ECONOMIC I

TUTORIAL 8
(CHAPTER 16,18)
Name: Chong Aee Lin
Chong Poh Lin
Question 1

For each of the following characteristics, say whether it

describes a monopoly firm, a monopolistically
competitive firm, both, or neither.

a) Faces a downward-sloping demand curve.

b) Has marginal revenue less than price.
c) Faces the entry of new firms selling similar
products.
d) Earns economic profit in the long run.
e) Equates marginal revenue and marginal cost.
f) Produces the socially efficient quantity of output.
Answer:
(a) Faces a downward sloping demand curve: BOTH
Both types of firms face a downward sloping demand curve, as
with increase in price people will always demand a lower
quantity of that good (based on the universal law of demand).

(b) Has a marginal revenue less than price : BOTH

Price is measured by the demand curve, and for both types,
marginal revenue curve lies below the demand curve,
indicating that any quantity level, price charged is higher than
the marginal revenue earned.
(c) Faces the entry of new firms selling similar products:
Monopolistically Competitive Firm
Monopoly firm faces no competition. Monopolistically
competitive market structure however, has the characteristic
of slightly differentiated and similar product, which allows
new firms to enter (until zero profit condition is reached in
the long run ).

(d) Earns economic profit in the long run: Monopoly Firm

Since, under monopolistically competitive firm structure,
new firms can enter in the long run, demand faced by each
firm decreases, thereby resulting in 0 profit in long run.
Monopoly firm, however, faces no competition.
(e) Equates marginal revenue and marginal cost for profit maximization:
BOTH
This is the profit maximizing condition for firms under both types of
market structure.

(f) Produces the socially efficient quantity of output: NEITHER

Both firms have some seller power, and so they can always manipulate
and adjust prices in a way such that socially efficient level of output is
not reached. Also, with theory of perfectly competitive markets, we know
that socially efficient level occurs where price charged equals the
marginal cost (such that no mark up exists), while there, price lies above
the marginal cost and so, quantity of output always lies below the
efficient level.
Question 2

Sparkle is one of the many firms in the market for

toothpaste, which is in long-run equilibrium.

a) Draw a diagram showing Sparkle’s demand curve,

marginal-revenue curve, average-total-cost curve, and
marginal-cost curve.
Label Sparkle’s profit-maximizing output and price.
Answer 2(a):

The market for toothpaste is monopolistic in nature in which there

are large number of buyers and sellers with a differentiated product.
The optimal point of production is where marginal cost and marginal
revenue are equal to each other. The long-run equilibrium is a point
where there are no profits. It is shown in the diagram below. Here,
Q1 is the profit maximizing level of output and price is P.

GRAPH
2b) What is Sparkle’s profit? Explain.

Answer:
It is given that the firm is in long run equilibrium.
The Average Total Cost is equals to price at point X
at quantity Q1. Hence, the profit of sparkle is zero.
2c) On your diagram, show the consumer surplus derived from
the purchase of Sparkle toothpaste. Also show the deadweight loss
relative to the efficient level of output.

Answer:
Consumer surplus is the difference between the consumers’
maximum willingness to pay and actual price level.
Diagrammatically, the area below the demand curve and above the
price line represents consumer surplus.

The consumer’s surplus from the purchase of sparkle toothpaste is

A+B area as shaded. The efficient level of production (Q) is where
the demand curve intersects the marginal cost curve. Hence, the
deadweight loss is area C, the area above marginal cost and below
demand, from Q1 to Q.
2d) If the government forced Sparkle to produce the efficient
level of output, what would happen to the firm? What would
happen to Sparkle’s customers?

Answer:
If the government forced sparkle to produce the efficient level
of output then the firm would lose money because price is less
than the average total cost, so the firm would close its
operations in the long run.
If the government forced sparkle to produce, then sparkle
customers cannot earn consumer surplus because there is mo
production at all.
Question 3

Sleek Sneakers Co. is one of many firms in the market for shoes.

a) Assume that Sleek is currently earning short-run economic profit.

On a correctly labeled diagram, show Sleek’s profit-maximizing output
and price, as well as the area representing profit.

Answer:
The market for shoes for the Sleek Sneakers Co. in the short run is shown
in the below diagram.

GRAPH
The abbreviations D, MR, MC, ATC, P, Q represents the demand,
marginal revenue curve, marginal cost curve, average total cost curve,
price and quantity for shoes produced by the Sleek Sneakers Co. A
monopolistic competitive firm maximizes its profit where MR=MC and
the price is determined by using the demand curve. So the profit
maximizing quantity for the Sleek Sneakers Co. is Q and the price is P.
When the price P exceeds the average total cost, the firm makes profit.
The area representing the profit is in red color.
3b) What happens to Sleek’s price, output, and profit in the
long run? Explain this change in words, and show it on a
new diagram.

Answer:
When the shoe firm earns economic profits in the short-run, it attracts
more firms into the market to avail the profits. When more firms enter
into the market, consumers have choice of more similar products in
the market and thus reducing the demand faced by each firm already
existing in the market. As a result their demand curve shifts towards
the left and the firms start experiencing declining profit in the long
run. The process of entry of new firms continues till there is no scope
of earning profits and that all the firms in the industry earn zero
economic profit. This is the case of long run equilibrium which
explained below diagram. GRAPH
3c)Suppose that over time consumers become more focused on stylistic
differences among shoe brands. How would this change in attitudes
affect each firm’s price elasticity of demand? In the long run, how
would this change in demand affect Sleek’s price, output and profit?

