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Unformatted text preview: Chapter 9 Monopoly, Oligopoly, and Monopolistic Competition 14 June 2011 1. Two car manufacturers, Saab and Volvo, have xed costs of $1 billion and marginal costs of $10,000 per car. If Saab produces 50,000 cars per year and Volvo produces 200,000, calculate the average production cost for each company. On the basis of these costs, which company's market share do you think will grow in relative terms? Answer: For Saab, he has a xed cost of $1 billion and a marginal cost of $10,000 per car. Total variable cost = Marginal cost × Quantity = 10 , 000 × 50 , 000 = $500 , 000 , 000 Total cost = Total variable cost + Total xed cost = $500 , 000 , 000 + $1 , 000 , 000 , 000 = $1 . 5 billion Average cost = Total cost Quantity = 1 , 500 , 000 , 000 50 , 000 = $30 , 000 For Volvo, he has a xed cost of $1 billion and a marginal cost of $10,000 per car. Total variable cost = Marginal cost × Quantity = 10 , 000 × 200 , 000 = $2 , 000 , 000 , 000 Total cost = Total variable cost + Total xed cost = $2 , 000 , 000 , 000 + $1 , 000 , 000 , 000 = $3 billion Average cost = Total cost Quantity = 3 , 000 , 000 , 000 200 , 000 = $15 , 000 Why Volvo's average cost is only half of Saab's even if they actually face the same xed and marginal costs? This is because Volvo's annual production is 4 times larger than Saab's. Assuming that both Saab and Volvo sell at the same price, a lower average cost implies a larger pro t. Profit = ( P- ATC ) × Q 1 The higher pro t allows Volvo to grow relative to Saab. Volvo will further increase its output relative to Saab. A increase in output will further reduce the average cost. The lower average cost will translate into a higher pro t and hence allow Volvo to grow even more relative to Saab. Eventually, Volvo will become a monopoly, or a so called natural monopoly. 2. State whether the following statements are true or false, and explain why. (a) In a perfectly competitive industry, the industry demand curve is horizontal, whereas for a monopoly it is downward-sloping. Answer: False. In perfectly competitive market, individual rms are so small relative to the market size that the decision of a rm to change its output level will have no impact on the market price. Thus, a rm in perfectly competitive market is a price-taker. From the individual rm's perspective, the demand curve appears horizontal, even if the market demand may be downward sloping. When a rm raises its price above the market price, since goods sold by di erent rms are identical and buyers have perfect information about prices and quality of the good, all buyers to turn to the alternative sellers. If a rm lowers its price below the market price, all buyers will turn to the seller, however, it can only satisfy a small number of the buyers and the remaining buyers will go to the other sellers. Thus, lowering price below the market price does not generate a higher pro t. (Challenge: Can you show that mathematically or in a graph that lowering price below the market price does not generate a higher...
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