c


 


 


Munira Sultana
Lecturer

DEPARTMENT OF BUSINESS ADMINISTRATION

cc
 


 
 

GROUP: 1
SECTION: A, 11TH BATCH BBA
 


Md. Faruk Hossain 01
Md. Ariful Haque 21
Md. Arafin Rizvi 31
Rakibul Hasan Kakon 41
Rafiqul Alam 51
Farzana Hafiz 61



    
Microeconomics

 

?

    
Ans:
!"#$"#$"%#: Short run costs are the costs over a period during which some factors of production
are fixed. The function which shows the relation between cost & the variable factors & fixed factors is called
short run cost function. The short run cost function is-
C= f(X, T, P, K)
Here, C= Total Cost
F= Fixed Cost factors
V= Variable costs factors
#& # $" #$"%#: Long run costs are the costs over a period long enough to permit the change of all
factors of production. That means in this period there is no fixed factor. The function which shows the relation
between cost & the variable factors is called long run cost function. The long run cost function is-
C= f (V)
Here, C= Total Cost
V= Variable costs factors

In the short run cost curve it can be seen that there are both fixed costs & variable costs. The curve starts from
over the origin. On the other hand, Long run cost curve has no fixed cost. So it starts from the origin.
In the short run cost function, the fixed factors are-

A? Salaries of administrative staff

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Microeconomics

A? Depreciation of machinery
A? Expenses of building depreciation & repairs
A? Expenses for land maintenance & depreciation
A? Rent of building

In the short run & long run cost functions the variable factors are-

A? Raw materials
A? Cost of direct labor
A? The running expenses of fixed capital such as fuel
A? Transport cost


K ?
 

 
Ans:
&%#' $" ( ) Marginal means extra. So, marginal cost means the extra or additional cost that is
incurred for producing one extra unit of output. In economics, marginal cost is the change in total cost that
arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a
good. Numerically, MC is the change in total cost divided by change in output. So,




  
Or, MCn = TCn- TCn-1

*     c 
1 10 10 10
2 5 15 7.5
3 3 18 6
4 7 25 6.2
5 15 40 8





K P a g e 
Microeconomics

"' " ( ): Total cost means the sum of all fixed costs & variable costs. So total cost can be defined
numerically as-
TC= Total fixed cost (TFC) + Total variable cost (TVC)
In the short run cost, there are both fixed cost & variable cost. But in the long run cost, there is only variable
cost so for the long run, total cost is
TC= Total variable cost (TVC)
*     c 
1 10 10 10
2 5 15 7.5
3 3 18 6
4 7 25 6.2 

5 15 40 8 





?
 
  
Ans: Marginal Cost (MC): Marginal means extra. So, marginal cost means the extra or additional cost that is
incurred for producing one extra unit of output. In economics, marginal cost is the change in total cost that
arises when the quantity produced changes by one unit.
Average Cost: Average cost is the total cost divided by the number of output produced. Average cost implies
cost per output. So average cost is-






Relationship between AC & MC is described for 3 conditions
as bellow-
When MC<AC: When MC is less than AC, AC declines. The
rate of decline in MC is greater than the rate of decline in
AC.
When MC=AC: When MC is equal to AC then AC neither
raises nor declines. AC remains constant. The changing rate of AC is always here equal to the rate of MC.

 P a g e 
Microeconomics

When MC>AC: When MC is greater than AC, the AC is less than MC. The change rate of MC is greater than the
rate of AC.
In the figure, to the left of the point E, MC is less than AC. So, AC is gradually declining. At the point E, MC=AC.
Here AC is neither raising nor declining. Again, to the right of the point E, MC is greater than AC. Here, AC
gradually increases. The rate of change in MC is greater than AC in all aspects.


( ?

! "# $%&
'
Ans: Average Cost: Average cost is the total cost divided by the number of output produced. Average cost
implies cost per output. So average cost is-






By constructing a cost schedule & drawing a graph, it can be explained that AC curve is U shaped.
*   c 
1 20 20 25 c
2 24 12 20
3 30 10 15

4 60 15 10
5
5 110 22
0
0 1 2 3 4 5 6

Figure: Average Cost Curve

The explanation can be divided in three stages as-
Primary Stage: In the primary stage, the Average cost curve is declining as the total production is increasing. So
the AC curve is going downward.
Optimum stage: At the optimum stage, AC curve stops decreasing. It neither falls nor rises. After this stage, AC
curve starts rising upward. In the cost schedule, 3 no. quantities show the optimum stage where the curve is at
the lowest point.
Post optimum stage: At this stage, AC curve rises as the production increases. Thus the AC curve tends to be
upward.
From the above discussion, it can be said that in normal situation, AC curve is U shaped.

( P a g e 
Microeconomics

V ()      

Ans: $#%  $', in microeconomics, are the cost advantages that a business obtains due to
expansion. They are factors that cause a producers average cost per unit to fall as scale is increased.
Economies of scale is a long run concept and
refers to reductions in unit cost as the size of a
facility, or scale, increases. Economies of scale
may be utilized by any size firm expanding its
scale of operation. The common ones are
purchasing (bulk buying of materials through
long-term contracts), managerial (increasing the
specialization of managers), financial (obtaining
lower-interest charges when borrowing from
banks and having access to a greater range of
financial instruments), and marketing
(spreading the cost of advertising over a greater
range of output in media markets). Each of these factors reduces the long run average costs (LRAC) of
production by shifting the short-run average total cost (SRATC) curve down and to the right.

