CHAPTER 5: Perfect Competition 1a. a perfect competitor, since there are numerous farmers in this market, easy entry and exit, and a standardized product (once beef has been graded and cut) whose price is determined by the interaction of demand and supply in the market b. an oligopolist, because this business operates in a market dominated by only a few firms c. a monopolistic competitor, given that there are many businesses of this type in a large metropolitan area, relatively easy entry and exit, and differences (relating to location and/or quality) in the products sold by each business d. a perfect competitor, since there are numerous sellers in this market, easy entry and exit, and a standardized product whose price (for example, expressed in US$) is determined by the interaction of demand and supply in the market e. an oligopolist, because this business operates in a market dominated by only a few firms f. a monopolist, given that this business is the sole seller of a product with no close substitutes g. a monopolistic competitor, because there are many visual artists, who find it relatively easy to enter or exit this occupation and whose products have differences based on quality and/or the medium used h. a monopolist, since this country is the sole producer of a product with no close substitutes i. a monopolistic competitor, given that there are many businesses selling books online, and each sells very similar (though not identical) items j. an oligopolist, because there are likely only a few sellers of any one type of antique porcelain china k. an oligopolist, because there are likely only a few wireless providers in any given region or country 2a. Column 1 (price): 0.48, 0.48, 0.48, 0.48, 0.48, 0.48, 0.48, 0.48; Column 5 (marginal revenue): 0.48, 0.48, 0.48, 0.48, 0.48, 0.48, 0.48, 0.48; Column 6 (marginal cost): 0.23, 0.16, 0.20, 0.29, 0.39, 0.54, 0.95, 2.07; Column 7 (average cost): 0.41, 0.29, 0.26, 0.27, 0.29, 0.33, 0.42, 0.63; Column 8 (profit): -18, 7, 39, 67, 86, 95, 89, 42, -117. This gardener operates in a perfectly competitive market, since price is constant at 48 cents per kilogram, no matter how much this gardener decides to sell. b. 500 kilograms. At this quantity of output, profit in column (8) of the table reaches its highest positive value of $95. This value can be derived using the profit-maximizing output rule, since 500 kilograms is the quantity at which marginal costs in column (6) are closest to the business s marginal revenue of 48 cents per kilogram. This is because marginal cost has a value lower than marginal revenue between 400 and 500 kilograms (39 cents), and a value higher than marginal revenue between 500 and 600 kilograms (54 cents). Chapter 5 43
c. FIGURE 5A 1 Profit-Maximization Graph for a Vegetable Gardener The profit-maximizing point is at point a on the graph. The gardener's $95 profit is shown by the area of the shaded rectangle ($0.19 x 500), whose height ($0.19) is the difference between price ($0.48 at point a) and average cost ($0.29 at point b), and whose width is quantity of output (500). d. The breakeven point occurs at a price of 26 cents and a quantity of 300 kilograms (point c), which is the minimum point on the AC curve. Chapter 5 44
3a. FIGURE 5A-2 Total Revenue and Total Cost Curves for a Vegetable Gardener b. - Chapter 5 45
c. The profit-maximizing output of 500 kilograms occurs when the business s profit, as shown in the top accompanying graph by the difference between total revenue ($240 at point a) and total cost ($145 at point b), reaches a maximum of $95. In the bottom accompanying graph, this is shown by the maximum point (point c) on the total profit curve. 4a. Column 1 (price): 0.80, 0.80, 0.80, 0.80, 0.80, 0.80; Column 3 (total revenue): 0, 72, 176, 246, 288, 308, 320; Column 6 (total cost): 400, 455, 510, 565, 620, 675, 730; Column 7 (average fixed cost): 4.44, 1.82, 1.30, 1.11, 1.04, 1.00; Column 8 (average variable cost): 0.61, 0.50, 0.54, 0.61, 0.71, 0.83; Column 9 (average cost): 5.05, 2.32, 1.84, 1.72, 1.75, 1.83; Column 10 (marginal cost): 0.61, 0.42, 0.63, 1.04, 2.20, 3.67. b. FIGURE 5A 3 Profit-Maximation Graph for a Fisher c. 307 kilograms. This value can be derived using the profit-maximizing rule, since 307 kilograms is the quantity at which marginal costs in column (10) are closest to the fisher s marginal revenue of 80 cents per kilogram. This is because marginal cost has a value lower than marginal revenue between 220 and Chapter 5 46
