Question

True/False/Uncertain

Answer each of the following statements True/False/Uncertain. Give a full explanation of your answer including graphs where appropriate. (When in doubt, always include a fully labeled graph.)

A) Average variable cost is equal to average total cost in the long-run.

B) Firms in a perfectly competitive market can earn positive profits in the short and long-run.

C) A monopolist conducting perfect price discrimination does not maximize total surplus.

Answer 1

A) In the long run, there is no fixed cost and all costs are variable, and hence average of them would also be the same. The correct option is True.

B) Firms in a perfectly competitive market may earn positive profit in the short run, but not in the long run. The reason is that, in the short run, firm may have the production function that imposes lower average cost, and hence make positive or supernormal profits. But in the long run, as due to the existence of assumption of free entry and exit, many firms attract in the the market as they see those profits which results in increase in supply and decrease in price. As price decreases, upto the point where price is equal to the minimum of average cost of the product in the firm, the profits are zero in the long run. Hence, the correct option is False.

C) The total surplus is equal to the consumer surplus (CS) and producer surplus (PS). When a monopolist conducts a perfect price discrimination, they basically captures all the CS, along with producing at the competitive output in the market. The competitive output is pareto efficient, in the sense that it leaves no deadweight loss, and have the maximum total surplus as against in a normal monopoly pricing. Hence, the perfect price discrimination does grabs the whole total surplus and leaves no consumer surplus, it does maximize the total surplus available in the market as it produces at marginal cost equal price level, and hence produces at competitive output, and leaves no deadweightloss.

As can be seen in the above figure, the producer surplus is the yellow shaded area. The per unit price charged is equal to the demand curve. But the total surplus is maximum as there is no deadweight loss in the market.