%$#%  $' are the opposite.
Diseconomies of scale are the forces that
cause larger firms to produce goods and
services at increased per-unit costs. They are
less well known than what economists have
long understood as "economies of scale", the
forces which enable larger firms to produce
goods and services at reduced per-unit costs.

In general economies of scale are more significant and important for investors, but diseconomies of scale can
occur and are worth considering especially when dramatic expansion or acquisitions are being considered.

   
! ! 

V P a g e 
Microeconomics

The long-run average cost curve is the envelope of an infinite number of short-run average total cost curves,
with each short-run average total cost curve tangent to, or just touching, the long-run average cost curve at a
single point corresponding to a single output quantity. The key to the derivation of the long-run average cost
curve is that each short-run average total cost curve is constructed based on a given amount of the fixed input,
usually capital. As such, when the quantity of the fixed input changes, the short-run average total cost curve
shifts to a new location.
The long-run average cost curve can be derived by identifying the factory size (or quantity of capital) that can
produce each quantity of output at the lowest short-run average total cost. For example, The Wacky Willy
Company has one short-run average total cost curve corresponding to a 10,000 square foot factory, another
short-run average total cost curve corresponding to a 10,001 square foot factory, another for a 10,002 square
foot factory, etc. Each of these short-run average total cost curves
incurs the lowest average total cost for the production of a given Y

quantity of output. The long-run average cost curve is then the

combination of all minimum short-run average total cost values.
Cost
We have said that the long run average cost curves are U-shaped.
But empirical studies have shown that the LAC curves are L-
LAC
shaped, rather than U-shaped as in the figure. We find that there is
a rather rapid downward slope in the early part of the curve,
 in O Output X
the initial stages of production.

 *+,++++*+,  
c+
,  (+ )
Cost of production that does NOT change with changes in the quantity of output produced by a firm in the
short run. Total fixed cost is one part of total cost. The other is total variable cost. At any and all levels of
output, fixed cost is the same. It includes cost that is not dependent on, or is unrelated to, production. The
best way to identify fixed cost is to produce zero output. Fixed cost is incurred whether or not any output is
produced. A cost measure directly related to total fixed cost is average fixed cost.
Total fixed cost is the opportunity cost incurred in the short-run production that does not depend on the
quantity of output. As the name clearly implies, total fixed cost is fixed. A firm can produce a little output or a
lot, increase or decrease production, or even stop producing altogether, but fixed cost remains unchanged.

 P a g e 
Microeconomics

!"'+%-. " /

The total fixed cost curve graphically represents the relation between total fixed costs incurred by a firm in the
short-run production of a good or service and the quantity produced. Because total fixed cost is fixed, the total
fixed cost curve is a horizontal line.

The total fixed cost curve (TFC) for Wacky Willy Stuffed Amigos production is illustrated in the graph. The
distinguishing characteristic of this curve is that it is a horizontal line. Total fixed cost is $3 for zero production
and it remains $3 for every level of production, no more and no less.
p

 



p



TFC=TC-TVC

"' "( )

Total cost may be defined as the summation of all costs incurred in the purchase of factors of production (land,
labour, capital, Organization).
Total cost is the overall opportunity cost incurred by a firm in
production. For short-run production, total cost consists of variable
cost, which depends on the quantity produced, and fixed cost, which
does not vary with production. The variable component of total cost,
is guided by the law of diminishing marginal returns and is key to
short-run production and supply decisions.

p p



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Microeconomics

Like most relations found in the study of economics, that between total cost and the quantity of production
can be represented by a curve. The total cost curve is presented in the exhibit to the right.
As might be expected the total cost curve has a positive slope. As the quantity of output produced increases,
so too does total cost. However, the slope of the total cost curve is not constant. It is relatively steep for small
quantities, flattens for intermediate levels of production, and then once again steepens for the largest
quantities. The shape of the total cost curve is based on short-run production returns, especially the law of
diminishing marginal returns.

Another observation is that the total cost curve does not go through the origin, but rather begins at a positive
value on the vertical axis. In other words, if the quantity of output is zero, total cost is positive. This vertical
intercept indicates fixed cost.
Total cost=total fixed cost + total variable cost

&%#'$"
Marginal cost is the amount of additional cost to be incurred
Y
on the production of an additional unit of product.
In other words, marginal cost is the ratio between changes in MC
total cost and changes in the number of production. Thus

!




here MC=marginal cost, TC=total cost, q=quantity of

production.
O X
The change in total cost (or total variable cost) resulting from
a change in the quantity of output produced by a firm in the
Marginal cost
short run. Marginal cost indicates how much total cost
changes for a give change in the quantity of output. Because changes in total cost are matched by changes in
total variable cost in the short run (remember total fixed cost is fixed), marginal cost is the change in either
total cost or total variable cost. Marginal cost, usually abbreviated MC, is found by dividing the change in total
cost (or total variable cost) by the change in output.

c/& "(c )

Average cost is the per unit cost of production determined by dividing, the total cost with the number of units
produced.

