Chapter 9 (MR & MC)

Question 1

Marginal revenue

Answer 1

• Additional revenue from more sales or from selling one more unit
• marginal revenue depends on market structure (how competitive an industry is) and whether a business is a price taker or price maker
• MR = P for Price taking business in perfect competition
• MR < P for Price making businesses in all other market structures

Question 2

One Price Rule

Answer 2

Products easily resold tend to have a single price in the market
- MR<P for price makers so when a price making business lowers price, it must lower price on ALL units sold, not just new sales

Question 3

Marginal Cost

Answer 3

• as output increases marginal cost increases for businesses operating near capacity or when businesses additional inputs cost more.
• marginal cost is usually CONSTANT for businesses not near capacity

Question 4

Diminishing Returns

Answer 4

• as output increases, decreasing productivity increases marginal costs

Question 5

Recipe for Max Profits

Answer 5

• first looking at the quantity decision then the price decision
• for each quantity, compare MR & MC
• if MR > MC, total profits will increase. Stop increasing quantity when MR < MC
• once you choose the TARGET quantity with max profits, set the HIGHEST POSSIBLE PRICE allowing you to sell the target quantity
• the intersection of the MR curve and MC curve is the KEY to the recipe for max profits

Question 6

Price discrimination

Answer 6

Charging different customers different prices for the same product or service

• breaks the one-price rule and is possible only when a business can:
  1. Prevent low price buyers from reselling to high price buyers
  2. Control resentment among high price buyers

Elastic demand: lowers prices
Inelastic demand: rise prices

• most examples of price distribution involve services which cannot easily be resold
• price discriminating business eliminates MR and MC for each separate group, then sets prices allowing the sale of all quantities for which MR>MC

Question 7

Price discrimination increases profits by

Answer 7

1. Charging lower price to elastic demand group (lower willingness to pay)
2. Charging higher price to inelastic demand group (higher willingness to pay)

Question 8

Max Profits in Perfect Competition

Answer 8

Perfect competition with price-taking business, is an EFFICIENT market structure:
1. Businesses just earn normal profits and economic profits are 0
2. Maximum total surplus

Question 9

Max profits in all other market structures

Answer 9

All other market structures with price-making businesses are INEFFICIENT:
1. With the same inputs, businesses reduce output and raise prices
2. Businesses earn economic profits
3. Total surplus < perfect competition because of deadweight loss from reduced output

Question 10

Benefits to market structures with price making power and economic profits

Answer 10

• product variety
• economic profits finance innovations and creative destruction, improving living standards for all