PJC_H2_ECONS_P2_Q2

Pioneer Junior College (Economics Department) 1 PJC 2017 H2 Prelim Exam Paper 2 Question: The firm’s decisions and strategies are affected by cost, revenue, and threat from existing and potential competitors. (a) Explain how producers in imperfect markets make rat ional price and output decision based on cost and revenue consideration. [10] (b) Discuss the extent to which the behaviour of firms is in fluenced by the threat of competition. [15] Producers in imperfect market would make rational d ecision of maximising profit by producing at an output where marginal cost is equal to marginal revenue (MC=MR). They would also attempt to price discriminate if they have control over the market t o maximize profits. In the case where they earn subnormal profit, it would also make decisions whet her to shut down or continue production to maximise profit. Producers will aim to produce at the output where MC=MR to maximise profit. In Figure 1, Producers will produce at Q M, where MC = MR to maximise output and sell it at p rice = PM as indicated by the AR (DD) curve. If producers pr oduce at Q 1, which is below profit maximising output, the marg inal revenue is MR 1 while marginal cost is MC 1. This means that the additional revenue is more than additional cost and producers could generate more revenue and profit if they increase output towards Q M. On the other hand, producers produce beyond Q M, for example, Q 2, the marginal cost of producing at Q 2 is MC 2 while marginal revenue is MR 2. This means that producers can reduce cost by reducing it s output, leading to an increase in profits. Hence, producers would decrease its output to increase its profits. At Q M, where MC=MR, producers cannot increase its profits any fu rther by changing its output. Hence, producers will produce at output Q M, and price it at P M to maximise profit. For producers who dominate the market (e.g.: Monopo ly), they could also practice price discrimination to maximise revenue and profit. Price discrimination is the practice of charging di fferent prices for the same product or services for reasons not due to cost differences. It can occur when producers have control of market supply, able to separate the market with little cost and the sep arate markets have different price elasticity of demand. For example, public transport firms are able to cha rge a lower price for students and elderly, where their demand is price elastic (due to high proporti on of income spent). This would allow public transport companies to earn higher revenue as the l owering of price will result in a more proportionate increase in quantity demanded, leadin g to an increase in total revenue. On the other hand, they will be able to charge a higher price fo r working adults