Question

Definitions/Short Answers

1. What are the factors that make a market perfectly competitive?

2. Dead weight loss

3. Consumer surplus

4. Price floor

5. Price Supports

6. Suppose the price elasticity of demand is -2. What is economic meaning of the price elasticity of demand?

7. Two-part tariff

8. Perfect price discrimination

Answer 1

1. Perfect competition is a sort of market where there are large number of buyers and sellers for a homogenous product and the price is determined by the forces of demand and supply. The individual buyer or seller has no control over the market. The factors that make a market perfectly competitive are: 1) Existence of large number of buyers and sellers, 2) Homogenous product, 3) Perfect knowledge about the market, 4) Freedom of entry and exit, 5)Independent decision making, 6)Perfect mobility of factors, and 7) No transport cost.

2). Deadweight loss is the loss of satisfaction to the society which arises out of inefficient allocation of resources. When the market is not producing at its equilibrium point, there is a reduction in total welfare to the society and this loss is known as deadweight loss. When the market price is above the equilibrium price, the quantity demanded falls below the quantity that the producers are willing to supply. When the market price falls below the equilibrium price, the quantity supply falls below the quantity that the consumers are willing to buy. This lack of production and consumption cause reduction in total surplus.

3) Consumer surplus is the difference between the price that the consumers pay for a commodity and the price that they are willing to pay. For example if the consumer is willing to pay for a commodity $5 and he gets the commodity at $3. The difference $2 is the consumer surplus.

4) Price ceiling and price floor are the two price controls introduced by the government. Price floor is fixing minimum price above the market equilibrium price below which no sale is permitted. This is implemented during times of falling price to ensure higher and more stable income to the producers

5) The price support is a method where the government protects the producers by buying the surplus from the market in order to prevent the falling of prices below a certain level.

6) The price elasticity of demand is the degree of change in demand due to a given change in price. It explains how much demand increase with fall in price and decrease with rise in price. The elasticity of demand is negative for normal goods. It means that if price increase the demand decrease.

7) Two part tariff is a type of price discrimination followed by monopolist. Under this the monopolist charge a fixed price and per unit price. For example for amusement park, there is an entry fees and per unit usage fees.

8) Under perfect price discrimination the monopolist charge maximum price that the consumers are willing to pay and leave no consumer surplus. Each unit is sold at the maximum price that the consumers are willing to pay. This is otherwise known as the price discrimination of the first degree.