307 kilograms ($0.63), and a value higher than marginal revenue between 307 and 360 kilograms ($1.04). At this quantity, the fisher is making a loss of (- )$319 (= 246-565). Based on the graph drawn in answer to part b above, the profit-maximizing point (point a) occurs where the horizontal marginal revenue curve intersects the marginal cost curve. The fisher's $319 loss is shown by the area of the shaded rectangle ($1.04 x 307), whose height ($1.04) is the difference between price ($0.80 at point a) and average cost ($1.84 at point b), and whose width is quantity of output (307). d. The breakeven point occurs at a price of $1.72 and a quantity of 360 kilograms (point c), at the minimum point on the AC curve. The shutdown point occurs at a price of $0.50 and a quantity of 220 kilograms (point d), at the minimum point on the AVC curve. The business s supply curve is the marginal cost curve above the shutdown point. The breakeven point represents the price and related profit-maximizing quantity where the fisher is making a zero economic profit--in other words, only normal profits. The shutdown point represents the lowest possible price and related quantity at which the fisher will continue his occupation in the short run. The business s supply curve shows the quantity supplied by the fisher at each possible price of mackerel. e. Because he continues to make a loss, the fisher will leave the industry in the long run. 5. These conditions support Adam Smith s contention that the profit-maximizing behaviour of business-owners can provide products to consumers and at the lowest possible price and in a way that maximizes consumer benefits. As long as minimum-cost pricing is met, with price equal to minimum average cost, businesses are taking advantage of all possible cost advantages associated with increasing returns to scale and they are passing on all of these cost savings to consumers. As long as marginal-cost pricing is met, with price equal to marginal cost, every unit of a product for which extra benefits to the consumer exceed the extra costs to the producer is being produced. But these conditions show that the invisible hand of competition works completely only when markets are perfectly competitive and in long-run equilibrium. There is no guarantee that real-world markets, which rarely are perfectly competitive and rarely reach long-run equilibrium, fully satisfy these conditions. Chapter 5 47
6. FIGURE 5A-4 Long-Run Supply in an Increasing Cost Industry Chapter 5 48
7. Both types of programs hinder the achievement of marginal-cost pricing, since with either program the affected perfectly competitive market cannot reach long-run equilibrium, where price and marginal cost are equal. With a price ceiling, actual output falls short of the output level where price and marginal cost are equal. With a price floor, the prevailing output is above this equilibrium output level. Nor will the conditions of minimum cost pricing be met with either type of program. With a price floor, suppliers sell at a price higher than at the long-run equilibrium point where price equals minimum average cost. With a price ceiling, suppliers are forced to sell at a price lower than at the equilibrium point, but not all consumers can gain these savings, given the product shortage. Internet Application Questions 1a. Important barriers are: (1) restrictions on foreign ownership of Canadian airline companies, (2) the special rule stating that no one can own more than a certain percent of Air Canada s shares, (3) the difficulty in acquiring terminal facilities at some Canadian airports, and (4) airline companies ability to stop others using their computerized reservation systems. b. If the federal government removed these barriers, it might create a more competitive Canadian airline industry, but new entrants would likely be foreign airlines. Many Canadians would dislike foreign companies flying Canadian airline routes, even if this were to reduce airfares and improve quality of service. Such political realities mean that the article s suggested methods for increasing competition are unlikely to be adopted soon. 2a. According to the article, the four largest retail Internet companies (Bell, Telus, Rogers and Shaw) control two thirds of the market, with other companies, including wireless-based upstarts, already serving one third of the market (p. 11). b. Globerman argues that, because of the meaningful threat of entry in the retail Internet market, existing providers, though relatively dominant in the market, are heavily constrained from overcharging their customers, since they know that high prices will quickly attract new competition (p. 12). ANSWERS TO QUESTIONS AT THE END OF 'HOW RESOURCE MARKETS OPERATE' 1a. Column 3 (marginal product): 120, 80, 70, 50, 20, 10, -10; Column 4 (average product): 120, 100, 90, 80, 68, 58.3, 48.6. Marginal product is positive when the first six workers are hired, since throughout this employment range total product rises when employment is increased. Marginal product is negative when the seventh worker is hired, since total product declines when employment is increased beyond six workers. b. When marginal product is positive and declines, total product rises at a lower and lower rate. Once marginal product becomes negative, total product falls. Because marginal product falls from the first worker onward, average product also declines as more workers are added. The two are only equal when the first worker is hired. Chapter 5 49
c. FIGURE 5A-5 Total, Marginal, and Average Product Curves for Ham-It-Up Radios Chapter 5 50
