12-Discussion Questions - Solutions

12-Discussion Questions - Solutions - Lecture 12: Perfect...

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Lecture 12: Perfect Competition (II) Suggested questions and exercises (Pindyck and Rubinfeld, Ch.8). Questions: 6, 7, 9 Exercises: 10, 12, 13 QUESTIONS 6. At the beginning of the twentieth century, there were many small American automobile manufacturers. At the end of the century, there are only three large ones. Suppose that this situation is not the result of lax federal enforcement of antimonopoly laws. How do you explain the decrease in the number of manufacturers? (Hint: What is the inherent cost structure of the automobile industry?) Automobile plants are highly capital-intensive. Assuming there have been no impediments to competition, increasing returns to scale can reduce the number of firms in the long run. As firms grow, their costs decrease with increasing returns to scale. Larger firms are able to sell their product for a lower price and push out smaller firms in the long run. Increasing returns may cease at some level of output, leaving more than one firm in the industry. 7. Industry X is characterized by perfect competition, so every firm in the industry is earning zero economic profit. If the product price falls, no firms can survive. Do you agree or disagree? Discuss. Disagree. As the market price falls, firms cut their production. If price falls below average total cost, firms continue to produce in the short run and cease production in the long run. If price falls below average variable costs, firms cease production in the short run. Therefore, with a small decrease in price, i.e., less than the difference between the price and average variable cost, the firm can survive. With larger price decrease, i.e., greater than the difference between price and minimum average cost, the firm cannot survive. In general, we would expect that some firms will survive and that just enough firms will leave to bring profit back up to zero. 9. Why does a tax create a deadweight loss? What determines the size of this loss? A tax creates deadweight loss by artificially increasing price above the free
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12-Discussion Questions - Solutions - Lecture 12: Perfect...

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