Monopolistic and Oligopoly Firms: Second Tutorial Submission Question Assessment Answer
In the short run, a monopolistically competitive firm maximizes its profit at a point where MR is equal to MC. Depending on the cost structure of the firm, the firm will earn profit if its average total cost is less than demand at the point where MR=MC. Similarly, the firm will incur losses if its average total cost is higher than demand at the point where MR=MC. And if the firm’s cost structure is such that even the Average variable cost also exceeds price, then the firm should shut down in order to minimise its losses (Davies & Cline, 2005).
In the above graph, MR=MC at point where supply is 40 t-shirts and price is 12.5/t-shirt. However, at the point of 40 t-shirts, the demand curve dictates a price of 20/t-shirt.
- At this point where q=40, the ATC as given by ATC1 is $17.5/t-shirt. Hence, ATC1 (17.5) < D (20) which indicates that firm will earn a profit of 20-17.5 or 2.5/t-shirt. At 40 units, total profit will be 100.
- At this point where q=40, the ATC as given by ATC2 is $22.5/t-shirt. Hence, ATC2 (22.5) > D (20) which indicates that firm will incur losses of 2.5/t-shirt. At 40 units, total loss will be 100. The firm should consider its AVC and if AVC exceeds the demand price of 20/t-shirt, then firm should shut down or exit.
A monopolistic competition is characterised by presence of low barriers to entry of new firms in the market. This implies that if a market is exhibiting high profits, new firms will be attracted to enter the market and they can do so relatively easily due to low barriers. For example, a barrier such as an established trade brand existing in the market can be a barrier for a new entrant. Let’s say the toothpaste market is dominated by Colgate and in such a case, a new brand entering the toothpaste market will face a barrier due to prestige and recognition of Colgate brand. Another typical barrier is government regulations and policies. A typical example would be banking industry where a bank is required to get approvals and licenses from the government and also has to follow multiple legal regulations. This will be a barrier for any new entrant.
The above screenshot indicates the calculation of nominal GDP for both 2017 base year and 2018. It has been calculated by taking sum total of value for each product (that is, production units into price per unit). The value of second-hand goods has been excluded from this sum total to arrive at nominal GDP which stood at $1,169.84mn for 2017 and $1,126.28mn for 2018.
The real GDP for 2018 has been calculated by multiplying production units in 2018 by corresponding price per unit in 2017 which is the base year. This leads to real GDP of $1,053.59mn for 2018. The real GDP is an important indicator as it assists in comparison across years by removing the impact of inflation or price increase so as to ascertain actual growth in the economy.
Further, the value of GDP deflator has been calculated by dividing nominal GDP by real GDP and multiplying by 100. This leads to GDP deflator of 106.90 (Chappelow, 2020).
In order to verify, the real GDP calculation for each product for 2018 was multiplied by this deflator value and then the sum total was found to be equal to the nominal GDP value of $1,126.28mn.
It was seen that both nominal GDP and real GDP in 2018 have declined as compared to the base year of 2017. This indicates that the economy of Goodland Republic is going through a declining phase of business cycle or economy is shrinking in total size. In other words, the GDP is declining in absolute numbers such that the growth rate of GDP is negative.
As the name suggests, business cycles are periodical changes in and economy such that it expands and contracts with respect to the economy’s GDP. As in above graph:
- Peak: Characterised by saturation point where maximum GDP growth is attained and prices are also the highest. From here on, the economic growth trends downwards. It is typically marked by contractionary government policies so as to cool down the heated economy with inflationary pressures looming in.
- Recession: Characterised by decreasing demand such that here is excess supply and prices start to fall. Hence, income and GDP also starts to fall.
- Trough: The point where the growth rate of GDP becomes negative such that GDP declines in absolute terms till the point the demand and supply are the lowest.
- Growth/Recovery: Since the economy is at the bottom during trough, it now starts to recover after this point such that the low prices lead to increase in demand and consequently also in supply. The confidence in the economy returns so that investment activity also picks up. Hence, the economy stabilises with increased rate of GDP growth. It is typically marked by expansionary government policies so as to increase confidence in the economy and encourage consumers to spend.
- Expansion: Characterised by increasing production and price levels accompanied by low interest rates.
|Value if inflation is 4%
|Increase (decrease) in Value
|Value if inflation is 6%
|Increase (decrease) in Value
In above table, the total deposit of $200,000 earns an annual interest of 5% which calculates to $10,000 annually. Hence, after one year, the total value is $210,000, an increase of $10,000.
