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EXAMINATION QUESTIONS

1. Microeconomics as a science, its methodology and methods.


2. Basic problem of the organization of economic activity.
3. Production possibilities curve and rational economic choice. Opportunity cost.
4. Positive and normative analysis.
5. The nature of the demand. Demand function. The determinants of demand.
6. Market demand versus Individual demand.
7. The nature of the supply. Supply function. The determinants of supply.
8. Market supply versus individual supply.
9. Market equilibrium establishment and price of equilibrium.
10. Applied aspects of the model of demand and supply. Consequences of the government
intervention in the market mechanism (by fixing the prices, taxation, subsidies).
11. Preferences, prices and income as general determinants of consumer behavior. Assumptions
of consumers preferences.
12. Utility as the economic category. Utility functions.
13. Total and marginal utility. The law of the diminishing of marginal utility.
14. The marginal rate of substitution of goods and the slope of indifference curves.
15. Indifference curve analysis.
16. Budget constraint of a consumer
17. Consumer equilibrium.

Interior and corner solutions.

Consumer equilibrium means that condition, which gives him/her maximum utility from full
use of income.
The consumption decision of a rational consumer is motivated by the desire to maximise
utility or satisfaction. But this decision is constrained by his limited purchasing power. Given
the assumptions about consumer's preferences, we can draw the indifference curves showing
different levels of satisfaction. Three such indifference curves, I0, I1, I2 are drawn in Figure
3.27. The budget line AB contains commodity bundles which are purchasable. The
consumption bundles like a, b, c lying on the budget line AB are purchasable. The consumer
will choose that commodity bundle which lie on the highest indifference curve. The
consumption bundle b on indifference curve I1 is the obvious choice because the alternative
commodity bundles such as a and c are located on lower indifference curve I0. The
indifference curve lying above I1, such as I2. consists of commodity bundles which are not
attainable with the given budget line AB.
The consumption choice of b from among alternative consumption bundles maximises the
utility subject to purchasing power limitations specified by the budget line. The consumer is
in equilibrium at point b because he has no incentive to choose any other commodity bundle.
Note that consumption choice at b contains OX0 amount of good X and 0Y0 amount of good

Y. At the equilibrium consumption point b, budget line AB is tangent to the indifference


curve I. Since the negative of the slope of the indifference curve is called MRSx,y and the
negative of the slope of the budget line is (Px/Py), the condition for equilibrium consumption
choice is given by the equation written below :
MUX/MUY= PX/PY

18. Income - consumption curves.


We now, consider the effect of a change in M on equilibrium consumption demand, if P, and P,
are held constant. Consider a rise in M at fixed prices. We have earlier stated that the purchasing
power of money income in terms of good X is (MIPX) and the purchasing power in the units of
good Y is (MIPY). When M rises, both MIPX and MIPY rises. In other words, the consumer can
purchase more of both X and Y if M rises at fixed prices. However, this does not mean that the
consumer will actually increase the consumption of both X and Y. The division of higher
purchasing power among various items of consumption depends on consumer's preferences.
There can be five possible changes in consumption pattern:
(i) both X and Y rise
(ii) X rises but Y falls in such a way that the rise in P,X is higher than the fall in PO'
(iii) X falls and Y rises such that the rise in P,Y is higher than the fall in P,X
(iv) X rises but Y remains constant
(v) X remains constant but Y rises.
We give below a graphical analysis of each situation

In Figure 3.31, the budget line has a constant slope. The initial budget line as well as income
level is indicated by M0 and the corresponding consumption choice by commodity bundle a. If
income rises to M1, the budget line have a parallel rightward shift to M1 and the new
consumption choice is shown by the commodity bundle b. The diagram shows that bundle b
contains more of both X and Y than bundle a. Therefore, income rise leads to a rise in the
equilibrium consumption of both X and Y. If we imagine many equilibrium consumption choices
like a. b starting from the origin and lying on an upward-sloping curve OE, we have a complete
picture of how equilibrium consumption plan changes with the change in the level of income.
The upward-sloping line OE is the income-consumption curve (ICC).

19. Engel curves.


The Engel curve shows the equilibrium consumption of one of the two goods as a function of
income, prices remaining unchanged.
If we take drawn in Figure 3.31, we see that the consumption of X rises by the same proportion
as the rise in income. By plotting M on the horizontal axis and X on the vertical axis, we draw
the Engel curve as a straight line through the origin in Figure 3.38.