 P a g e 
Microeconomics

Average cost is a general notion of the per unit cost incurred in the production of a good or service. It is
specified as the total cost divided by the quantity of output. Average cost plays a key role in the short-run
production decision by a firm when evaluated against the price, which is per unit revenue. A comparison
between per unit revenue (price) and per unit cost (average cost) indicates whether a firm is making a profit,
incurring a loss, or should shut down production operations.
A generic formula for calculating average cost is specified as:





 

c/&+%-. "(c+ )
Average fixed cost is per unit fixed cost determined by dividing the total fixed cost with the quantity of
production.






Average fixed cost is the total fixed cost per unit of output incurred when a firm engages in short-run
production. It can be found in two ways. Because average fixed cost is total fixed cost per unit of output, it can
be found by dividing total fixed cost by the quantity of output. Alternatively, because total fixed cost is the
difference between total cost and total variable cost, average fixed cost can be derived by subtracting average
variable cost from average total cost.
The standard method of calculating average fixed cost is to divide total fixed cost by the quantity of output,
illustrated by this equation:






An alternative specification for average fixed cost is found by subtracting average variable cost from average
fixed cost:






c/&0%'$"(c0 )
For any output level is calculated by dividing total variable cost (TVC) by that output (Q).







Average variable cost is the total variable cost per unit of output incurred when a firm engages in short-run
production. It can be found in two ways. Because average variable cost is total variable cost per unit of output,
it can be found by dividing total variable cost by the quantity of output. Alternatively, because total variable

 P a g e 
Microeconomics

cost is the difference between of total cost and total fixed cost, average variable cost can be derived by
subtracting average fixed cost from average total cost.

In general, average variable cost decreases with additional production at relatively small quantities of output,
then eventually increases with relatively large quantities of output. This pattern is illustrated by a U-shaped
average variable cost curve.

!c/&0%' " /

The relation between average variable cost and the quantity of c/&0%' " /
production can be represented by a curve, such as the one
conveniently presented in the exhibit to the right.

The key feature of this average variable cost is the shape. It is U-

shaped, meaning it has a negative slope for small quantities of
output, reaches a minimum value, then has a positive slope for
larger quantities. This U-shape is indirectly attributable to the law
of diminishing marginal returns.

"'0%' "(0 )

Cost of production that does change with changes in the quantity of output produced by a firm in the short
run. Total variable cost is one part of total cost. The other is total fixed cost. Variable cost depends on the level
of output. If a firm produces more output, then variable cost is greater. If a firm produces no output, then
variable cost is zero. A cost measure directly related to total variable cost is average variable cost.
Total cost=total fixed cost + total variable cost
Total variable cost is the opportunity cost incurred in the short-run production that depends on the quantity of
output. As the name clearly implies, total variable cost is variable, it changes. If a firm produces a little output,
then total variable cost is less. If a firm produces a lot of output, then total variable cost is more.

A firm can avoid variable cost in the short run by reducing production to zero. This bit of information often
comes in handy when the price received by a firm is so low that it falls short off covering variable cost at any
positive quantity of production. As such, the firm might find it most "profitable" to cut losses by shutting down
production and avoiding variable cost, until the price increases.

 P a g e 
Microeconomics

c

- +    - 
%#%"%#1"
A market is a mechanism to each the goods and services are traded between buyers and sellers, on the other
words, a market is a public place where provisions and other objectives were exposed for sale, but the word
has been generalized no as to mean any body of persons who are in intimate business relations and carry on
extensive transaction in any commodity.
 



 
There are mainly two types of market. Those are perfect market and imperfect market.

Market

Perfect Imperfect
market market

Monopoly Monopolistic Oligopoly Duopoly Monopsony

$"1"
A market is said to be perfect when all the potential sellers and buyers are promptly aware of the prices at
which transaction take place and all the offers made by other seller and buyers and when any buyer can
purchase from any seller and conversely.

$"1"
A market is said to be imperfect when some buyer of seller or both are not aware of the offers being made by
the offers. Naturally, therefore different prices come to prevail for the same commodity at the same time in an
imperfect market. There are five types of imperfect market. They are as follows-

 P a g e 
Microeconomics

A? Monopoly market
A? Monopolistic market
A? Oligopoly Market
A? Duopoly Market
A? Monophony market

 
  - 
c/&
/#(c
)
Average revenue is the per unit revenue earned by a firm out of selling individual unit of product to be
determined average revenue by dividing the total revenue the number of unit sale.




&%#'
/#(
)
Marginal revenue may be defined as the amount of revenue to be earned by a firm by way of selling an
additional unit of output or product.

!






 


 

Relationship between AR and MR in different market are given below with the help of a table.

#%" c
(c/&
/#) 
("'
/#) 
(&%#'
/#

1 22 22 22
2 21 42 20
3 20 60 18
4 19 76 16
5 18 90 14
6 17 102 12
7 16 112 10
8 15 120 8
9 14 126 6
10 13 130 4

K P a g e 
Microeconomics

In the above table, column 2 shows the average revenue, while column 4 shows the marginal revenue.
Marginal revenue has been derived from the total revenue of the table. Thus in going from two to three units
the marginal revenue are 18 and is found out by subtracting 42 from 60 and so on. The table further indicates
that when average revenue is falling, marginal revenue is less than average revenue.

