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# If the price average variable cost the firm will

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If the Price < Average variable cost , the firm will temporary shuts down to minimise loss. If P< AVC, by producing the firm is not only unable to cover all its AVC but also faces its fixed cost. b) Using demand and supply analysis together with the cost curves, explain why the actions to minimise loss lead to firms’ making normal profit in the long run? 3 + 3 = 6 Marks In the long run a perfectly competitive firm will only make a normal profit. Normal profit is the minimum profit necessary to keep a firm in operation. When there is no barrier of entry, supply curve will shift, other firms will enter the market and force the price to go down.

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QUESTION 6 In a market structure where firms are mutually interdependent, price competition is not common. Explain using the game theory matrix, with relevant assumptions, how firms make decisions when they behave collusively and non-collusively. In the absence of price competition, how do firms maintain or increase their market share? 6 Marks The game theory analyses the strategic decisions of players and it maybe cooperative or competitive. Consists of 2 firms only, the strategy is setting the price high and low, making profit is the payoffs. From firm A perspective, firm B charges a low or high price, Firm A’s best strategies is to charge a low price. Irrespective of what firm A is to charge a lower price. Similarly Firm B will do the same from its perspective. A Non-cooperative outcome is that both firms will charge a low price and guarantee \$9 million each. However, it is not the optimum outcome of the game. Optimum outcome is possible when both firms were able to cooperate, both charging a high price and make \$14 million each. The repeat nature of this game makes tacit cooperation a more likely outcome. However this is against the law. The problem is cheating will occur and agreement will be broken, the price will then rain to the low price. In the absence of price competition, firms use technique such as advertising, product differentiation, research and develop new product. These expenditures can shift the demand curve to the right. As result, both price and output may be higher.
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