Companies in a Monopolistic Competitive Market - Assignment Example

ASSESSMENT TWO Solution The local firm in Abu Dhabi that is operating under a perfectly competitive environment should shut down in the short run. Given that the price in market is 4 AED and the firm produces 30 units, its total revenue will be 120 AED (30 × 4). Given that the firm’s total cost is 500 AED and its fixed cost is 200 AED, the firm’s variable cost is 300 AED (500-200). Therefore, for an output of 30 units, which yields revenues of 120 AED, the firm should shut down in the short run because the total revenue of 120 AED is less than 300 AED of variable costs. It is irrational for the firm to lose 200 AED in fixed costs to realize 120 AED in revenue. The firm would be worse off, if it produced in the short run because the total loss that the firm will incur in this case is 380 AED (120-500). It is prudent if the firm shuts down and saves 200 AED rather than losing 380 AED in the short run. At the point where the firm produces 30 units and sells each unit at 4 AED, MRC (marginal revenue cost) is less than AVC (average variable cost). Solution 2 Assuming that Coke has already attained the monopoly status such that Coke is a monopolist, Coke actively engages itself in price discrimination because it has price setting power (Carbaugh). Given that there is a difference in price elasticity of demand for Coke in various regions, the company varies its price and extracts consumer surplus, which leads to additional revenue and profit. Coke discriminates on price by selling its product to distributors at different prices. For instance, the price of the same can of Coke in Seattle is higher than it is in Sidney. Separately, consumers from the UK purchase Coke at a higher price, compared to consumers from other countries within the continent. When Coke is able to separate the markets, it makes profits denoted by area MC, P, X, Y + MC1, P1, X1, Y1. The price charged when Coke separates the market will be P while output Q will be produced in a relatively elastic sub-market. Coke will charge a lower price in a relatively inelastic sub-market (P1). Solution 3 When duopolists, Etisalat and Du form a cartel between themselves, the firms would want to maximize their joint profits by producing a smaller quantity and charging higher prices. The optimal total industrial output selected by Etisalat and Du would be the monopoly quantity (Agarwala). It would be agreed that Etisalat and Du contribute in production of the agreed quantity and then share the profit between them equally. Consequently, the price and output in the market will be affected in that the quantity produced by the firms will be reduced while the prices will go up. This is because as the two firms seek to maximize profits jointly, they will agree to reduce the quantity that they will produce so that they can charge higher prices and make profit by sharing the share of output and profits. The firms will maximize their profits where MR=MC (QM), which is lower than Q1. This means that the firms will charge higher prices (PM compared to P1) and make supernormal profits (area A). Solution 4 The suggestion by a policy maker that the government should split the entire of DEWA a monopolist unit into small pieces so that competition can drive down prices will not have any effect in terms of price reduction. This is because economies of scale will not be achieved, and it will be difficult for new firms to enter the market, given the high initial costs production. In case the government manages to bring in competition; prices will be lowered to P1, given that quantity produced will increase to Q1. The only revenue realized by DEWA and other firms (area A) will be so low that it will not cover the costs and this will discourage all firms from the market. Solution 5 Gas Station A Gas Station B High price Low price High price 200,000 AED; 200, 000 AED 50,000 AED; 400,000 AED; Low price 400,000 AED; 50,000 AED 80,000 AED; 80,000 AED; In consideration n of the pay-off matrix, the dominant strategy adopted by Gas Station A by lowering price will result into Gas Station A making a profit of 400,000 AED while Gas Station B realizes only 50,000 AED. Similarly, when Gas station B uses its dominant strategy of low price, it will realize a profit of 400,000 AED while Gas Station A will only realize 50,000 AED as profit. Therefore, the dominant strategy is 400,000 AED from charging low price and 80,000 from charging high price. Charging the low price will be the maximum pay off matrix. In case the Gas Stations collude, they would agree to raise prices together, leading to a profit of 80,000 AED for each Gas Station. Solution 6 Companies in a monopolistic competitive market produce low quantity and charge high prices, compared to companies in perfect competition. A firm in a monopolistic competition market earns supernormal profits in the short run. In monopolistic competition, more efficient firms continue to earn supernormal profits in the long run (Jain and Sandhu). This is the reason why a cosmetic firm operating in a monopolistically competitive market environment spends a lot of money in advertisement and ends up with super-normal profit even in long run. The firm is capable of charging high prices to offset advertisement costs, given that it is efficient and has differentiated its products. Works Cited Agarwala, S.K. Microeconomics. New Delhi: Excel Books India Press, 2008. Print. Carbaugh, Robert J. Contemporary Economics: An Applications Approach. New York: M.E. Sharpe Press, 2013. Print. Jain, TR and AS Sandhu. Microeconomics. New York: FK Publications, 2014. Print. Read More