1.? !" 
#$% &  


# & 

'()*+,-,./,
2.? "$" 

/).(0(1






2).3,0.('()*+,-,./,
3.? !$ !" 
2).3,0./).(0(1


!


When competition is perfect, as already seen the average revenue curve of the firm is a horizontal straight
line. This is so because an individual firm under perfect
Y
competition by its own action cannot influence the
price. The seller under perfect competition can sell any
Revenue
amount of the commodity at the ruling market price. In AR=MR
P
this case when average revenue curve is the horizontal
line the marginal revenue curve coincides with the
average revenue curve. This is so because additional O X
Quantity
units are sold at the same price as before and no loss is
incurred on the previous units which would have resulted if the sale of additional units would have forced the
price down.

(  
      !
,45
Ans: By making use of the formula!
 ,
, where MR is marginal revenue, AR is average revenue and e

is elasticity of demand. We can find out the relationship between AR, MR, and TR on the one hand and
elasticity of demand e is equal to one then-

 P a g e 
Microeconomics

 6
!
  7

6 6

 &
6

8
Similarly, it can be shown that if e 1, MR is positive and if e<1, MR is negative.
The relationship can be illustrated by the
following diagram. Y
In this diagram DD is a straight line demand
H
curve or AR curve, MR is the marginal revenue
D
curve and OD is the total revenue curve. At the TR
middle point C of AR curve elasticity is one
C
(e=1). On its lower half it is less than one (e<1).
,45
Referring to the formula !
 given
,

above, we can say that marginal revenue

corresponding to the middle point C of the O N D
MR X
demand curve is zero. This is shown by the fact
that MR curve cuts the X axis at N which corresponds to the point C on the AR curve. If the quantity is greater
than ON, it will correspond to that portion of the AR curve where e<1 marginal revenue is negative because
MR goes below the X Axis.
Likewise, for a quantity less than ON, e>1 and the marginal revenue is positive this means that if quantity
greater than ON is sold, the total revenue will be diminishing and for a quantity less than ON the total revenue
TR will be increasing.
Thus the total revenue (TR) will be maximized at the point H where elasticity is equal to one, and marginal
revenue is zero.


V   
     !+ ++
*     !- 

Generally, a perfectly competitive market exists when every participant is a "price taker," and no participant
influences the price of the product it buys or sells. Specific characteristics may include:

( P a g e 
Microeconomics

o?
#%#%" 23
#%#%" '' Infinite consumers with the willingness and ability to buy the product
at a certain price, Infinite producers with the willingness and ability to supply the product at a certain
price.
o? ,#"23-%" % It is relatively easy to enter or exit as a business in a perfectly competitive
market.
o?
$"
#"%# - Prices and quality of products are assumed to be known to all consumers and
producers.
o? #$"%# "' - Buyers and sellers incur no costs in making an exchange [Perfect mobility].
o? +%c%"-%%4
%" - Firms aim to sell where marginal costs meet marginal revenue, where
they generate the most profit.
o? &#
.$" The characteristics of any given market good or service do not vary across
suppliers.

Some subset of these conditions is presented in most textbooks as defining perfect competition. More
advanced textbooks try to reconcile these conditions with the definition of perfect competition as equilibrium
price taking; that is whether or not firms treat price as a parameter or a choice variable. It should be noted
that a general rigorous proof that the above conditions indeed suffice to guarantee price taking is still lacking
(Keeps 1990, p. 265).
In the short term, perfectly-competitive markets are productively inefficient as output will not occur where
marginal cost is equal to average cost, but electively efficient, as output will always occur where marginal cost
is equal to marginal revenue, and therefore where marginal cost equals average revenue. In the long term,
such markets are both electively and productively efficient.
Under perfect competition, any profit-maximizing producer faces a market price equal to its marginal cost.
This implies that a factor's price equals the factor's marginal revenue product. This allows for derivation of the
supply curve on which the neoclassical approach is based. (This is also the reason why "a monopoly does not
have a supply curve.") The abandonment of price taking creates considerable difficulties to the demonstration
of existence of a general equilibrium except under other, very specific conditions such as that of monopolistic
competition.

*  - 

In economics, monopoly is a pivotal area to the study of market structures, which directly concerns normative
aspects of economic competition, and sets the foundations for fields such as industrial organization and
economics of regulation. There are four basic types of market structures under traditional economic analysis:

V P a g e 
Microeconomics

perfect competition, monopolistic competition, oligopoly and monopoly. A monopoly is a market structure in
which a single supplier produces and sells the product. If there is a single seller in a certain industry and there
are no close substitutes for the goods being produced, then the market structure is that of a "pure monopoly".
Sometimes, there are many sellers in an industry and/or there exist many close substitutes for the goods being
produced, but nevertheless firms retain some market power. This is called monopolistic competition, whereas
in oligopoly the main theoretical framework revolves around firm's strategic interactions.
o? %#&' '' In a monopoly there is one seller of the monopolized good who produces all the output.
Therefore, the whole market is being served by a single firm, and for practical purposes, the firm is the
same as the industry. In a competitive market (that is, a market with perfect competition) there are an
infinite number of sellers each producing an infinitesimally small quantity of output.
o? 1"
5: Market Power is the ability to affect the terms and conditions of exchange so that the
price of the product is set by the firm (price is not imposed by the market as in perfect
competition).Although a monopoly's market power is high it is still limited by the demand side of the
market. A monopoly faces a negatively sloped demand curve not a perfectly inelastic curve.
Consequently, any price increase will result in the loss of some customers.
+"#'%"%$1"

