5. Indicate whether each of the following statements is true or false, and expla

Question

5. Indicate whether each of the following statements is true or false, and explain your answer.
A. If a monoplist is producing a level of output at which demand is inelastic, the firm is not maximizing profits and increasing output will decrease total revenu.
B. When a monopolist maximizes profits, the price is greater than the marginal cost of producing the output. This means that consumers are willing to pay more for additional units of the product than these additional units of the produce. Thus, the monopolist should produce and sell addional units of output.
C.A monopolistically competitive firm produces a level of output at which price equals $80, marginal revenue equals $40, average total cost equals $100, marginal cost equals $40 , and average fixed cost equals $10. To maximize profit, the firm should produce a smaller output and sell it at a higher price.
D. In a monopolistically competitive market, a firm has market power because it produces a differentiated product. This means that the firm earns positive ecoomic profit in the long run.

Explanation / Answer

A. This is two statements. So, let's break it down. First, "If a monoplist is producing a level of output at which demand is inelastic, the firm is not maximizing profits" We know that a monopolist maximizes profit by setting price above marginal cost. This means setting high prices and producing low quantities. So, this is going to be the elastic portion of the demand curve. So far, this seems good. Second, "increasing output will decrease total revenu." If a firm is producing in the elastic portion of the demand curve, E>1. This means the firm could increase revenue by decreasing prices and increasing quantities. So, the second part of this statement is false. Maximizing revenue is different from maximizing profit. A is false. B. Again, let's break this down. "When a monopolist maximizes profits, the price is greater than the marginal cost of producing the output." This is obviously true. "This means that consumers are willing to pay more for additional units of the product than these additional units of the produce." I think you mean that consumers are willing to pay more for additional units of the product than these additional units cost to produce. This is also true, by definition. "Thus, the monopolist should produce and sell addional units of output." This depends on what the questioner means by "should." Certainly, it would be welfare maximizing to produce more quantities and sell at lower prices. But this is not what a profit maximizing firm will do. Profit maximization occurs when a monopolist prices above marginal cost. B is false. C. We maximize profit when MR=MC. In this case, MR=MC=40. Therefore, we are maximizing profit (assuming we produce at all). But there is another problem here. Notice that ATC=100. We know that ATC=AFC+AVC, and that AFC=10. So, AVC=100-10=90. But price is only 80. So, the firm should shut down immediately because it can't cover its variable cost. This means that it should sell fewer units (zero), but it won't be pricing them at anything. You can't price units you don't sell. C is false. D. Again, this is two statements. "In a monopolistically competitive market, a firm has market power because it produces a differentiated product." This is true by definition. "This means that the firm earns positive ecoomic profit in the long run. " This is false. In order to earn economic profit in the long-run, you have to have a way of keeping out competition. If there is profit in a market in the short run, new firms will enter in order to grab it up. And they will continue to do this until there is none left. It won't matter that you have a differentiated product because competitors can always make a product that is only very slightly different than yours. And, at the limit, this difference becomes zero. D is false.

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