Key983S - BUSINESS 702 THIRD EXAM KEY SPRING 1998...

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Sheet1 Page 1 BUSINESS 702 THIRD EXAM KEY SPRING 1998 MANAGERIAL ECONOMICS Short Questions (10 points each) 1. Market Structure Concepts. Indicate whether each of the following statements is true or false, and explain why. A. In long-run equilibrium, every firm in a perfectly competitive industry earns zero profit. Thus, if price falls, none of these firms will be able to survive. B. Perfect competition exists in a market when all firms are price takers as opposed to price makers. C. A natural monopoly results when the profit-maximizing output level occurs at a point where long-run average costs are declining. D. Downward-sloping industry demand curves characterize both perfectly competitive and monopoly markets. E. A decrease in the price elasticity of demand would follow an increase in monopoly power. 1. SOLUTION A. False. In long-run equilibrium, every firm in a perfectly competitive industry earns zero excess profit. Following a decrease in industry prices, high cost producers will be forced to exit. However, remaining firms will continue to operate and earn a normal rate of return on investment. B. True. Perfect competition exists in a market when individual firms have no influence over price. Such firms take industry prices as a given. C. False. A natural monopoly occurs in a market when the market clearing price, or price where Demand (Price) = Supply (Marginal Cost), occurs at an output level where long-run average costs are declining. D. True. Downward sloping demand curves follow from the law of diminishing marginal utility and characterize both perfectly competitive and monopoly market structures. E. True. A decrease in the price elasticity of demand would result following an increase in monopoly power. 2. Market Structure Concepts. Indicate whether each of the following statements is true or false and explain why. A. Equilibrium in monopolistically competitive markets requires that firms be operating at the minimum point on the long-run average cost curve. B. A high ratio of distribution cost to total cost tends to increase competition by
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Sheet1 Page 2 widening the geographic area over which any individual producer can compete. C. The price elasticity of demand tends to fall as new competitors introduce substitute products. D. An efficiently functioning cartel achieves a monopoly price/output combination. E. An increase in product differentiation tends to increase the slope of firm demand curves. 2. SOLUTION A. False. Stable equilibrium in perfectly competitive markets requires that firms must operate at the minimum point on the long-run average cost curve. In monopolistically competitive markets, however, equilibrium is achieved at a point of tangency between firm demand and average cost curves. This tangency typically occurs at an output level below the point of minimum long-run average costs.
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