BECC-101 Solved Assignment

Question 1

(a) Monopoly vs. perfect competition; and the long-run position of a monopoly firm

Monopoly and perfect competition are treated as two “extreme” market forms in the course, and the key difference is the degree of control over price and entry.

• Number of firms and market power: In perfect competition there are many sellers, each too small to influence market price (a firm is a price taker). In monopoly, there is a single seller and the firm faces the market demand itself, so it becomes a price maker with a downward-sloping demand (AR) curve.
• Demand (AR) and marginal revenue (MR): A competitive firm’s AR is horizontal and AR = MR. Under monopoly (and monopolistic competition), AR lies above MR because the demand curve slopes downward.
• Output and price outcomes: Monopoly typically produces a lower quantity and charges a higher price than a perfectly competitive outcome for the same demand and cost situation, because the monopolist selects output where MR = MC and then charges the price from the demand curve.
• Supply curve: In perfect competition (above the shutdown point) the MC curve represents the firm’s short-run supply. Under monopoly, a unique “supply curve” is not well-defined because output is chosen from MR = MC together with the demand curve, not from price alone.

Long-run equilibrium under monopoly (explained clearly)

In the long run, the monopolist still follows the marginal principle and chooses output where MR = MC (with MC cutting MR from below for stability), then sets the associated price on the AR (demand) curve. What makes the long run different from perfect competition is entry. In perfect competition, free entry drives economic profit to zero in the long run. In monopoly, entry is blocked by barriers, so the firm may continue to earn positive profits, or it may just break even, depending on demand and cost conditions.

From a student’s “market sense” viewpoint: if a seller is protected by legal restrictions, control over a key input, or other barriers, competitive pressure cannot easily erode its market position, so the long-run outcome need not converge to the perfectly competitive benchmark.

(b) Why diminishing returns to scale can arise in the long run

In the long run, all inputs are variable, so the relevant idea is returns to scale. Diminishing returns to scale means that when all inputs are increased together (say labour and capital), output increases by a smaller proportion. In the course material, diminishing returns to scale are tied to diseconomies of scale, which raise long-run average cost beyond some size.

Common reasons highlighted in the discussion of diseconomies include:

• Managerial and coordination limits: As the firm becomes very large, monitoring, communication, and coordination become harder, which reduces efficiency and slows the output response to scaled-up inputs.
• Control and supervision difficulties: Layers of supervision can create delays and distort information, leading to waste and weaker decision-making at scale.
• Internal friction: Large organizations may face internal conflict, duplication, and slower adaptation, all of which reduce the productivity gains from expanding inputs.

Question 2

(a) Cournot duopoly: best-response equations, equilibrium output/price, profits, and comparison with competitive outcome

We are given a duopoly facing:

• Market demand: P = 14 − Q, where Q = Q₁ + Q₂
• Costs: AC = MC = 2 for each firm

In the Cournot framework, each firm chooses quantity, taking the rival’s quantity as given, and the best-response (reaction) curve comes from MR = MC.

(i) Best-response (reaction) functions

$$ \begin{aligned} P &= 14 – (Q_1+Q_2) \ TR_1 &= P\cdot Q_1 = [14-(Q_1+Q_2)]Q_1 = 14Q_1 – Q_1^2 – Q_1Q_2 \ MR_1 &= \frac{\partial TR_1}{\partial Q_1} = 14 – 2Q_1 – Q_2 \end{aligned} $$

$$ MR_1 = MC \Rightarrow 14 – 2Q_1 – Q_2 = 2 \Rightarrow Q_1 = \frac{1}{2}(12 – Q_2) $$

So Firm 1’s best response is Q₁ = (1/2)(12 − Q₂). Similarly, Firm 2’s best response is Q₂ = (1/2)(12 − Q₁).

(ii) Cournot equilibrium output and price

Solving the two best-response equations simultaneously yields symmetry (same costs), so Q₁ = Q₂. Substituting gives Q₁ = Q₂ = 4, hence total output Q = 8 and price P = 14 − 8 = 6.

(iii) Profits of the two firms

$$ \pi_1 = (P – AC)\,Q_1 = (6-2)\times 4 = 16,\quad \pi_2 = (6-2)\times 4 = 16 $$

Thus each firm earns profit 16 (in the same monetary units as the price).