The real life Engel curve need not always be straight line. In general, when income rises, the
consumption of a good may rise by a proportion greater than or less than the rise in income. The
Engel curve in Figure 3.39, is convex from below, implying that X/M rises as M rises.

A luxury is defined as a good for which the proportion of income spent (EXIM) rises with the rise
in income. A necessity is defined as a good for which (EXIM) falls as income rises. On average,
the proportion of income spent on food decreases (i.e., the proportion of income spent on nonfood items increases) with the increase in income.
20. Price - consumption curves and derivation of demand curve.

21. Price elasticity of demand.


If we denote the amount of 'all, other goods' by Z and price per unit of Z by Re. I. expenditure on
all other goods equals Rs. Z. The budget equation can be written as
M = PxX + Z or Z= -PxX + M

22. Income elasticity of demand.


23. Cross price elasticity of demand.
24. Supply elasticity.
Price elasticity of supply measures the degree of responsiveness of quantity supplied of a
commodity to change in its own price.
The value of elasticity of supply can be calculated by the formula:
Ex= Percentage change in the quantity supplied / Percentage change in price
This may be expressed as:
Ex=(Q/Q) / (P/P) = (Q/ P) x (P/ Q)
Elasticity of supply is positive since the supply curve slopes upwards from left to right. However,
in case of backward bending supply curve the supply curve will have a segment on which Ex is
negative.
Types:

Periods of Supply Elasticity

(a) Momentary: In the momentary period or the very short run supply is fixed and E, is zero.
(b) Short run: In the short run supply can be varied with the limit of the present fixed assets
(buildings. machines. etc.). Thus E, in the short run is generally low.
(c) Long run: In the long run all factors may be varied and firms may enter or leave the industry.

25. Applied aspects of the theory of elasticity.


26. The production function.
27. Isoquants and their characteristics.
28. Production with one variable input.
29. Total, average and marginal product of a variable input and the interdependence between
them.
30. Production with two variable inputs. MRTS.
31. Returns to scale. Determinants of increasing and decreasing returns to scale. Constant returns
to scale.
32. The Nature of production costs. Explicit and implicit costs. Accounting and Economic costs.
33. The cost function.
34. Isocost lines and their characteristics.
35. Short - run cost.
36. Optimal combination of input factors for a firm.
37. Long - run cost.
38. Economies and diseconomies of scale.
39. The nature and features of perfectly competitive markets. The competitive firms demand
curve.
40. Total revenue total cost approach.
41. Total Revenue and profit of the firm. Accounting, economic and normal profit.
42. Marginal revenue marginal cost approach: profit maximization, losses minimization and
shut-down decisions.
43. A perfectly competitive firm and market supply curve in the short-run.
44. Long-run equilibrium in perfectly competitive firm.

45. Pure monopoly and its properties.


46. Monopoly demand. Monopoly total revenue and its maximization.
47. The demand for a monopolist product. Marginal revenue curve for a monopolist.
48. Short-run profit maximization and losses minimization by monopoly firm.
49. Social price of monopoly.
50. Monopoly power.
The monopoly power consist in the capacity of the firm to set the price of its products at a higher
level as marginal cost, modifying the supply quantity. The power of the monopoly firm depends
on the available substituents of this good and on the market quota of the firm. When trying to
maximize the profit, the monopoly firm has to modify the production volume or the selling price,
and when he decide to modify the quantity supplied, it has to minimize the price. So the price is
higher than marginal revenue and higher than marginal cost. The difference between selling price
and marginal cost can be used to evaluate the monopoly power. Another coefficient used to
calculate the monopoly power is the elasticity coefficient of the demand in relation with the
price.
51. Price discrimination under monopoly.
Price discrimination consists in firm application of different prices for different unities of the
same product, and this action hasnt any link with the cost differences. Price discrimination in
possible only if the monopoly firm can divide buyers in dependence with their demand elasticity
and if the reselling of its goods are impossible. There are 3 types of price discrimination:
-

Perfect price discrimination (1st degree) suppose that for each particular buyer it will set
a particular price. Perfect price discrimination can be only if the monopoly firm knows
the consumer demand curve and sell each unit of good at the demand price (at the higher
price which the consumer is able to buy a certain quantity of goods). By knowing the
reservation price, the seller is able to sell the good or service to each consumer at the
maximum price he is willing to pay, and thus transform the consumer surplus into
revenues. So the profit is equal to the sum of consumer surplus and producer surplus. The
marginal consumer is the one whose reservation price equals to the marginal cost of the
product. The seller produces more of his product than he would to achieve monopoly
profits with no price discrimination, which means that there is no deadweight loss.
Examples of where this might be observed are in markets where consumers bid for
tenders, though, in this case, the practice of collusive tendering could reduce the market
efficiency.

