Question

a)What is the primary facet of perfect competition that does not allow for the presence of long-run economic profits? Explain.

b)Discuss why economists view a single-price monopoly market structure as inefficient.

c)Airports typically charge a higher price for parking during holidays than they do during other times of the year. What type of pricing strategy is this an example of and why is it optimal? Explain.

d)Would you expect the demand for a monopolistically competitive firm's product to be more or less elastic than that for a monopolist's product? Explain.

Answer 1

a)What is the primary facet of perfect competition that does not allow for the presence of long-run economic profits? Explain.

A firm in a perfectly competitive market might be able to earn economic profit in the short run, but not in the long run.

The existence of economic profits attracts entry, economic losses lead to exit, and in long-run equilibrium, firms in a perfectly competitive industry will earn zero economic profit. It will induce entry or exit in the long run so that price will change by enough to leave firms earning zero economic profit.Suppose there are two industries in the economy, and that firms in Industry A are earning economic profits. By definition, firms in Industry A are earning a return greater than the return available in Industry B. That means that firms in Industry B are earning less than they could in Industry A. Firms in Industry B are experiencing economic losses.

Given easy entry and exit, some firms in Industry B will leave it and enter Industry A to earn the greater profits available there. As they do so, the supply curve in Industry B will shift to the left, increasing prices and profits there. As former Industry B firms enter Industry A, the supply curve in Industry A will shift to the right, lowering profits in A. The process of firms leaving Industry B and entering A will continue until firms in both industries are earning zero economic profit. That suggests an important long-run result: Economic profits in a system of perfectly competitive markets will, in the long run, be driven to zero in all industries.

b)Discuss why economists view a single-price monopoly market structure as inefficient.

In a monopoly, the firm will set a specific price for a good that is available to all consumers. The quantity of the good will be less and the price will be higher (this is what makes the good a commodity). The monopoly pricing creates a deadweight loss because the firm forgoes transactions with the consumers. The deadweight loss is the potential gains that did not go to the producer or the consumer. As a result of the deadweight loss, the combined surplus (wealth) of the monopoly and the consumers is less than that obtained by consumers in a competitive market. A monopoly is less efficient in total gains from trade than a competitive market.

Monopolies can become inefficient and less innovative over time because they do not have to compete with other producers in a marketplace. For private monopolies, complacency can create room for potential competitors to overcome entry barriers and enter the market. Also, long term substitutes in other markets can take control when a monopoly becomes inefficient.

c)Airports typically charge a higher price for parking during holidays than they do during other times of the year. What type of pricing strategy is this an example of and why is it optimal? Explain.

Value based pricing strategy is represented in this example.

As the demand(value) for parking is high during holidays,higher prices will be charged than other times of the year .

Value based pricing sets prices primarily on the perceived or estimated value to the customer (rather than on the cost of the product, the market price, competitors' prices, or historical prices). The goal of value-based pricing is to align the price with the value of the product.

It is optimal because it enables the airports to maximize their profits during the boom period(i.e holidays) as the customers are also ready to pay more during that period.

d)Would you expect the demand for a monopolistically competitive firm's product to be more or less elastic than that for a monopolist's product? Explain.

The monopolistically competitive firm's product is differentiated from other products, the firm will face its own downward‐sloping “market” demand curve. This demand curve will be considerably more elastic than the demand curve that a monopolist faces because the monopolistically competitive firm has less control over the price that it can charge for its output. The firm's control over its price will depend on the degree to which its product is differentiated from competing firms' products. If the firm's product is not differentiated from other products, the firm will face a relatively elastic demand curve and will have less control over the price it can charge. If the firm's product is differentiated compared to a competing firm's products, the firm will face a relatively inelastic demand curve and will have more control over the price that it can charge.