PRICE DETERMINATION

What are the two conditions for a profit-maximizing firm to reach equilibrium?

• Marginal Revenue = Marginal Cost (MR = MC)
• MC must cut the MR curve from below.
• Applicable to all market structures.

What is the relationship between Marginal Revenue, Average Revenue, and Price Elasticity of Demand?

• MR = AR × (e - 1) ÷ e
• If e = 1, then MR = 0.
• If e > 1, then MR is positive.
• If e < 1, then MR is negative.

When should a perfectly competitive firm shut down in the short run?

• When Price is less than Average Variable Cost (P < AVC).
• Total Revenue is less than Total Variable Cost.
• The firm continues to bear only fixed costs.

Differentiate between Value in Use and Value in Exchange.

• Value in Use = Utility or satisfaction from consuming a good.
• Value in Exchange = Purchasing power of a good in the market.
• Example: Water has high value in use, diamonds have high value in exchange.

What additional features convert Pure Competition into Perfect Competition?

• Perfect market knowledge.
• No transaction costs.
• Perfect mobility of factors of production.

Why is the demand curve of a perfectly competitive firm horizontal?

• The firm is a price taker.
• Market determines the price.
• Demand is perfectly elastic.
• Therefore, Price = Average Revenue = Marginal Revenue.

What is the long-run equilibrium condition under Perfect Competition?

• Price = MR = AR = MC = Minimum Average Cost.
• Firms earn only normal profits.
• Firms operate at optimum capacity.

What is the short-run supply curve of a perfectly competitive market?

• The upward-sloping portion of the Marginal Cost curve.
• It begins above the minimum Average Variable Cost.
• Below AVC, the firm shuts down.

What happens when demand increases and supply decreases simultaneously?

• Equilibrium price always increases.
• Equilibrium quantity is uncertain.
• Final quantity depends on the size of the shifts.

What conditions are necessary for price discrimination?

• Monopoly power.
• Separate markets.
• No resale between markets.
• Different price elasticities of demand.

How does a monopolist allocate output between two markets?

• MC = MR in both markets.
• Higher price is charged where demand is less elastic.
• Lower price is charged where demand is more elastic.

What are the three degrees of price discrimination?

• First Degree – Charges each customer the maximum they will pay.
• Second Degree – Different prices based on quantity purchased.
• Third Degree – Different prices for different consumer groups.

What is the defining feature of Monopolistic Competition?

• Many sellers.
• Differentiated products.
• Products are close substitutes.

Why does excess capacity exist in Monopolistic Competition?

• Firms face downward-sloping demand.
• Output is below optimum scale.
• Firms do not produce at minimum Average Cost.

What are selling costs?

• Costs of advertising and promotion.
• Used to increase demand.
• Common in Monopolistic Competition and Oligopoly.

What does Sweezy's Kinked Demand Curve explain?

• Price rigidity in Oligopoly.
• Price increases are usually not followed.
• Price decreases are usually matched.
• Prices tend to remain stable.

Why is there a gap in the Marginal Revenue curve in Sweezy's model?

• Elasticity changes suddenly at the kink.
• Creates a discontinuous MR curve.
• Small changes in MC do not change price or output.

Differentiate between Pure Oligopoly and Differentiated Oligopoly

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• Pure Oligopoly – Homogeneous products.
• Differentiated Oligopoly – Differentiated products.
• Examples: Cement vs Automobiles.

Differentiate between Collusive and Competitive Oligopoly.

• Collusive Oligopoly – Firms cooperate and fix prices.
• Competitive Oligopoly – Firms compete independently.

Why is the demand curve in Oligopoly indeterminate?

• Firms are interdependent.
• Competitors' reactions are uncertain.
• Price decisions depend on rivals.

True or False: A monopolist can incur losses in the short run.

• True.
• Loss occurs if Price is less than Average Total Cost.
• Firm continues if Price is at least equal to Average Variable Cost.

Compare long-run profits under different market structures.

• Perfect Competition – Normal profits.
• Monopolistic Competition – Normal profits.
• Monopoly – Supernormal profits.

What is a Natural Monopoly?

• Exists because of large economies of scale.
• One firm can supply the market at the lowest cost.
• Examples: Electricity distribution, Railways.

How does Total Revenue change when price falls?

• Elastic demand – Total Revenue increases.
• Unitary elastic demand – Total Revenue remains unchanged.
• Inelastic demand – Total Revenue decreases.

What is Price Leadership?

• One firm sets the price.
• Other firms follow.
• Types:
• Dominant Firm Leadership
• Barometric Leadership
• Low-Cost Leadership

What is a Cartel?

• Agreement among competing firms.
• Fixes prices and output.
• Maximizes joint profits.
• Behaves like a monopoly.

Why is Marginal Revenue less than Average Revenue under Monopoly and Monopolistic Competition?

• Selling one more unit requires lowering the price.
• Lower price applies to all units sold.
• Therefore, MR is less than AR.

True or False: Perfect Competition involves selling costs.

• False.
• Products are homogeneous.
• Buyers have perfect knowledge.
• Advertising is unnecessary.

Rank market structures from lowest to highest price control

• Perfect Competition
• Monopolistic Competition
• Oligopoly
• Monopoly

Mnemonic: PMOM

What efficiency conditions are achieved under Perfect Competition but not under Monopoly?

• Perfect Competition: Price = Marginal Cost (Allocative Efficiency).
• Perfect Competition: Price = Minimum Average Cost (Productive Efficiency).
• Monopoly: Price is greater than Marginal Cost, creating deadweight loss.