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Essay Questions2

Essay Questions2 - 23 Explain what the supply curve of a...

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23. Explain what the supply curve of a perfectly competitive firm corresponds to. The supply curve of a perfectly competitive firm corresponds to its marginal cost curve above the Average Variable Cost curve (in the short run) or above the Average total Cost curve (in the long run). 24. Why do firms continue to operate when they are making losses? Quick answer: Because they would lose more money if they completely shut down. Graph – Chapter V Fig. XIII Important Points: 1. In the short run, firms have to pay their Fixed Costs 2. So, in the short run they will lose money when they shut down so they have to decide, do I lose more money if I shut down or if I operate? 3. Firms will operate at a loss if Price is below minimum ATC but above minimum AVC. Example: Airlines did this after 9-11 hoping that other airlines would shut down and their profits would increase to cover their variable costs. 25. Compare and contrast long run equilibrium under perfect competition with long run equilibrium under: a) a monopoly protected by a patent b) monopolistic competition 1. L-R equilibrium in Perfect competition has the following features i. Graph – chapter V Fig. XVII ii. Economic Profit = 0 iii. ATC is minimized iv. Price = Marginal cost 2. L-R equilibrium in Monopolistic Competition (theory developed by Edward Chamberlin (USA) and Joan Robinson (England)) i. Graph – Chapter VII Fig. II ii. Economic Profit = 0 iii. ATC is not minimized iv. Price > Marginal Cost 3. L-R equilibrium in a Patent Monopoly has the following features (patent = barrier to entry) i. Graph – Lecture 13 ii. Economic Profit can be > 0 but Patent doesn’t guarantee a super-normal profit, the monopoly could make a loss iii. ATC is not minimized iv. Price > Marginal Cost *Remember that Monopolistic competition is kind of between Perfect competition and monopoly 26. Why would you regulate a natural, or technical, monopoly and how? Remember: A natural and a technical monopoly are the same thing.

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Definition: A natural monopoly occurs when one firm can supply a good at a lower cost than two or more firms. This usually means that the ATC curve is falling over most of the range of the demand curve. Graph: Chapter VI Figures XIII and XIV Why regulate? Because the monopoly output is not efficient, the Marginal Benefit to society does not equal the Marginal Cost. How to regulate? You enforce a price, in one of two ways 1. Subsidize natural monopolies, this is called Marginal Cost Regulation. Make monopoly produce at quantity where P=MC and then pay them whatever they lose. Problem is firms have no incentives to keep costs down. They buy spinning rims etc. Graph – Chapter VI – Fig. XV 2. Average cost Regulation – Force the monopoly to charge P = ATC. Works better in principle than it does in practice. Graphs – Chapter VI Fig XVII and XVIII 27. Assume you are the economic advisor to the California PUC. What regulatory alternatives would you consider?
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Essay Questions2 - 23 Explain what the supply curve of a...

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