The term 6#'%"%$1"7 is derived from the Greek words moons which means alone or single and
pollen which means to sell. It is defined as a situation in which a single company owns all or nearly all of the
market for a given type of product or service.
This would happen in the case that there is a barrier to entry into the industry that allows the single company
to operate within competition (for example, vast economies of scale, barriers to entry, or governmental
regulation). In such an industry structure, the producers will often produce a volume that is less than the
amount which would maximize social welfare. It is also explained as the exclusive power; or privilege of selling
a commodity; the exclusive power, rights, or privilege of dealing in some articles, or of trading in some market,
sole command of the traffic in anything, however obtained; as the proprietor of a patented article in given a
monopoly of its sale for a limited time.
1. Exclusive possession or control of one firm/company to produce and sell a commodity or a service.
2. The firm is an industry, since the distinction between firm and industry doesnt exist.
3. Contradicts a perfect competition market.
4. No close substitute of the product/service is available in the market.
5. The sellers are the price makers and not price takers, since they are the sole suppliers.

 P a g e 
Microeconomics

6. High entry barriers for the other firms, thus restricting competition.
7. The entry barriers can be legal, technological, economical or natural. As rightly said by Milton Friedman that
monopoly frequently arises from government support or from collusive agreements among individuals.
8. The firm faces a downward sloping demand curve for its product; since the firm is an industry. It means it
cant sell more output unless the price is lowered.

+"'%&'21"
Oligopoly competition can give rise to a wide range of different outcomes. In some situations, the firms may
employ restrictive trade practices (collusion, market sharing etc.) to raise prices and restrict production in
much the same way as a monopoly. Where there is a formal agreement for such collusion, this is known as a
cartel. A primary example of such a cartel is OPEC which has a profound influence on the international price of
oil.

%"-%%4"%#$#.%"%# An oligopoly maximizes profits by producing where marginal revenue equals

marginal costs.
c%'%"2""%$ Oligopolies are price setters rather than price takers
#"2#.-%" Barriers to entry are high. The most important barriers are economies of scale, patents, access
to expensive and complex technology, and strategic actions by incumbent firms designed to discourage or
destroy nascent firms.
  % "Few"a "handful" of sellers. There are so few firms that the actions of one firm can
influence the actions of the other firms.
#&
#
%": Oligopolies can retain long run abnormal profits. High barriers of entry prevent sideline firms
from entering market to capture excess profits.

.$".%#"%"%# Product may be standardized (steel) or differentiated (automobiles).

$"#5'.& Assumptions about perfect knowledge vary but the knowledge of various economic actors
can be generally described as selective. Oligopolies have perfect knowledge of their own cost and demand
functions but their inter-firm information may be incomplete. Buyers have only imperfect knowledge as to
price, cost and product quality.

#".#.#$ The distinctive feature of an oligopoly is interdependence. Oligopolies are typically
composed of a few large firms. Each firm is so large that its actions affect market conditions. Therefore the
competing firms will be aware of a firm's market actions and will respond appropriately. This means that in
contemplating a market action, a firm must take into consideration the possible reactions of all competing
firms and the firm's countermoves. It is very much like a game of chess or pool in which a player must

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Microeconomics

anticipate a whole sequence of moves and countermoves in determining how to achieve his objectives. For
example, an oligopoly considering a price reduction may wish to estimate the likelihood that competing firms
would also lower their prices and possibly trigger a ruinous price war. Or if the firm is considering a price
increase, it may want to know whether other firms will also increase prices or hold existing prices constant.
This high degree of interdependence and need to be aware of what the other guy is doing or might do is to be
contrasted with lack of interdependence in other market structures. In a PC market there is zero
interdependence because no firm is large enough to affect market price. All firms in a PC market are price
takers, information which they robotically follow in maximizing profits. In a monopoly there are no
competitors to be concerned about. In a monopolistically competitive market each firm's effects on market
conditions is so negligible as to be safely ignored by competitors.

 .          + +   -  

  
Price and output determination in monopolistic market under short run:Since the firm has a downward-
sloping demand curve, it will also have a downward-sloping marginal revenue (MR) curve. A profit-maximizing
firm produces where marginal cost (MC) equals marginal revenue (q0 in the graph below) and charges the

price determined by demand (P0).

 P a g e 
Microeconomics

In panel (a) of the figure, the monopolistic competitor will make a profit. However, like a monopoly, a
monopolistic competitor is not guaranteed to make a profit in the short run. The firm may make a loss in the
short run; its profitability will depend on the demand. This is shown in panel (b).
To more fully understand price and output determination in monopolistic competition, try the following Active
Graph exercise:

Price and output determination in monopolistic market under long run:

The action in a monopolistically competitive market occurs when the market moves to the long run. Since
other competitors selling a similar good can enter the market, two changes will occur:

o? Firm demand will decrease.

o? Firm demand will become more elastic.