(iv) Comparison with competitive equilibrium

Under perfect competition, price equals marginal cost (P = MC). With MC = 2:

$$ 14 – Q = 2 \Rightarrow Q = 12,\quad P = 2 $$

So compared with perfect competition, Cournot duopoly produces lower total output (8 instead of 12) and charges a higher price (6 instead of 2).

(b) Kinked demand curve model: why prices can be rigid in oligopoly

The kinked demand curve idea (associated with Paul Sweezy) is used to explain price rigidity in oligopoly, where firms are interdependent and must anticipate rival reactions.

Core behavioural assumption: each firm expects rivals to match price cuts (to avoid losing customers), but not match price increases (to gain customers from the firm that raised price).

• If a firm raises price, rivals keep prices unchanged, so the firm loses many customers; demand on this upper segment is relatively more elastic.
• If a firm cuts price, rivals also cut price, so the firm gains fewer customers than it would if rivals stayed put; demand on this lower segment is relatively less elastic.

This creates a kink at the prevailing price-output point on the firm’s demand curve.

Why this implies “sticky” prices

Because the demand curve has a kink, the corresponding MR curve is not smooth; it has a discontinuity (a vertical gap). As long as the firm’s MC curve crosses MR within that gap, moderate cost shifts do not force a change in the prevailing price—profit maximisation can still occur at the same price. This is the main explanation for price rigidity in the model.

Question 3

(a) Economic rent and the Ricardian explanation of land rent

Economic rent refers to the part of a factor’s payment that exceeds what is necessary to keep it in its current use (i.e., above its transfer earning). In the land market discussion, this idea is closely connected with land’s scarcity and the perfectly inelastic nature of land supply.

Ricardian theory of rent explains rent mainly as a differential surplus. Because land differs by fertility and/or location, better land yields higher output (or lower cost) than marginal land. The “marginal” land (the least productive land in cultivation) earns no rent; rent emerges on superior lands as the surplus over what is earned on marginal land under the same price.

To present it: as demand for agricultural produce expands, cultivation extends to less productive land, setting a higher cost margin. That margin raises the market price enough that superior lands now generate a surplus, which appears as rent.

(b) Why factor demand is called “derived demand”

Demand for factors of production (like labour, land, capital) is called derived demand because firms do not want inputs for their own sake; they want inputs to produce output that consumers demand. Therefore, the demand for an input depends on (i) the productivity of that input and (ii) the demand (and price) for the final product.

In the marginal productivity framework used in the factor market block, the hiring (or use) decision is tied to marginal revenue product: firms expand input use up to the point where the input’s marginal revenue product equals its price (for example, wage for labour).

Question 4

Why wage rates differ across professions (illustrated with “professor vs. school teacher”)

Wages vary across occupations because labour services are not identical and labour markets reflect differences in skill, training, responsibility, working conditions, and scarcity of the required ability.

Using the “professor paid higher than a school teacher” illustration, the wage gap can be explained through several course-consistent factors:

• Human capital and training: A professor typically requires more years of specialised education and research training, which increases skill and often reduces the number of qualified candidates, pushing the equilibrium wage upward.
• Responsibility and productivity differences: The expected roles (research output, advanced teaching, supervision, institutional responsibilities) can raise the perceived marginal contribution of the job, supporting higher pay where demand exists.
• Compensating wage differentials: Jobs differ in non-monetary characteristics; wages may compensate for less attractive aspects (work intensity, pressure, location constraints) or reflect benefits and job security patterns.
• Institutional factors: Market structure, bargaining strength, and institutional pay scales can also contribute to persistent wage differences across sectors.

Question 5

Negative externalities and why market output is not socially optimal (with a diagram explanation)

A negative externality exists when a firm’s or consumer’s action imposes costs on others that are not reflected in the market price. In this case, private decision-makers compare private benefits and private costs, but society must consider social costs.

Key idea: with a negative externality, MSC (marginal social cost) lies above MPC (marginal private cost) by the marginal external cost. Market equilibrium occurs where demand intersects MPC, but the socially optimal output occurs where demand intersects MSC. Hence, the market produces more than the socially desirable quantity.

