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QUESTION 12 Which of the following is NOT an assumption of perfect competition: a. There are...

QUESTION 12

Which of the following is NOT an assumption of perfect competition:

a. There are no barriers to entry.

b. All firms have access to the same technology and input factors.

c. All firms pay the same price for input factors (and if quantity discounts apply, all firms buying the same input quantity face the same price).

d. Firms try to push competitors out of the market by setting the price of the product they sells at a level that is lower than the competitors’ price.

e. There are no barriers to exit.

f. Consumers are small in the sense that they cannot individually affect the market, so they behave as price-takers.

QUESTION 13

If electricity retailing is a natural monopoly in a particular location, a regulatory agency could improve economic efficiency by:

a. Introducing competition by allowing entrant firms to use the incumbent firm’s distribution network, after paying a regulated fee equivalent to the marginal network usage cost.

b. Capping the electricity price.

c. Regulating the business’ rate of return.

d. All of the above.

Please explain both answers to question 12 and 13! Thank you!

Solutions

Expert Solution

12. In a perfectly competitive market the sellers have the freedom for entry and exit. There are no barriers to the entry of new firms and the exit of the existing firms.

Perfect competition exists in the factor market. Each seller ha access to similar state of technology and inputs.

The price of factors is same to all the firms.

The firm has the option to remain or exist the industry. No barriers to the exit of the firm.

The perfect competition is characterized by large number of small buyers and sellers. No individual seller or buyer can influence the market price by his own action. The seller and buyer in this market is a price taker.

The demand curve facing a competitive firm is perfectly elastic. The individual seller cannot reduce his own price in order to catch more shares in the market. The supply made by a single seller is a small fraction of the entire output of the industry. Thus the price cut done by a single seller has no effect upon the market. The single seller is a price taker and not a price maker. All units can be sold by the price fixed by the industry.

Answer: d. Firms try to push out competitors out of the market by setting the price of the product they sell at a level that is lower than the competitor’s price.

13. Most of the monopoly firm operates below the full capacity. They restrict the output and charge a high price. But in competitive market the firms are operating with their full capacity and thus they set the price at the lowest level of their average unit cost. The natural monopoly is operating at the inefficient level of output. Thus the efficiency of a natural monopoly market can be improved by allowing competitors in the market.

The efficiency in a natural monopoly can be improved by regulating price. The government can introduce price ceiling on the natural monopoly. This will improve its allocative and productive efficiency.

The regulation on the rate of return also improves the efficiency of natural monopoly.

Answer: d. All the above


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