April 2008 Q12

[manifold]

I'm having trouble getting the answer out to Q12 because the marginal cost / revenue curve are crossing each other more than once. Would someone mind talking me through the answer (B) please?

12. A firm is part of a monopolistically competitive market. It is known to be in a long run equilibrium position and earning only normal profits.

Output    Total Revenue    Total Cost
100          500                 600
200        1,000                700
300        1,200                900
400        1,900              1,200
500        2,000              2,300

From the information given in the table what will be the output of the firm?

A Greater than 100 but less than 200
B Greater than 200 but less than 300
C Greater than 300 but less than 400
D Greater than 400 but less than 500

 

[callum.stewart]

Total Revenue = Total Cost (normal profits) twice, with outputs roughly between 0 and 150 and between 400 and 500 if you plot the 2 against output. I don't know why you would chose one over the other apart from the fact that only one is covered by any of the options - D

 

[manifold]

I'd agree, but the examiners report says the answer is B which is why I'm confused.

Output        "Profit"   Marginal revenue     Marginal costs
   0 - 100    -100      500                       600
100 - 200     300      500                       100
200 - 300     300      200                       200
300 - 400     700      700                       300
400 - 500    -300      100                     1100

They're in a long-run equilibrium which implies that MR = MC. This will actually occur three times for the given figures, but for the sake of argument it looks like the examiners were expecting the answer "200 - 300" as they are explicitly equal in the workings above. However, at this level the company is making supernormal profits so it can't be B.

I agree that they're making normal profits between 100 - 200 and 400 - 500, and the other places that MR = MC are somewhere in 0 - 200 and 300 - 500, but it's impossible to be more exact than that. That suggests to me that the answer could be A or D, but equally it may not be depending on the shape of the curves.

I almost wonder if there's a typo in the question or the answer... but it seems more likely that I'm missing something very obvious.

 

[callum.stewart]

Please don't trust anything i said, i recognised a couple of words from when i did economics in 1st yr uni and typed it into wiki! Something doesn't seem right though...

 

[Margaret Wood]

Don't worry!

Don't worry about this question. It is a poor question.

Firstly, there is a flaw in the question itself. The question says that the firm is operating in monopolistic competition and it is in a long-run equilibrium position making only normal profits. However, if we look at the table, we can see output levels where total revenue exceeds total cost, ie the firm can make supernormal profit. Since we assume that firms always operate to maxmimse profits, presumably the firm will do so. Therefore it cannot be in long-run equilibrium. We must instead find the short-run equilibrium position.

Secondly, the anwer given by the examiners (B) is not the profit-maximising position. At an output of 200 and 300, only £300 profit is earned, whereas at an output of 400, £700 profit is earned. The examiners have used the MC=MR rule, but have not realised that MC=MR twice in this case. If you plot MC and MR between the output levels, then MC=MR at both 250 and somewhere between 350 and 400. The second one is the relevant one, because here MC is rising and MR is falling, ie profits are falling from increasing output (whereas at an output of 250, MR is rising so profits are rising from increasing output).

For a fuller explanation and diagrams see ASET.

 

[manifold]

Thank-you!