Q1. A competitive constant cost industry always has a horizontal long run aggregate supply curve, true or false, explain
A long-term industry supply curve signifies that the minimum price at which the firm will offer various number for sale. Moreover, it also means that sufficient time is given for two things i.e. for adjusting plant size and to enter or leave the industry. The shape of the long-run industry supply curve depends on the behaviour of costs of production of an industry because the output of the whole industry is altered. Competitive constant cost industry is those industry in which in spite of expansion of input for the industry, the price and cost of production remains same. In other words, the long run supply curve is horizontal. An example of the competitive constant cost industry is match industry. Since, the entry of new firms brings about an increase in demand and does not affect the long-run average cost curve of an individual firm. It means that the minimum efficient level of production doesn’t change. The above-explained case is an example where the industry supply will have perfectly elastic curve because the factor i.e. the price remains unchanged, even when the industry expands, the additional unit will be produced at same unit cost. The reason for the occurrence of constant cost industry is most likely attributed to the industry’s very small demand for resources. The short-run supply curve will be shifted to the right as the production has already been stimulated, thereby increase in the supply. This process will continue until the market price drives it down to the initial level as a result the excess profit will also disappears completely. However, if the condition of the constant cost remains same the larger quantity will be offered for sale at the same price in long run. Therefore, in above discussed situation, the long-run industry supply curve will be completely elastic-----a horizontal straight line. Thus, the statement is correct.
Q2. In the short run profit maximizing firm produces output if it covers all its marginal costs. True or false, explain?
According to one of the output determining rule (i.e. MR=MC rule) make clear that in short run, the firm will maximize profit by producing the output at which marginal revenues equals marginal cost. That means, in the short-run, the firm has a fixed plant. Thus, the firm can adjust its output by making changes in its variable resources such as materials, labour etc that are used in producing the output. Perhaps, it adjusts its variable resources to achieve the output level that maximize its profit. Moreover, specifically, the firm compares the amounts or cost that each additional unit of output will add to total revenue and to total cost. In other words the firm compares the marginal revenues (MR) to the marginal cost (MC) of each successive unit of the output. Therefore, by estimating all above described values, if a firm covers all its marginal cost then its marginal revenues will exceed the marginal cost; this means that the firm will gain more revenues from selling that unit. Also, then producing will be more preferable than to shutting down the same. In addition to this, a firm can maximize its profit when an increment in margin percentage is equals to the reciprocal of the absolute value of the price elasticity of demand. That price will be its profit-maximizing price. Also, it has been analysed that when the marginal revenue cost is equal to the marginal cost, then the incremental margin percentage will be also equals to the reciprocal of the absolute value of the price elasticity of demand. Therefore, for maximizing profit the firm should set the price such that incremental margin percentage = -1/price elasticity of demand. Lets explain it with an example, suppose a firm find that at its present level of output, the cost of making another unit per month (marginal cost) is less than the revenue that would be gained by selling that unit (marginal revenue). So, producing another unit will be the better option for increasing the total profit by the firm. A change in the optimal level of output will be required by the firm in the short-run if there is a change in the market price to maximize its profit. It will lead to optimal output when the price will be equal to its marginal cost, as long as marginal cost will be greater than the average variable cost. Lastly, the firm will shut down the production only if the price falls below average variable cost. So, from the above discussion it is clear that the statement is true.
Q3. A monopolist continues to produce output even if it is suffering from loss given the good has positive income elasticity, true or false, explain?
Understanding of income elasticity is an important factor for the firm to see how changes in the macro-economy will change or convert into the demand for the good or service produced by it. There are two types of factors one which is influencing and dependent i.e. the consumption of goods items related to the luxuries is very much dependent on the changes in economic growth and consumer incomes. But on other side, factor does not have much impact on one other i.e. the necessities items such as food and housing are comparatively less affected by economic swings and the corresponding changes in consumer incomes. Accordingly, there are two possibilities for the goods to have positive income elasticity of demand i.e. the first possibility is to attain value greater than one for income elasticity of demand and second is that it lie in the range of 0 and 1.The former is in the case of luxury goods where for a 1% change in income, demand for the good changes by more than 1%. However the later one corresponds to the necessities goods where for a 1% change in income, demand for the good changes by less than 1%. Therefore, a firm is which is facing loss will continue to produce an output for following reasons. 1) As it will be recovered in the long-run when the economy will change which will brings changes in the income of the consumer in turn and thereby increase in the demand for its good. This is because the goods produced by the firm belong to the category of positive income goods. Increase in income will correspond to increase in demand either in greater (luxury) or comparatively lesser (general goods). 2) The shutting down the production is seems to be less favourable in terms of its profits. As the profit from production will likely to be more than the shutting down the same.
Q4. A monopolist having only fixed cost always sets a price at which price elasticity is greater than unity. True or false? Explain
Price elasticity is denoted as the percentage change in quantity demanded or supplied over the associated percentage change in price. Popularly, it is used to know the changes in quantity demanded or supplied will price increases or decreases of that commodity. This is known as either price elasticity of demand or price elasticity of supply. When the monopolists have only fixed cost but not variable cost, then maximizing revenue will be exactly same as maximizing profit. So, the monopolist will simply choose that point on the demand curve where the price elasticity is equal to one. A natural monopoly has found to have very disparate cost structure. For example, having a high fixed cost for a product and it does not depend on the output, but its marginal cost of producing one more good is more or less constant and found to be small. An important aim for any firm is significant return on investment, in order to fulfil this; the firm with high fixed costs should have a large number of customers. This is the main point where an economy of scale becomes important.
It is important to note that each firm incurs huge initial costs, but with the business gaining larger market share and increases it’s output. This results in reduction of fixed cost in large number of customers. Therefore, in industries that is having large initial investment as capital requirements, the average total cost decreases as there is increase in output over a large range of output levels.