These curves differ from those in Figure 4.3 because of the absence of a range of increasing returns. Thus there are no employment levels with rising marginal and average product, or with total product rising at a higher and higher rate. 2a. Column 3 (marginal product): 16, 12, 9, 7, 3; Column 5 (total revenue): 0, 48, 84, 111, 132, 141; Column 6 (marginal revenue product): 48, 36, 27, 21, 9. FIGURE 5A-6 Labour Demand and Supply Curves for a Salmon Fisher Wages ($ p er ho u r ) M RP=D b N o. o f Wo r k er s b. The fisher s marginal revenue product curve, MRP=D b, reflects the shape of the marginal product curve, since marginal product is multiplied by the constant product price of $3 to derive marginal revenue product. The horizontal labour supply curve, S 0 b, reflects the fixed $15 wage at which the fisher hires boat-hands. c. Using the profit-maximizing employment rule, boat-hands should be hired up to the point where marginal revenue product equals the fixed $15 marginal resource cost. The fisher will therefore employ 4 boat-hands, since each adds more than $15 to revenue. Using the graph, the labour demand and labour supply curves intersect at an employment level of 4 workers. d. Using the profit-maximizing employment rule, the fisher should now employ 3 workers, because each adds more than $24 to revenue. Using the graph, the labour demand and labour supply curves, D b and S 1 b, intersect at an employment level of 3 workers. 3. No, the demand and supply of entrepreneurship cannot be analyzed using Chapter 5 51
marginal productivity theory, because entrepreneurship cannot be measured in standard units. ANSWERS TO QUESTIONS AT THE END OF CAN CAPITALISM SURVIVE? 1. Possible reasons include (i) the rise in average tax rates in industrialized countries, which have caused a significant portion of voters to become alienated from big government and its supporters; (ii) the effects of the information revolution, which has provided a host of new entrepreneurial opportunities; and (iii) the increasing integration of national economies, which has made it difficult for national governments to pursue the same sorts of policies they once did. 2. Schumpeter might point to the changes that took place in the Canadian economy in the early 1990s, when a steep downturn in several traditional manufacturing industries, such as textiles, was accompanied by the beginnings of this country s high tech sector, with resources gradually moving from the former to the latter. According to Schumpeter s view, this movement of resources - while a costly misfortune for many involved in the declining industries - was a necessary creative phase that made the Canadian economy stronger in the long run. ANSWERS TO QUESTIONS AT THE END OF RESOURCE DEMAND (at the Online Learning Centre) 1a. Column 3 (marginal product): 16, 12, 9, 7, 3; Column 5 (total revenue): 0, 72, 112, 129.5, 132, 117.5; Column 6 (marginal revenue product): 72, 40, 17.5, 2.5, -14.5. FIGURE 5A 7 Labour Demand and Supply Curves for a Salmon Fisherman Chapter 5 52
b. The curve in part a declines more quickly than the labour demand curve in the previous question because, as employment increases, marginal product is now multiplied by lower and lower prices, rather than by a uniform $3 price. This reflects the price adjustments that must be made to sell new units of output in an imperfectly competitive product market. c. At a $10 wage, the fisherman should employ 3 boat-hands, since the amount each adds to revenue exceeds the $10 marginal resource cost. Using the graph, D b and S 0 b intersect at 3 workers. At a wage of $29, the fisherman should employ 2 workers, because the amount each adds to revenue exceeds the $29 marginal resource cost. Using the graph, D b and S 1 b intersect at 2 workers. 2a. Because silicon is a complementary resource in relation to labour, the demand for labour increases as a result of a fall in the price of silicon. b. Since this machinery is a substitute resource for labour, the demand for labour employed in making computer chips increases as a result of a rise in the machinery s price. ANSWERS TO QUESTIONS AT THE END OF A MEASURE OF JUSTICE (at the Online Learning Centre) 1. Aristotle s criticism of professional traders - that they make a profit at the expense of others - would elicit disagreement from most economists today. They would argue that the profit made by traders is not necessarily at the buyer s expense, but rather a payment for a service that the trader provides to the buyer. Just because this service is intangible does not necessarily make it any less beneficial to buyers than the goods they purchase from others. 2. Students may either agree or disagree with this Aristotelian criticism. Those agree may do so by arguing that it is ethically indefensible to place an exchange value on things such as a human life that should, by their very nature, be beyond monetary measurement. Those who disagree may do so by arguing that to place an exchange value on such concepts as a human life is not unethical if the valuation process is employed for something - such as the process of selling life insurance - that is widely considered to add human welfare. Chapter 5 53