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Requirement
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Show how a perfectly competitive firm can make a loss in the short run and yet remain in the market. What happens to the firm in the long run?
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Compare the output and price levels in a market if it was structured as a perfectly competitive market or a monopoly market. Is a monopoly market bad for the economy? Use real-life examples to support your decision.
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What is your country’s current level of inflation? How it has been calculated? Do you think that the inflation that is present has demand-pull or cost-push origins? Justify your answer.
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What type of unemployment is common in your country and how this is different from other types of unemployment? What will be the cost to the economy of unemployment?
Solution
Question: 1
Show how a perfectly competitive firm can make a loss in the short run and yet remain in the market. What happens to the firm in the long run?
Answer: A perfectly competitive firm sells homogeneous products to the buyer and seller that are huge in number. The firm has the perfect knowledge about the market, the products and services and the other sellers in the market. The perfectly competitive firm does not have the ability to influence the price in the market, and it acts as the price taker (Kane, 2013). It cannot increase or decrease the price of its products in the market because when the firm increases the price, the customers either shift to other sellers because products are homogeneous, or the other sellers increase their price too when they see one firm increasing its price and if the perfectly competitive firm decreases the price, the other sellers also reduce the price to attract the customers (Makowski, 2014). Since the information flows freely, so the price cannot be increased or decreased as per the will of the firm.
In the short run, the loss is minimized by the perfectly competitive firm when MR=MC. In the above diagram, this condition is satisfied at Qf which is the quantity at the firm. This marginal revenue or the MR is coming from the market where the price is determined by the interaction of demand and the supply. The demand and supply interact in the market at Pm. So the market price is Pm and the quantity in the market is Qm. So, the perfectly competitive firm will take the price set by the market, i.e. it will take Pm as the price that became the marginal revenue of the firm (MR). Thus, this is the loss in the short run because the price is less than the average total cost. But the firm still remains in the market because it has the opportunity to earn revenue and produce till the price exceeds the average variable cost. So, the per-unit loss is the difference between the ATC and the point where the MR=MC. This is shown by the shaded area in the diagram. Thus, the firm may make the loss in the short run because the price may get lowered than the average total cost, but it will remain in the market because the price is still above the average variable cost, so it has the opportunity to produce.
In the long run, many firms will exit the market because there are losses in the market. When they exit the market, the supply will decline, and the supply curve of the market will shift left (Makowski, 2014). This will lead to a decline in the overall quantity supplied in the market from Q to Q' and the price will rise to P’ from P. The perfectly competitive firm will take this increased price and hence its MR curve will rise. It will rise up to the point where MR=MC=ATC. The quantity supplied by the firm will also rise from Qf to Q’f. This point O in the diagram is the break-even point. In the long run, the perfectly competitive firm remains at break-even because if it increases its price further, it will lose customers and if it decreases its price less than the break-even price, then other firms will also decrease their price and the market price will fall.
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Question: 2
Compare the output and price levels in a market if it was structured as a perfectly competitive market or a monopoly market. Is a monopoly market bad for the economy? Use real-life examples to support your decision.
Answer: In the perfectly competitive market, there are no limitations on the entry and exit of the firms in the market. Also, the information flows freely in the market. So, the sellers cannot influence the price at which they sell the products. They are the price takers. Whatever price is set by the market, the firms in this market have to sell at that price only. In the diagram, the price and output are determined by the interaction of the demand D' and supply curve S'. They meet at E and hence the quantity and price level at which goods are sold are Q and P.
In the monopoly market, there is just one seller who sells the goods that are highly differentiated. The single producer is controlling the entire market. Here, the market and the firm r the seller is the same thing. In the diagram, the AR or the average revenue curve is the price curve, and the MR curve is also downward sloping. The seller produces up to the quantity where MR=MC as beyond that level, the MC will rise higher than MR. The price set by the monopolist is P, and it earns revenue equal to the shaded area in the diagram.
By comparing both the markets, it can be said that perfectly competitive firm does not have the opportunity to control the output and the price, but the monopolist has this opportunity, he is able to charge a price that is more than the MR=MC point. It is able to earn more profits than a perfectly competitive firm (Rios, 2013).
The monopoly market is not bad because these firms invest large amounts in the R&D and make continuous efforts to supply good products to the customers (Case, 2012). They are bad only when the government makes them forcefully. Monopolies are formed by choice when they feel that they have some capability or resource which is entirely distinct and unique in the market. For example, Google is a monopoly. It is continuously investing in innovation, and a lot of free things are provided by Google to the customers. Thus the customers are getting benefitted from it.so; a monopoly like Google is not at all bad for the economy.
Question: 3
What is your country’s current level of inflation? How it has been calculated? Do you think that the inflation that is present has demand-pull or cost-push origins? Justify your answer.
