Demand and cost function
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1. Indicate whether each of the following statements is true or false and explain why.
a. A competitive firm that is incurring a loss should immediately cease operations.
b. A pure monopoly does not have to worry about suffering loses because it has the power to set its prices at any level it desires.
c. In the long run, firms operating in perfect competition and monopolistic competition will tend to earn normal profits.
d. Assuming a linear demand curve, a firm that wants to maximize its revenue will charge a lower price than a firm that wants to maximize its profits.
e. If P>AVC, a firm's total fixed cost will be greater than its loss.
f. When a firm is able to set its price, its price will always be less than its MR.
g. A monopoly will always earn economic profit because it is able to set any price that it wants to.
2. The demand and cost function for a company is estimated to be as follows:
P = 100 - 8Q
TC = 50 + 80Q - 100Q2 + 0.6Q3
a. What price should the company charge if it wants to maximize its profits in the short run?
b. What price should it charge if it wants to maximize its revenue in the short run?
c. Suppose the company lacks confidence in the accuracy of cost estimated expressed in a cubic equation and simply wants to use linear approximation. Suggest linear representation of this cubic equation. What difference would it make on the recommended profit-maximizing and revenue-maximizing prices?
3. In the short run, firms that seek to maximize their market share will tend to charge a lower price for their products than firms that seek to maximize their profit. Do you agree with this statement? Explain.
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Demand and cost function
1. Indicate whether each of the following statements is true or false and explain why.
a. A competitive firm that is incurring a loss should immediately cease operations.
False. The condition for shut down in short run is that the price should be more than average variable cost. A firm can be making losses under two circumstances.
1. If AVC>AR. In this case the firm is not able to able to recover its fixed costs in short run and should immediately cease operations.
2. If AVC<AR but AC>AR...the firm is able to recover some of its fixed costs but still be making losses. Since firm can cut its losses by continuing the operations in short run it should continue its operations.
Thus, answer is false.
b. A pure monopoly does not have to worry about suffering loses because it has the power to set its prices at any level it desires.
False. Although the firm is free to charge any price, the demand is determined by the price charged by the monopoly. If it increases the price, the demand will decrease. Generally, the marginal costs for a monopoly first decrease and then increase with volume whereas the marginal revenues always decrease with increase in volume. If there is no point on the graph where average cost is lower than the average revenues, the monopoly will incur losses no matter however the price it can increase. Thus, it is not always possible for the monopoly to make profits even by increasing price. Take one such scenario in following graph. The monopoly will always make ...
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