How to draw the diagram (step-by-step)

• Put Quantity on the horizontal axis and Price/Cost on the vertical axis.
• Draw the demand curve as the marginal social benefit (MSB) curve (downward sloping).
• Draw MPC as the private supply curve (upward sloping).
• Draw MSC above MPC (also upward sloping).
• Mark market equilibrium at MSB ∩ MPC (this gives Q_m).
• Mark social optimum at MSB ∩ MSC (this gives Q).

$$ \text{With a negative externality: } MSC = MPC + MEC,\ \text{so } Q_m > Q^ $$

Why the “optimal output” is not reached automatically

The market outcome is driven by private cost signals (MPC), so the external cost is not fully internalised in the price. As a result, individual producers/consumers do not face the full cost of their decisions, and output remains above the efficient level unless corrective action aligns private incentives with social costs.

Question 6

Meaning of excess capacity

Excess capacity is a long-run concept commonly linked with monopolistic competition. It is the gap between the least-cost output (where long-run average cost is minimised) and the profit-maximising output the firm actually produces in the long run.

Why it arises: in monopolistic competition the firm faces a downward-sloping demand curve, so the long-run equilibrium (MR = LMC) occurs at an output to the left of the minimum point of LAC. Even when firms earn only normal profit in the long run (due to entry), they still do not operate at the minimum LAC point, so part of capacity remains unutilised.

Question 7

Income consumption curve (ICC) for an inferior good (diagram guidance included)

An income consumption curve traces the consumer’s equilibrium bundle as income changes, holding prices constant. In indifference-curve analysis, each income level gives a new budget line parallel to the previous one, and the chosen tangency point changes accordingly.

Inferior good case: if good X is inferior, then as income rises the consumer buys less of X (after some point), shifting consumption toward the other good. Therefore, the ICC can bend “back” toward the axis of the superior/normal good.

How to draw it

• Draw axes for X (horizontal) and Y (vertical).
• Draw two (or three) parallel budget lines: B₁, B₂, B₃, each farther from the origin as income increases.
• On each budget line, draw an indifference curve tangent at the chosen bundle (E₁, E₂, E₃).
• Join E₁, E₂, E₃ to form the ICC.
• For an inferior good X, show the joined points moving toward lower X as income rises (the curve bends back).

Question 8

Policy instruments used by government to address inefficient market outcomes

In the market-failure discussion, government intervention is motivated by situations where the market mechanism does not yield efficient outcomes (for example, externalities, public goods issues, monopoly power, or information problems).

Common policy instruments (presented in a study-ready list) include:

• Taxes and subsidies: used to discourage activities with negative external effects and encourage activities with positive spillovers, by changing private incentives toward the socially desirable direction.
• Direct regulation: standards, limits, and rules that restrict harmful activities or require specific practices when price-based incentives alone are insufficient.
• Public provision / direct production: when private markets underprovide socially important goods or services, the state may provide them directly or finance provision.
• Regulation of monopoly and promotion of competition: where market power reduces output and raises price, policy can aim to limit abuse of market power and improve outcomes.

Question 9

Efficiency and efficient resource allocation among firms

Efficiency in microeconomics is discussed in terms of using scarce resources in a way that avoids waste and aligns production with what society values. The course emphasises productive efficiency (least-cost production) and allocative efficiency (resources allocated so that price reflects marginal cost).

Efficient allocation among firms means that for a given total industry output, production should be distributed across firms so that it is impossible to reduce total cost by shifting output from one firm to another. A standard way to express this is: marginal costs should be equalised across firms producing the same good; otherwise, output can be moved from a higher-MC firm to a lower-MC firm to cut total cost.

Under perfect competition, the long-run equilibrium conditions (P = MR = MC and price equal to minimum long-run average cost) illustrate why perfect competition is treated as a benchmark for efficiency in the text.

Question 10

Short note: features of an oligopolistic market structure

Oligopoly is characterised by a small number of firms and interdependence: each firm’s pricing/output decisions are influenced by expected rival reactions.

• Few sellers (often large firms) and many buyers.
• Interdependence: strategic thinking about rivals is central; firms may use formal models (e.g., Cournot quantities) or behavioural expectations (kinked demand).
• Barriers to entry are typically present, helping incumbent firms maintain market position.
• Product nature: products may be homogeneous or close substitutes (differentiated).
• Price rigidity (often): prices can be “sticky” because of asymmetric rival reactions, captured by the kinked demand curve explanation.
• Non-price competition: firms may rely on methods other than price cuts (quality changes, service, etc.) when price competition is risky.
• Possibility of collusion: firms may attempt cooperative behaviour (explicit or implicit), though outcomes can be unstable due to incentives to deviate.