2nd degree price discrimination consist in the setting of the same price for all
consumers, but differ in relation with the quantity purchased. Larger quantities are

available at a lower unit price. This is particularly widespread in sales to industrial


customers, where bulk buyers enjoy higher discounts. Additionally to second degree price
discrimination, sellers are not able to differentiate between different types of consumers.
Thus, the suppliers will provide incentives for the consumers to differentiate themselves
according to preference. As above, quantity "discounts", or non-linear pricing, is a means
by which suppliers use consumer preference to distinguish classes of consumers. This
allows the supplier to set different prices to the different groups and capture a larger
portion of the total market surplus.
-

In third degree price discrimination, price varies by attributes such as location or by


customer segment, or in the most extreme case, by the individual customer's identity;
where the attribute in question is used as a proxy for ability/willingness to pay.

52. Monopolistic competition and its properties.


Monopolistic competition is an intermediary type of market which combines elements of
monopoly market and those of the market with perfect competition as high competition and an
insignificant part of monopoly power. This type of market is distinctive for clothes, shoes
production, furniture, food production and others.
Monopolistically competitive markets have the following characteristics:
- There are many producers, and each of them has a small share on the market and a limited
control over the price.
- There are different products which dont represent perfect substituents of goods offered by
other firms. Each firm has a unique role as a seller of a certain quantity of goods, possessing a
certain market power, who own the monopoly in a narrow specialized field. The differentiation
of the goods can appear through its quality, services, placement, package, and others.
- There are few barriers to entry and exit. In the long run there are no entry and exit costs. There
are numerous firms waiting to enter the market, each with their own "unique" product or in
pursuit of positive profits. Any firm unable to cover its costs can leave the market without
incurring liquidation costs. This assumption implies that there are low start up costs, no sunk
costs and no exit costs.
- Firms dont take care on the competitors reactions. On the market there isnt an
interdependence between firms and when one of them decide something about the price and
production volume, it doesnt mind about the competitors reactions.
53. Short-run equilibrium under monopolistic competition.
Monopolistic Competition is a market structure featuring few large and many small firms, fairly
low entry barriers similar goods and relatively high competition. The short-run, is a time period

in which at least one factor of production is fixed and firms can usually gain some abnormal
profit.

The firm will produce quantity Qs at price Ps. The firm produces where marginal cost (MC) and
marginal revenue (MR) curves meet, because MC is the cost of producing an one more of the
good and MR is the revenue of selling one more good and their meeting point is the most
efficient production. This means that the shaded area between Ps, ACs (average cost of
producing one good at this quantity) and the AR curve (average revenue curve) is the abnormal
profit the firm makes. AR is equivalent to the demand curve and is the average revenue the firm
makes per item sold. Producing at this point ensures the highest amount of profit. Thus,
equilibrium is created in the short run.
54. Long-run equilibrium under monopolistic competition.
Monopolistic Competition is a market structure featuring few large and many small firms, fairly
low entry barriers similar goods and relatively high competition. The long-run period is when all
factors of production are variable. In the long run, there are no abnormal profits because of the
features of Monopolistic competition. There are a few large firms, but many small firms that will
compete for profit and thus drive the price down. Also, low entry barriers mean new firms will
enter the market and further add competition. Finally, the goods are similar enough to ensure that
competition will always remain high.