Inflation erodes value of money by reducing the purchasing power of money. Hence, an inflation of 4% means that whatever could be bought for $100 initially now requires $104 to be spent (McBride, 2019):
- If there is inflation of 4%, the value of money reduces by 4%. This is calculated by multiplying $210,000 by (100%-4%) which leads to total value of $201,600, an increase of $1,600.
- If there is inflation of 6%, the value of money reduces by 6%. This is calculated by multiplying $210,000 by (100%-6%) which leads to total value of $197,400, a decrease of $2,600.
It can be seen that as long as inflation is lower than interest rate, there is an increase of value on total deposit amount. As soon as inflation increases above interest rate, there is a decline in initial value of deposit amount leading to a loss.
|Population Above 15 yrs (mn)
|Not in the Labour Force (remaining)
The labour force is sum total of adult population which is employed and which is unemployed. Hence, the labour force is 13.5 million +0.7 million = 14.2 million or 68.3% of the total adult population (above 15 years of age) (US Bureau of Labour Statistics, 2020).
People who are not in the labour force refers to the portion of adult population which is not working and is not looking for job either for any reason, such as, voluntary retirement, taking care of family, no need for job, or have quit looking for a job. From above, the remaining portion or the people who are not in labour force are 6.6 million or 31.7% of adult population (above 15 years of age) (US Bureau of Labour Statistics, 2020).
Structural unemployment occurs due to structural changes or shifts in economy such that the skills of available labour force do not match the required skillset and hence, cause unemployment of such labour. This is a critical type of unemployment as it cannot be rectified easily and can cause unemployment rates to be at higher levels for longer period of time leading the economy to operate below its potential level. If left on its own, the natural rate of unemployment can also increase. The structurally unemployed need to be trained so as to match their skills with the required skillset (Amadeo, 2020).
For example, it can occur due to technological advancements. The rampant use of computer and internet has made a large proportion of older workforce redundant as they are not well-versed or comfortable with the new technology. Even when they are willing and available for employment, they might not get it due to mismatch of skills required in terms of expertise of using computers or internet. The digitization and technological advancement has become a big cause of structural unemployment in Australia and other countries. This is because the aging or relatively older work population is unable to keep pace with the rapidly changing technology making their skills a mismatch for the required skillset. Even younger population is required to constantly update their skills to remain relevant in the labour market.
The aggregate demand in an economy is sum total of consumption, investment, and government expenditure and net exports during a period. Hence, AD = C+I+G+X
Increasing government spending is one of the tools used under expansionary fiscal policy. If government expenditure increases, aggregate demand will also increase. Apart from this, the increase in government spending has a multiplier effect whereby a dollar increase in government expenditure will lead to more than a dollar increase in income. This is known as multiplier effect.
The government spending is typically to improve infrastructure, education, pension or welfare payments. This leads to improvement in productivity or efficiency by removing bottlenecks and improving skillsets of the citizens. All of this contributes to increasing income for various groups, leading to much more expansion in income (Pettinger, 2019).
However, for the purpose of personal investing, the increased government expenditure may lead to crowding out effect. The intention of increasing government expenditure is to encourage spending and investment. However, the increased government expenditure is through increased demand for borrowed funds. In turn, this may lead to increase in interest rate such that the private investment will be discouraged or may even decrease due to higher interest rates. Hence, the demand for loans from government to increase its expenditure leads to increase in interest rates and decline in demand for loans from private investors (Kenton, 2019).
As shown above, the aggregate demand curve is represented on a graph with x-axis indicating GDP and y-axis indicating price. Also, AD =C+I+G+X. Hence, the reasons for downward sloping AD curve from left to right can be explained as follows (Pettinger, 2017):
- Change in ‘C’: when the prices are low, consumers’ purchasing power is higher leading to more expenditure and higher demand which means higher AD (or GDP). However, as prices increase, purchasing power declines leading to lower AD (or GDP).
- Change in ‘X’: Lower prices in domestic country will make exports competitive such that net exports will increase such that AD (or GDP) will increase. Higher prices will make exports dearer such that net exports will decrease and AD (or GDP) will decrease.
- Change in interest rates: Lower price levels are usually accompanied by lower interest rates such that AD (or GDP) is higher.