Answer:
When consumers become more stylish oriented regarding their shoe
brands, consumers demand for new stylish shoes will not be affected by
any significant change in prices. In some cases consumers are willing to
pay high prices for a new brand shoes. So the demand becomes price
inelastic- that is a proportionate change in price brings a less than
proportionate change in demand. Therefore, the demand curve becomes
steeper. The stylish newbrands will operate as a barrier to the other firms
and the increased prices above the average total cost may allow the Sleek
Sneakers Co. to earn normal profits in the long-run.
Question 4.

Leadbelly Co. sells pencils in a perfectly competitive product

market and hires workers in a perfectly competitive labor market.
Assume that the market wage rate for workers is $150 per day.

a) What rule should Leadbelly follow to hire the profit-

maximizing amount of labor?

■ As per rule – a profit maximizing-firm always employs labor

up to the point where the value of the marginal product of labor
(VMPL) equals the wage(W). So Leadbelly Co.hires labor up
to the point where the VMPL equals the wage rate of $150.
4b) At the profit-maximizing level of output, the marginal product
of the last worker hired is 30 boxes of pencils per day.
Calculate the price of a box of pencils.

ANSWER:
■ We know that at the profit-maximizing output, VMPL=W.
■ Given that W=$150
VMPL=MPL x P
MPL= 30
Since, VMPL=W
MPL X P = $150
30 X P = $150
Therefore, P = $150/30
= $5
4c) Draw a diagram of the labor market for pencil workers
(as in figure 4 of this chapter) next to a diagram of the labors supply and
demand for Leadbelly Co. (as in figure 3).
Label the equilibrium wage and quantity of labor for both the market
and the firm. How are these diagrams related?

ANSWER:
Like any other prices, the wage rate is determined by the demand and
supply of labor in its market. In fig (a) of the figure below, the wage rate
of $150 is determined at the point where demand equals the supply of
labor. The firm accepts this market wage rate as given and hires that
quantity of labor at which the VMPL=W ($150). Fig (b) of the diagram
shows the VMPL curve which is also the profit-maximizing firm’s labor-
demanded curve and that firm hires L amount of labor.
GRAPH
4d) Suppose some pencil workers switch to jobs in the growing
computer industry. On the side-by-side diagrams from part (c), show
how this change affects the equilibrium wage and quantity of labor for
both the pencil market and for Leadbelly. How does this change affect
the marginal product of labor at Leadbelly?
ANS =
■ When some pencil workers switch to jobs in the growing computer
industry, it reduces the supply of workers in the pencil industry. As a
result of this change, the supply curve of labor shifts to leftwards as
shown in the Fig (a) of the following diagram. When, supply of labor
decreases, the market wage rate will increase from $150 to W1. Now the
firm accepts this new market wage rate as given and hires that quantity
of labor at which the VMPL=W1. Fig(b) of the diagram shows that the
profit-maximizing firm will hire less quantity of labor – that is L1.
GRAPH
Question 5

Policymakers sometimes propose laws requiring firms to give workers certain

fringe benefits, such as health insurance or paid parental leave. Let’s consider
the effects of such a policy on a labor market.

a) Suppose that a law required firms to give each worker $3 of fringe

benefits for every hour that the worker is employed by the firm. How does this
law affect the marginal profit that a firm earns from each worker at a given
cash wage? How does the law affect the demand curve for labor?
Draw your answer on a graph with the cash wage on the vertical axis.
Answer:

5(a). The imposition of the $3 of fringe benefits raises the marginal

cost of the employers. The rise in the marginal cost reduces the
marginal profits of the employer. The increase in the cost leads to a
decline in the demand for labor. The demand curve shifts leftwards.
Cash Wage Supply

W1 Initial Equilibrium

W2

Demand
Demand’
Quantity Of Labor
Q2 Q1
5b) If there is no change in labor supply,
how would this law affect employment
and wages?

■ If there is no change in labor supply, still

there will be decrease in demand for labor
causing the reduction in employment and
a decline in the wage rate.
5c) Why might the labor-supply curve shift in response to this law?
Would this shift in labor supply raise or lower the impact of the law
on wage and employment?

■ The labor-supply curve might shift because the

implementation of the fringe benefits leads to an
increase in the wages of the labor. The rise in the
wages leads to an increase in the supply and the
supply curve shifts to the right. The increase in the
supply reduces the wages rate. The fall in the wage
rate might lead to the increase in the employment of
the labor.
The shift in the labor supply curve is shown below:
Cash Wage
S
S’

W1

W2

Quantity Of Labor
Q1 Q2
5d) As discussed in chapter 6, the wage of some
workers, particularly the unskilled and inexperienced, are
kept above the equilibrium level by minimum-wage laws.
What effect would a fringe-benefit mandate have for
these workers?
■ The imposition of the minimum wage law leads to an
increase in the wage rate, the demand for the labor
falls at the high wage rates. The imposition of the
fringe benefits further increase the wages. This leads to
further decline in the demand for labor. The gap
between the demand and supply of labor will
further increase.