In this diagram, the firm produces where the LRMC, or long run marginal cost curve, and the
marginal revenue curve meets. The LRMC describes the cost of producing one more of the good
when no factors of production are fixed over the long run. That point is, in the long run,
equivalent to the LRAC, or long run average cost curve, which shows them average cost of
producing one good at this quantity over the long run. Because the LRAC curve is above the AR
curve, there is no abnormal profit, as the average cost of the good equals the average revenue of
the good. Thus, in the long run, equilibrium is acquired.
55. Monopolistic competition and economic efficiency. Excess capacity.
Monopolistically competitive markets are less efficient than perfectly competitive markets. In
terms of economic efficiency, firms that are in monopolistically competitive markets behave
similarly as monopolistic firms. Both types of firms' profit maximizing production levels occur
when their marginal revenues equals their marginal costs. This quantity is less than what would
be produced in a perfectly competitive market. It also means that producers will supply goods
below their manufacturing capacity. Firms in a monopolistically competitive market are price
setters, meaning they get to unilaterally charge whatever they want for their goods without being
influenced by market forces. In these types of markets, the price that will maximize their profit is
set where the profit maximizing production level falls on the demand curve.This price exceeds
the firm's marginal costs and is higher than what the firm would charge if the market was
perfectly competitive. Regardless of whether there is a decline in producer surplus, the loss in
consumer surplus due to monopolistic competition guarantees deadweight loss and an overall
loss in economic surplus.
Excess capacity. The difference between the quantity of products which correspond with the
minimum level of long-run average cost and the quantity of products offered by the firm in
conditions of long-run equilibrium is called excess capacity of firm production

56. Monopolistic competition, pure monopoly and perfect competition: comparative


analysis.
In conditions of monopolistic competition, firms offer differentiable goods, in contradiction to
homogeneous ones offered by firms from perfect competition market, and unique goods offered
by pure monopoly firms. In monopolistic competition industry, consumers are imposed to pay
higher prices for differentiate goods. In perfect competition market, economic profit become
equal with 0 (zero) when the price is equal with minimum total average costs for long period
(P=LRACmin). So in case of equilibrium for long-run activity of perfect competition,
P=LRMC=LRACmin. Consumers buy goods at the minimum possible level of price. The prices
reflect minimum average costs for one unit of production and marginal cost.
The firm modify the price until MR=MC. Because the price is always bigger than marginal
revenue, in conditions of equilibrium the price will be higher than marginal cost. The equilibrium
of the firm from monopolistic competition resembles (se aseamana) with the equilibrium in the
monopoly situation through the idea that prices are higher than marginal costs. Because here
exist barriers to enter the market, in case of monopoly market, the price in long-run can be higher
than average costs. In conditions of monopolistic competition, free entrance on the market,
doesnt permit the existence of economic profit for a long period of time. The profit gained by
firms attract in this field other firms and maintain the prices at a lower level than in case of
existence of a monopoly firm. So, in conditions of monopolistic competition, prices are lower as
in case the products are offered by a monopoly firm, but the price level is higher as in case the
products are offered by firms from perfect competition.
57. The role of advertizing in the monopolistic competition
Some of the arguments in favor of advertising are
- advertising is informative,
- advertising increases sales and permits economies of scale,

- advertising increases sales and contributes to economic


growth,
- advertising supports the media,
- advertising increases competition and lowers prices.
Some of the arguments against advertising are
- advertising is not informative but competitive,
- the economies of scale are illusory,
- advertising raises the cost curve,
- advertisers may use their influence to bias the media,
- advertising is used as an entry barrier, and
- advertising is not a productive activity.
58. Oligopoly and its properties.
Oligopoly is a situation on the market where exist a limited number of producers (more than one)
and a big number of consumers. The main characteristics of oligopoly are:
A few large producers. Usually three, four, or five firms occupy the market
Homogenous or differentiated products. Some oligopolistic industries offer homogenous, or
standardized, products, e.g. those of steel, zinc, copper, lead, industrial alcohol. Other industries,
e.g. those of automobiles, tires, electronics, breakfast cereal, offer different products and place an
emphasis on nonprice competition, such as advertising.
Price maker, but still mutually interdependent. The small number of firms let oligopolies to
set prices and output levels, to some extent. However, because there are rival firms, oligopolies
must take note at how they react to its change in price, output, product or advertising.
-Strategic Behavior: self-interested behavior that takes into account the reactions of others
-Mutual interdependence: profit doesn't depend entirely on its own price and strategies
Relatively high entry barriers. Entry barriers exist that allow a handful of firms to achieve
economies of scales, but no more beyond that. Any new firms would have too small a market
share and would have to produce at too high a price. Sometimes the cost of capital is too high
and other times, ownership and control of the raw materials is a factor. Patents and brand loyalty
are also barriers of entry into an oligopolistic market.