As more firms enter the market, the demand for any one firm will decrease, since the firm is now sharing the
market with other firms.
A decrease in demand implies a leftward shift in the demand curve. Since the entering firms are producing
substitutes for the existing firms good, the demand for the existing good will become more elastic. An
increase in elasticity implies the demand curve is getting flatter. By combining these effects, as a
monopolistically competitive market moves from short-run profits to the long run, the firms demand curve
will move to the left and get flatter. Furthermore, the demand curve will continue to move until there are no
more firms entering the market. Firms will
stop entering the market when profits are
zero.
This occurs when the demand curve just
barely touches (i.e., is tangent to) the ATC
curve, as shown in the figure above. Once
the demand curve is tangent to the ATC
curve, the profit-maximizing price is equal
to the average total cost, and thus, profits
are zero. In the long run, competition will
drive monopolistically competitive markets

 P a g e 
Microeconomics

to make zero profits. The goal of the firm is to try to maintain as much short-run profit as possible by
differentiating its product. Eventually, though, in the long run, economic profits will be zero.
If a monopolistic competitor is losing money in the short run, the opposite holds true. If the market is not
profitable, firms will leave as the market moves towards the long run. When firms leave, there are fewer
substitutes, so demand becomes more inelastic and increases since market demand is split up among more
firms. The demand curve keeps getting steeper and moving to the right until it is tangent to the ATC curve,
where profits become zero and no other firms want to leave the market. (This would occur at point A in panel
(b) of the earlier figure.)

 
      +    +   
 + - 
Distinguish between monopoly and monopolistic:
Monopoly means a market situation in which there is only a single seller and large no. of buyers. Whereas
monopolistic competition is a market situation in which there is large no. of sellers and large no. of buyers.in
monopolistic competition, close substitutes are there in the sense that products are different in terms of size,
colour, packaging, brand, price etc. as in case of soap, toothpaste etc.but in monopoly, there is no close
substitute of the good, if any, it will be a remote substitute like in India, Indian railways has its monopoly but
its remote substitutes are present like bus and air service.in monopolistic competition, there is aggressive
advertising but in monopoly, there is no advertising at all or a very little.in monopolistic competition, demand
curve faced by the firm is more elastic because of availability of close substitutes. it means if a firm raises its
price, it will loose its large market share as customers in large will shift to close substitutes present in the
market. but in monopoly, the demand curve faced by the firm is less elastic because of no close substitutes. if
means if the firm raises its price, demand will not fall in a large quantity as it is only one in the market.

%#$"5#
$" "%"%#8#'%"%$
#'%"%$ "%"%#
A type of competition within an industry where:
1. All firms produce similar yet not perfectly substitutable products.
2. All firms are able to enter the industry if the profits are attractive.
3. All firms are profit maximizes.
4. All firms have some market power, which means none are price takers.

K  P a g e 
Microeconomics

Monopolistic competition differs from perfect competition in that production does not take place at the
lowest possible cost. Because of this, firms are left with excess production capacity. This market concept was
developed by Chamberlain (USA) and Robinson (Great Britain). Perfect Competition A market structure in
which the following five criteria are met:
1. All firms sell an identical product.
2. All firms are price takers.
3. All firms have a relatively small market share.
4. Buyers know the nature of the product being sold and the prices charged by each firm.
5. The industry is characterized by freedom of entry and exit.
Sometimes referred to as "pure competition". Perfect competition is a theoretical market structure. It is
primarily used as a benchmark against which other market structures are compared. The industry that best
reflects perfect competition in real life is the agricultural industry.
%#$#'2#.#'%"%$$"%"%#
Monopoly by definition means there is no competition (at least when I studied economics in the 1960s). A
monophony was when you had a near monopoly or few producers. Therefore, competition in a monophony
scenario is greater than in a pure monopoly. When there are few producers, there is a tendency towards price
fixing like what happens with the OPEC oil producers in the Middle East.

%#$"5##'%#.'%&'%
A monopoly is one company controlling a certain market, such as the post office. An oligopoly is a few
companies controlling a certain market, such as the car industry or the oil industry.

  .   '

.$".%#"%"%#
0"%$'.%#"%"%#
Vertical differentiation occurs in a market where the several goods that are present can be ordered according
to their objective quality from the highest to the lowest. It's possible to say in this case that one good is
"better" than another.
Vertical differentiation can be obtained:
1. along #.$%%/";

K P a g e 
Microeconomics

2. Along a few features, each of which has a 5%.%'#&of (continuous or discrete) values;
3. Across a large number of features, each of which has only a #$3#$ "flag".

In the second and third cases, it is possible to find out a product that is better than another one according to
one criterion but worse than it in respect to another feature.
Vertical differentiation is a property of the supplied goods but, as it is maybe needless to say, the $%/.
.%#$%#9'%"2 by different consumer will play a crucial role in the purchase decisions.
In particular, potential consumers can have %.$"%# of the features of the good (say because of
advertising or social pressure).
Consumer decision rules when the product is differentiated are presented in this paper.
When evaluating a real market, a good starting point is a top-down grid of interpretation; we shall present first
in 3 segments.

$'
%$ $%'"
Low R The price is low, the product simply works
Middle 
 Use of the good is comfortable. Most people use it. Mass market brand.
High
! Quality, exclusivity, durability
(= low life-long price),

To this basic classification, one should add two intermediate classes:

'
%$ $%'"
Middle-low R The cheapest nation-wide brand
Middle-high 
 The cheapest product of high quality

Two extreme classes should finally be added:

'
%$ $%'"
Extremely low R It usually does not work, it does not last, and it has important defects
Extremely High
! Exclusivity, non practical, status symbol

In this way, you can vertically position different brands and product versions, also using clues from advertising
campaigns.

