Principles of Microeconomics + DiscoverEcon code card

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Answers to Problems 1. As shown in the following table, Volvo’s greater production volume gives it substantially lower average production cost, and this advantage helps explain why Volvo’s market share has in fact been growing relative to Saab’s. Saab Volvo annual production 50,000 200,000 fixed cost $1,000,000,000 $1,000,000,000 variable cost $500,000,000, $2,000,000,000 total cost $1,500,000,000 $3,000,000,000 Average cost per car $30,000 $15,000 2a. False. The industry demand curve is downward sloping in both cases, but from the individual perfectly competitive firm’s point of view, the demand curve is horizontal. Because the individual firm is too small to affect the market price, it can sell as many units as it wishes at that price. b. True. If they try to charge a higher price they will lose all their business; if they try to charge a lower price, they will not be maximizing profit. c. True. This is the essential feature of natural monopoly. 3. The answer is c. The monopolist chooses the output level at which marginal revenue equals marginal cost and then charges a price consistent with demand at that level of output. Since price always exceeds marginal revenue, price is greater than marginal cost. There is no shortage: at the output chosen, demand and supply coincide. And the monopolist has no reason to maximize marginal revenue (which would require producing zero units of output).
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