Name Instructor Course Date Microeconomic of the firm 1. Price Taking (10 points) We assume that competitive firms are "price takers." Explain what this means. What is keeping competitive firms from setting prices? Is this a plausible assumption? For which industries is it a likely assumption?…
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In this respect, the firms only have the option of working with the prevailing price or lower. This constitutes what taking price is. There are various assumptions that compel the firms in this market to take prices. Sellers and buyers are many and any action towards increasing prices will only worsen sales through migration of buyers. Products are homogeneous and change of price will only divert buyers to get the same products from other firms selling at the prevailing or lower prices. These assumptions play a significant role in pushing firms to take the market prices or fail. Some of the industries with such assumptions include clothing and textile, Cosmetics, electrical and electronics industry among others. Some industries like medicine and drugs, energy among others cannot accommodate these assumptions hence exhibit other market structures. 2. Shut-down Point for a Firm (20 points) When will the competitive firm shut down in the short run? When will it incur a loss but continue to produce? Draw a graph showing each scenario and explain. It is important to note that shut down point is the level of output and price where the firm can just cover its total variable cost. Some of the key issues to consider in determining this point include; relative position of the average variable cost which is always at its minimum for this condition. Where the marginal cost curve crosses the average variable cost curve also sums up to shut down of the firm. At this point, the producer is indifferent between producing and temporarily shutting down. The firm incurs a loss from either action. In the event that market prices fall below the firm’s average variable cost, temporary shutdown is preferable in the short run. In case the firm continues to produce, losses from its operation merely add to losses that results from the firm’s fixed costs and shut down will lead to slump in losses. Figure 1 : Shut down when P < AVC ATC Price MC AVC P = MR Quantity A price taking firm that intends to remain operational will minimize losses or maximize profit if it will be able to produce the output level at the point where P = MC and variable costs are also covered. In this case, the portion of the firm’s short run marginal cost curve which lies above its average variable cost becomes the short-run curve of the firm. Figure 2: retrieved on May 13, 2013 from: http://www.analystnotes.com/notes/subject.php?id=119 Considering the grahp above, in case the price is below P1, the firm should shut down its operation. Long-Run Cost Curve, Economies of Scale, and Firm Size (15 points, 5 points each) A. Explain how economies of scale and the long-run cost curve influence firm size and firm concentration. The theoretical presentation starts with the short-run and shows the average cost curves (Total, fixed and variable) along with the marginal cost. The curves are presented in Figure 1 MC ATC cost in $ AVC AFC Quantity Figure 1. Short-run unit cost curves: marginal cost (MC), average total cost (ATC), average variable cost (AVC) and average fixed cost (AFC). The short-run cost curves are normally based on a production function with one variable factor of production that displays first increasing and then decreasing marginal productivity. Increasing marginal productivity is associated with the negatively sloped portion of the marginal cost curve, while decreasing marginal productivity is associated with the positively sloped port
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