KK P a g e 
Microeconomics

If you compare widely different goods fulfilling the same (highly-relevant) need, you may distinguish at the
extreme of your spectrum necessity goods and at the other luxury goods. In other cases, what makes this
difference is, instead, the nature of the need fulfilled.
As a general rule, better products have a higher price, both because of higher production costs (more noble
materials, longer production, more selective tests for throughput...) and bigger expected advantages for
clients, partly reflected in higher margins.
Thus, the quality-price relationship is typically upwards sloped. This means that consumers without their own
opinion nor the capability of directly judging quality may rely on the price to infer quality. They will prefer to
pay a higher price because they expect quality to be better.
This important flaw in knowledge and information processing capability - an instance of bounded rationality -
can be purposefully exploited by the seller, with the result that not all highly priced products are of good
quality .
Through this mechanism, the demand curve - that in the neoclassical model - is always downward sloped, can
instead turn out to be in the opposite direction.

%4#"'.%#"%"%#
When products are different according to features that can't be ordered, a horizontal differentiation emerges
in the market. A typical example is the ice-cream offered in different tastes. Chocolate is not "better" than
lemon. Horizontal differentiation can be linked to differentiation in colors (different color version for the same
good), in styles (e.g. modern / antique), in tastes. This does not prevent specific consumers to have a stable
preference for one or the other version, since you should always distinguish what belongs to the supply
structure and what is due to consumers' subjectivity.

It is quite common that, in horizontal differentiation, the supplier of many versions decide a unique price for
all of them. Chocolate ice-creams cost as much as lemon ones.
When consumers don't have strong stable preferences, a rule of behavior can be to change often the chosen
good, looking for variety itself. An example is when you go to a fast food and ask for what you haven't eaten
the previous time.
Fashion waves often emerge in horizontally-differentiated markets with imitation behaviors among consumers
and specific styles going "in" and "out".

K P a g e 
Microeconomics

  $/   &'




In economics and mostly especially in the theory of competition, barriers to entry are obstacles in the path of a
firm that make it difficult to enter a given market.[1]
Barriers to entry are the source of a firm's pricing power - the ability of a firm to raise prices without losing all
its customers.
The term refers to hindrances that an individual may face while trying to gain entrance into a profession or
trade. It also, more commonly, refers to hindrances that a firm (or even a country) may face while trying to
enter a market, industry or trade grouping. Barriers to entry restrict competition in a market.
!"

! defined an entry barrier as A cost of producing which must be borne by a firm which seeks to
enter an industry but is not borne by firms already in the industry.[2]

A barrier to entry is anything that prevents entry when entry is socially beneficial
Franklin M. Fisher(Diagnosing Monopoly 1979)[3],
Barriers to entry enable market control by limiting the number of competitors and thus the availability of close
substitutes. Barriers that limit entry into the supply side of market mean that buyers have fewer buying
alternatives, which give the sellers greater market control. Barriers that limit entry into the demand side of
market means that seller have fewer seller options which give the buyers greater market control.
The four primary barriers to entry are: (1) resource ownership, (2) patents and copyrights, (3) government
restrictions, and (2) start-up cost.

%"#"2#.1""$"
1.? Perfect competition: Zero barriers to entry.
2.? Monopolistic competition: Low barriers to entry.
3.? Oligopoly: High barriers to entry.
4.? Monopoly: Very High to Absolute barriers to entry

0 .  - 

%$.%$%%#"%#
Practice of selling goods or services at different prices to different buyers, even though sales costs are the
same for all the transactions. Buyers may be discriminated against on the basis of income, ethnicity, age, or

K( P a g e 
Microeconomics

geographic location. For price discrimination to succeed, other entrepreneurs must be unable to purchase
goods at the lower price and resell them at a higher one.

A pricing strategy that charges customers different prices for the same product or service. In pure price
discrimination, the seller will charge each customer the maximum price that he or she is willing to pay. In more
common forms of price discrimination, the seller places customers in groups based on certain attributes and
charges each group a different price. -Investment Dictionary.
Types of price discrimination
First degree price discrimination
In first degree price discrimination, price varies by customer's willingness or ability to pay. This arises from the
fact that the value of goods is subjective. A customer with low price elasticity is less deterred by a higher price
than a customer with high price elasticity of demand. As long as the price elasticity (in absolute value) for a
customer is less than one, it is very advantageous to increase the price: the seller gets more money for fewer
goods. With an increase of the price elasticity tends to rise above one. One can show that in the optimum the
price, as it varies by customer, is inversely proportional to one minus the reciprocal of the price elasticity of
that customer at that price. This assumes that the consumer passively reacts to the price set by the seller, and
that the seller knows the demand curve of the customer. In practice however there is a bargaining situation,
which is more complex: the customer may try to influence the price, such as by pretending to like the product
less than he or she really does or by threatening not to buy it.
$#..&%$.%$%%#"%#
In second degree price discrimination, price varies according to quantity sold. Larger quantities are available at
a lower unit price. This is particularly widespread in sales to industrial customers, where bulk buyers enjoy
higher discounts.
In reality, different pricing may apply to differences in product quality as well quantity. For example, airlines
often offer multiple classes of seats on flights, such as first class and economy class. This is a way to
differentiate consumers based on preference, and therefore allows the airline to capture more producer's
surplus.
!%..&%$.%$%%#"%#
In third degree price discrimination, price varies by attributes such as location or by customer segment, or in
the most extreme case, by the individual customer's identity; where the attribute in question is used as a
proxy for ability/willingness to pay.

