Question

1. Compare and contrast economic and accounting profits.  Explain why a firm in a perfectly competitive market would choose to remain in business, if its profit is zero at equilibrium. Illustrate any theories or concepts you decide to use to answer this question with numerical examples.

b. Complete the table below by filling in YES, NO, or MAYBE for each type of market structure.  

Do Firms:	Perfect Competition	Monopoly	Oligopoly
Make differentiated products?	NO	MAYBE	YES
Have Excess capacity?	NO	MAYBE	YES
Advertise	NO	NO	YES
Pick Q so the MR = MC?	YES	MAYBE	YES
Pick Q so that P = MC	YES	NO	NO
Earn economic profits in long-run equilibrium?	YES	NO	YES
Face downward-sloping demand curve?	NO	YES	YES
Have MR less than price?	NO	YES	YES
Face the entry of other firms?	YES	NO	YES
Exit in the long run if profits are less that zero?	YES	NO	YES

c. Class, can you provide an example of a company that operates in each of these industries?  Please discuss how the concept of barriers to entry and market power apply to each of these companies and the industries in which they operate.

d. Class, do you think society is better off under a monopoly or when the economy is dictated by perfect competition?  Do you think governments should step in to break up monopolies in order to increases efficiencies that can translate into more savings for consumers? Is there any cases where a government should let a monopoly exist?

Answer 1

a) Accounting profit only includes the economic costs and revenues that a firm incurs and gains. It is the difference between the economic cost a firm incurred and the revenues it earned. Economic profit includes both economic as well as opportunity costs to calculate profits.

Firms continue to operate under zero profits as at the level of zero profits the firm is earning exactly the costs it incurs. At zero profit the firm is making the best utilization of its resources and can easily operate at this level. The firm is earning equilibrium returns.

c) Perfect competition: Agricultural markets are an example of perfect competition. There are no barriers to entry in perfect competition due to homogeneity of products as is in the case of agricultural markets. Sellers would keep entering the market as long as the profits are high and would leave the market when the profits are less than zero. In the long run, the industry cannot make economic profits and can only break even. No individual seller or buyer has the power to affect the prices in the market due to the homogeneous nature of products.

Monopoly: Railways in India is an example of monopoly. There are restrictions imposed by the government and only the government has complete authority over railways in the country. There are barriers to entry and new firms are not allowed to enter the market in case of monopolies. The market power resides solely with the firm that exercises monopoly in the market. In the case of Indian railways, the government has full authority to revise the costs and prices as and when they want. However, they still need to set prices so as to continue making economic profits.

Oligopoly: Automobile industry is an example of an oligopoly market. Companies like Ford, Chrysler, etc. retain a major share of the market and can affect prices in the market. Oligopolies tend to maintain their dominance in the market and hence make it too costly or difficult for other sellers to enter the market. The oligopolies retain a major share of the market and have the power to affect market prices.

d) The kind of market depends on the nature of good being sold. Most necessity goods like health care and transportation need to be a monopoly of the government in order to ensure that competition does not lead to rise in prices and the consumers are not harmed in the process. However, goods like sugar, fruits, etc. that are not easily differentiated do not need any intervention and their demand and supply can easily be dependent on the forces of the market.