Two car manufacturers, Saab and Volvo, have fixed costs of $1 billion and margin

Question

Two car manufacturers, Saab and Volvo, have fixed costs of $1 billion and marginal costs of $10 000/car. If Saab produces 50 000 cars/year and Volvo produces 200 000, calculate the average production cost for each company. Based on these costs, which company's market share do you think will grow in relative terms? L03 State whether the following statements are true or false, and explain why. LO1, L02, L03 In a perfectly competitive industry, the industry demand curve is horizontal, whereas for a monopoly it is downward sloping. Perfectly competitive firms have no control over the price they charge for their product. For a natural monopoly, average cost declines as the number of units produced increases over the relevant output range. State whether the following statements are true, false, or uncertain, and explain why. A single-price profit-maximizing monopolist LO4 causes excess demand, or shortages, by selling too few units of a good or service, chooses the output level at which marginal revenue begins to increase. always charges a price above the marginal cost of

Explanation / Answer

1) THE MARKET SHARE OF VOLVO WILL GROW BECAUSE ITS AVERAGE FIXED COST WILL BE LESS THAN THAT OF SAAB COMPANY. THIS WILL RESULT IN A LOWER PER CAR COST AS COMPARED TO SAAB.

SAAB AFC = 1000000000 / 50000 = 20000.

VOLVO AFC = 1000000000 / 200000 = 5000.

HENCE THE COST PER CAR FOR SAAB IS 20000 + 10000 = 30000

AND COST PER CAR FOR VOLVO IS 5000 + 10000 = 15000.

2) A TRUE. IN PERFECT COMPETITION THE DEMAND CURVE IS HORIZONTAL BECAUSE THE DEMAND IS PERFECTLY ELASTIC. IN CASE OF MONOPOLY THE FIRM ITSELF IS THE INDUSTRY AND HENCE ITS DEMAND FALLS WITH RISE IN PRICE AND VICE VERSA.

2) B TRUE. IT IS SO BECAUSE THE BUYERS AND SELLERS HAVE PERFECT KNOWLEDGE OF THE MARKET. ANY FIRM TRYING TO SELL THE PRODUCT ABOVE MARKET PRICE WILL LOSE ALL OF ITS CUSTOMERS. HENCE A FIRM IS A PRICE TAKER ONLY.

2) C TRUE. IN CASE OF NATURAL MONOPOLY THE FIRM HAVE TO INVEST A HUGE AMOUNT IN THE INFRASTRUCTURE THEREFORE ONLY ONE FIRM CAN OPERATE. THE AVERAGE COSTS KEEPS ON FALLING DUE TO CONTINUOUS ECONOMIES OF SCALE.

3) A FALSE. THE MONOPOLIST CANNOT DO SO BECAUSE TO CREATE EXCESS DEMAND PRICE WILL HAVE TO BE REDUCED AND TO CREATE SHORTAGE PRICE WILL HAVE TO BE INCREASED. AND IN CASE OF SINGLE PRICE MONOPOLY IT IS NOT POSSIBLE.

3) B TRUE. BECAUSE THE MONOPOLIST WILL TRY TO REMAIN ABOVE THE POINT WHERE MC = MR.   

3) C TRUE.BECAUSE A MONOPOLIST WILL CHARGE ACCORDING TO THE WILLINGNESS OF THE CUSTOMERS TO PAY DETERMINED BY THE DEMAND CURVE.

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