KV P a g e 
Microeconomics


  $1
  &   !- '
  '
!!".5#%#"
When a firm is making a loss, it will have to decide whether to continue production or not. This decision will, in
fact, depend on the different total costs levels and whether the firm is operating in the short run or in the long
run.
If the firm is in the !"#, and is making a loss whereby:
o? Total costs (TC) is greater than total revenue (TR)
o? and whereby total revenue is greater or equal to total variable cost (TVC)
it is advisable for the firm to continue production. If it fails to achieve these conditions, it is advised to close
down so that the only costs the firm will have to pay will be the fixed costs.
Even if the firm stops producing, it will have to continue to meet the level of fixed costs. Since whether the
firm produces or not, it will have to pay fixed costs, it is better for it to continue production in an attempt to
decrease total costs and increase total revenue, thus making profits. This can be done by:
o? Increasing productivity. The most obvious methods involve automation and computerization which
minimize the tasks that must be performed by employees. All else constant, it benefits a business to
improve productivity, which over time lowers cost and (hopefully) improves ability to compete and
make profit.
o? Adopting new methods of production like Just in Time or lean manufacturing in an attempt to reduce
costs and wastages.
In the '#&#, the condition to continue producing requires the price P to be higher than the ATC, i.e. the line
representing market price should be above the minimum point of the ATC curve.
If P is equal to ATC, the firm is indifferent between shutting down and continuing to produce. This case is
different from the short run shut down case because in long run there's no longer a fixed cost (everything is
variable).

K  2
 & 

.5%&!"'
In economics, a deadweight loss (also known as excess burden or allocative inefficiency) is a loss of economic
efficiency that can occur when equilibrium for a good or service is not Pareto optimal. In other words, either
people who would have more marginal benefit than marginal cost are not buying the product, or people who
would have more marginal cost than marginal benefit are buying the product.

K P a g e 
Microeconomics

Causes of deadweight loss can include monopoly

pricing (see artificial scarcity), externalities, taxes
or subsidies (Case and Fair, 1999: 442), and binding
price ceilings or floors. The term deadweight loss
may also be referred to as the "excess burden" of
monopoly or taxation. For example, consider a
market for nails where the cost of each nail is 10
cents and the demand will decrease linearly from a
high demand for free nails to zero demand for nails
at $1.10. In a perfectly competitive market,
producers would have to charge a price of 10 cents
and every customer whose marginal benefit
exceeds 10 cents would have a nail. However if
there is one producer who has a monopoly on the
product, then they will charge whatever price will yield the greatest profit. For this market, the producer
would charge 60 cents and thus exclude every customer who had less than 60 cents of marginal benefit. The
deadweight loss is then the economic benefit forgone by these customers due to the monopoly pricing.
Conversely, deadweight loss can also come from consumers buying a product even if it costs more than it
benefits them. To describe this, let's use the same nail market, but instead it will be perfectly competitive, with
the government giving a 3 cent subsidy to every nail produced. This 3 cent subsidy will push the market price
of each nail down to 7 cents. Some consumers then buy nails even though the benefit to them is less than the
real cost of 10 cents. This unneeded expense then creates the deadweight loss: resources are not being used
efficiently.

()   - 

Ans:
Discussion of monopolistic competition by Chamberlin and Joan Robinson has shown that firms under
imperfect competition operate with excess capacity. According to these economists a firm under monopolistic
competition produces on output in the long run equilibrium, which is less than socially optimum or ideal
output.

K P a g e 
Microeconomics

In other words, they do not produce that level of output at which long run average cost is minimum. The will
happen when the firms operate at a point on the falling portion of the long run average cost curve. A firm
under monopolistic competition attains long run equilibrium when the demand curve (AR curve) facing it is
tangential to the long run average cost curve so that it may earn only normal profits. Since they are operating
on the falling portion of the long run average cost curve, the firms can reduce their average cost by expanding
their output to the minimum point of the Y
long run average cost curve. But they do not
LM
increase their output, because their profits
have already been maximized at the level of LAC
F
output smaller than at which their long run P S
average cost would be minimum. This
happens at a point where equality between
marginal revenue and marginal cost has E

been attained. MR AR

The operation of the firm under

monopolistic competition is shown it the O M N X
figure. In this case, the long run equilibrium OUTPUT
is achieved at OM output at which marginal
revenue is equal to marginal cost and price is equal to average cost. Here average revenue curve (AR) is
tangent to average cost curve (AC) at point F corresponding to output OM. It can be seen that at output OM
average cost is still falling and it continues to fall up to ON and thus reduce its long run average cost to the
minimum. Hence the ideal output is ON where the long run average cost is minimum. This means that this firm
is producing MN quantity less than the ideal output. Hence MN output represents excess capacity which
emerges under monopolistic competition.

K P a g e