplier. (a) Explain why a profit-maximising firm in the long-run equilibrium of perfect competition is generally both pr…

Accepted Answer

((a)) In the long-run equilibrium of perfect competition, free entry and exit competes away supernormal profit until price equals average cost at its minimum point, giving productive efficiency, and because each price-taking firm profit-maximises where marginal cost equals marginal re…  ((b)) Monopoly is not always less efficient, because if a single large-scale producer can achieve substantial economies of scale that many small competitive firms cannot, its average cost, and potentially its price, may be lower than under perfect competition, and if it channels super…

Question 6

Riverside Quarter is a small city district with a large number of independent coffee shops. Each shop sells its own differentiated blend and style of coffee, and any entrepreneur can open or close a coffee shop in the district without significant barriers. Economists classify th…

Accepted Answer

B

Question 7

ClearView Cinemas shows the same film, in the same auditorium, to two groups of customers it can tell apart at the door: adults, and students who must show a valid student ID. A ticket is checked against the name on the ID and cannot be resold or transferred to anyone else. Adul…

Accepted Answer

((a)) Adult market TR =15×240=3600 (i.e. $3600 per week); student market TR =9×160=1440 (i.e. $1440 per week); combined total revenue =3600+1440=5040 (i.e. $5040 per week)  ((b)) ClearView Cinemas must have some degree of market/monopoly power to set its own price rather than accept a single market price; it must be able to identify and keep the two groups separate, preventing resale of tickets between them; and the two groups must have different price e…  ((c)) Students typically have more elastic demand for cinema tickets, being more budget-constrained and having more substitutes such as streaming, so a high price would cause a proportionately large fall in the quantity they buy; adults typically have more inelastic demand, so raising…

Question 8

NovaChem and PolyForge are the only two firms producing a specialised industrial resin, an oligopoly with just two producers. Each firm must decide, independently and without knowing the other's choice in advance, whether to restrict its own output to keep the market price high,…

Accepted Answer

((a)) If both firms restrict output, NovaChem earns $40m; if NovaChem maximises output while PolyForge restricts, NovaChem earns $55m  ((b)) If PolyForge restricts output, NovaChem earns $55m by maximising versus $40m by restricting, so maximising is better; if PolyForge maximises output, NovaChem earns $25m by maximising versus $10m by restricting, so maximising is still better; since maximising output gives NovaChe…  ((c)) The Nash equilibrium is both firms maximising output, since neither firm can improve its own profit by unilaterally switching to restricting output given the other firm's choice; at this outcome each firm earns $25m, so combined annual profit =25+25=50, i.e. $50m  ((d)) In the single-period game shown, each firm has a private incentive to cheat on any agreement to restrict output, since maximising output raises its own profit whichever choice the rival makes, so a formal or informal agreement is likely to break down into the lower joint-profit…

Question 9

A national market for steel pipe fittings is supplied by five firms whose market share is large enough to be individually measured, alongside many other very small producers that make up the rest of the market between them. By share of total market sales revenue, Firm A holds 32…

Accepted Answer

B

Question 10

Fenwick Dairy is a small, price-taking milk producer. In both of the months described below it produces the same 500 litres of milk per day, and at this output its total fixed cost is $100 per day and its total variable cost is $275 per day; neither cost changes between the two…

Accepted Answer

((a)) Total cost =100+275=375 (i.e. $375 per day); average total cost =375÷500=0.75 (i.e. $0.75 per litre)  ((b)) Total revenue =0.90×500=450 (i.e. $450 per day); profit =450-375=75 (i.e. $75 per day); since price ($0.90) exceeds average cost ($0.75), Fenwick Dairy is earning supernormal profit  ((c)) Total revenue =0.60×500=300 (i.e. $300 per day); profit =300-375=-75, a loss of $75 per day; since price ($0.60) is below average cost ($0.75), Fenwick Dairy is earning subnormal profit  ((d)) Average variable cost =275÷500=0.55 (i.e. $0.55 per litre); since the Month 2 price of $0.60 is still above average variable cost of $0.55, each litre sold still contributes something towards fixed costs, so the farm should continue producing in the short run despite making a lo…

	PolyForge restricts output	PolyForge maximises output
NovaChem restricts output	NovaChem $40m, PolyForge $40m	NovaChem $10m, PolyForge $55m
NovaChem maximises output	NovaChem $55m, PolyForge $10m	NovaChem $25m, PolyForge $25m

Market Structures, Costs and Revenue: Economics 9708 (Cambridge International AS & A Level)

Syllabus coverage

Question 1

Question 2

Question 3

Question 4

Question 5

Question 6

Question 7

Question 8

Question 9

Question 10

Licences sold per month (Q)	1	2	3	4	5	6
Price $=$ AR ($)	100	90	80	70	60	50
Total cost, TC ($)	70	100	135	175	245	355