Answer: Inflation is the rise in the general price level of a country. The current inflation level of Trinidad and Tobago is 3.4% (http://www.tradingeconomics.com). This rate of inflation in the country helps in measuring the rise and the fall in retail prices broadly. The acceptable level of inflation is 2%. Above that, inflation is considered to be higher.
This has been calculated by putting together the number of goods that are present in an economy and making a ‘market basket’ of those goods. The cost of this basket is calculated, and the costs are compared over time. Thus, a price index is created with this which represents the cost of the basket of the market goods. The rate of inflation is generally calculated on the basis of the consumer price index or the producer price index but in the country, Trinidad and Tobago, the consumer price index method is used to calculate the rate of inflation. In this method, the changes in the prices of consumer goods and the services are observed and recorded (Moosa, 2014). The goods and services consist of food, clothes, automobiles, gasoline, etc. then the changes in the price are measured from the point of view of the purchaser.
The inflation that is present has cost-push origins because this inflation generates due to the rise in the cost of wages in the country and the price of raw materials (Addison, 2013). So, the country has recorded rise in the prices of its raw materials, and the wages have also become expensive for past few years. There has been an increase in the costs of the factors of production and that has reduced the aggregate supply or the aggregate production in the economy. The amount of goods produced in a country is less, and therefore the supply of goods is less in Trinidad and Tobago. But there is no fall in the demand, the demand in this country remains constant. This makes the price of the final goods higher and thereby the rate of inflation in the country rises.
Question: 4
What type of unemployment is common in your country and how this is different from other types of unemployment? What will be the cost to the economy of unemployment?
Answer: Unemployment is a condition in which there are people who are not working, but they are looking for jobs and paid work. In the country Trinidad and Tobago, the generic unemployment is common. The problem of unemployment in this country has been historic. Since the First World War, the country is facing chronic unemployment and also tackling the issues of underemployment. The labor surplus is there in the country for a long time. It is generic because it is present in some class or group of people. The people who are working in the sugar industry are unemployed in Trinidad and Tobago. Then there is unemployment in the agricultural sector too because the people in Trinidad and Tobago have developed a negative attitude towards the agricultural work. The people wait for the jobs that pay them higher and are non-agricultural. This also caused the shortage in the agriculture industry as the prices of coca rose in the country, and the country got opportunities to export the products. The urban areas are more hit by unemployment than the rural areas in Trinidad and Tobago. Then, the rate of unemployment of women is higher than that of men in Trinidad and Tobago. There was petroleum industry in the country that was booming, but the industry did not require labor as it was capital intensive. This industry contributes more to the output, export and revenue of the government of the country but the contribution of this to the employment rate of the country is very less (Downes, 1998).
It is different from the other types of unemployment as the cyclic unemployment occurs in cycles. When a country is hit by a recession, the people lose jobs in that country. So, the unemployment is not permanent. It occurs for a season and then it disappears when the country recovers from the recession period. But the generic employment is not cyclical. Then the frictional unemployment occurs due to the labor market turnover and the people take a time to get themselves new jobs. During the time when the people change jobs, they remain unemployed, and hence the rate of unemployment in a country rises (Wagner, 2014). But this does not happen in the generic unemployment. The generic unemployment is also dissimilar to the structural unemployment because that occurs due to the lack of demand for the certain type of people. In the country, the people are demanded in the agricultural sector, but the people of this country are not willing to work in that sector.
The cost to the economy due to unemployment
With unemployment, the standard of living of the people of a country falls. They are not able to save anything, and they suffer from serious financial troubles. Then the skills of the people who remain unemployed for long time deteriorates and the extra cost are put on the companies for training them. The government has to borrow money from other sources to create the employment opportunities for the people. When people are not employed, the resources of the country stay idle, and the wastage is caused to the resources of the economy. The human capital also gets eroded, and the personal income of the unemployed people falls.
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Addison, J.T. and Burton, J., 2013. The demise of “demand-pull” and “costpush” in inflation theory. PSL Quarterly Review, 33(133).
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Case, K.E., Fair, R.C. and Oster, S.M., 2012. Principles of economics. Prentice Hall,.
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Downes, A., 1998. An economic analysis of unemployment in Trinidad and Tobago.
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Kane, J., 2013. Econ 101: Chapter 10 Perfect Competition.
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Makowski, L., 2014. Perfect Competition, the Profit Criterion, and the Organiza-tion of Economic Activity. Journal of Economic Theory, 22, pp.105-25.
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Moosa, I.A., 2014. THE MEASUREMENT OF INFLATION. In Quantitative Easing as a Highway to Hyperinflation (pp. 29-48).
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Rios, M.C., McConnell, C.R. and Brue, S.L., 2013. Economics: Principles, problems, and policies. McGraw-Hill.
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Wagner, B., 2014. Types of Unemployment. Montana Department Of Labour And Industry, Research And Analysis Bureau.
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