J/02/3/02
1 The diagram shows a firm‟s cost and revenue curves.
At which level of output will the firm be making only normal profit?
marginal cost
average cost
average revenue
marginal revenue revenue/cost
quantity
O A B C D
J/03/3/10
2 The diagram shows the cost and revenue curves for the production of a textbook. The contract with the publisher entitles the author to a fixed percentage of the value of sales.
Which price would maximise the author's income from the book?
cost/ revenue
number of copies O
A B C
D AC
MC
MR
AR
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Understanding Economics 188 12- Objectives of Firms
N/03/3/14
3 The diagram shows a firm's cost and revenue curves.
cost / revenue
output O
MR MC
AC
AR
The firm changes its objective from profit maximisation to sales revenue maximisation.
Which groups are likely to be winners and losers as a result of this change?
winners losers A customers shareholders B managers customers
C workers managers
D shareholders workers J/04/3/14
4 The diagram shows the demand and cost curves of a monopolist who initially produces at his profit-maximising level of output.
D
O output
cost, revenue
MC AC
If the monopolist were required by the government to adopt marginal cost pricing, what would be the effect on the price charged and the output produced?
price output A increase increase B increase decrease C decrease increase D decrease decrease N/04/3/11
5 To maximise total revenue, up to which point should a monopolist increase output?
A where marginal revenue equals average revenue B where marginal revenue is maximised
C where marginal revenue is zero
D where price elasticity of demand is zero
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Understanding Economics 189 12- Objectives of Firms
J/06/3/10
6 The diagram shows the cost and revenue curves of a monopoly.
O X
AR AC
MC
MR
$
quantity What is the firm‟s objective if it produces output OX?
A to achieve normal profit B to maximise profit
C to maximise total revenue D to minimise average cost J/06/3/14
7 The maximum price that a privatised natural monopoly is allowed to charge its customers is determined by the following formula:
the price charged in the previous year plus the annual % change in the consumer price index minus 2 %.
Assuming the firm charges the maximum price allowed, how will an increase in productive efficiency affect customers and the company's shareholders?
customers shareholders
A gain gain
B gain no effect
C no effect gain
D no effect no effect N/06/3/10
8 A firm decides to aim to maximise sales revenue rather than profits.
What is likely to be one of the consequences of this decision?
A an increase in the price of the firm‟s product B a reduction in the price of the firm‟s shares C a reduction in the firm‟s market share
D a reduction in the number employed by the firm
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Understanding Economics 190 12- Objectives of Firms
N/07/3/10
9 The diagram shows a firm‟s cost and revenue curves.
O cost/revenue
output
MR Q AR
MC AC
Which policy objective is consistent with a decision by the firm to produce output OQ?
A maximising profit
B maximising revenue subject to earning a normal profit C maximising sales revenue
D satisficing profits N/08/3/12
10 The diagram shows the demand and cost curves of a monopolist who initially produces at the profit-maximising level of output.
D
O output
$
MC AC
The monopolist is required by the government to adopt marginal cost pricing.
What will be the effect on the price charged and the output produced?
price output
A increase increase B increase decrease C decrease increase D decrease decrease
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Understanding Economics 191 12- Objectives of Firms
N/09/3/12
11 he diagram shows the cost and revenue curves of a monopoly producer whose only cost of production is a fixed cost.
MR
A R
AFC X
Y
O output
$
What will such a monopolist do?
A set a price of OX in the short run and the long run B set a price of OY in the short run and the long run
C set a price of OX in the short run, but discontinue production in the long run D set a price of OY in the short run, but discontinue production in the long run N/11/32/11
12 The diagram shows the cost and revenue curves of a monopoly.
O W X Y Z
output cost,
revenue
MC AC
AR
MR
Which movement between levels of output would indicate a wish to change from unit cost minimisation to earning a normal profit?
A W to Y B W to Z C X to W D X to Z
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Understanding Economics 192 12- Objectives of Firms
N/12/32/13
13 The diagram shows a profit-maximising firm‟s cost and revenue curves.
MR MC
AC
AR W X Y Z
output O
cost , revenue
What would be the increase in the firm‟s output if it was required to charge a price equal to marginal cost?
A WX B XY C WY D XZ
J/13/32/11
14 The diagram shows a firm‟s cost and revenue curves.
cost, revenue
output O
MR MC
AC
AR
The firm changes its objective from sales revenue maximisation to profit maximisation.
Which groups are most likely to be winners and losers as a result of this change?
winners losers A customers managers B managers workers C workers shareholders D shareholders customers
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Understanding Economics 193 12- Objectives of Firms
N/13/32/10
15 The diagram shows a firm‟s cost and revenue curves.
cost, revenue
output O
MR MC
AC
AR
The firm changes its objective from profit maximisation to sales revenue maximisation.
Which groups are likely to be winners and losers as a result of this change?
winners losers A customers shareholders B managers customers
C workers managers
D shareholders workers N/13/32/12
16 The diagram shows the initial cost and revenue curves of a profit-maximising monopolist.
P
J K
AR MC
MR costs,
revenue
O
output
What would cause the firm to increase its output from OJ to OK?
A The government fixes the price at OP.
B he government requires the firm to charge a price equal to marginal cost.
C The government imposes an indirect tax on the firm‟s product.
D The firm is allowed to earn only a normal profit.
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Understanding Economics 194 12- Objectives of Firms
N/13/32/13
17 What makes it most likely that a firm‟s profits will be volatile and subject to substantial fluctuations?
A Fixed costs are a high percentage of total costs.
B It produces a diversified range of products.
C It produces basic consumer products.
D It sells its product in a number of different markets.
J/14/32/12
18 The diagram shows the cost and revenue curves of a monopolist.
Which output will the firm produce if its aim is to maximise sales revenue?
AR MR
MC AC
O
output costs,
revenue
A B C D J/15/32/12
19 The diagram shows the cost and revenue curves of a monopoly.
O X
AR AC
MC
MR
output cost,
revenue
What is the firm‟s objective if it produces output OX?
A to achieve normal profit B to maximise profit C to maximise total revenue D to minimise average cost
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Understanding Economics 195 12- Objectives of Firms
N/15/32/11
20 A firm, operating in an imperfectly competitive market, produces at the level of output where the price elasticity of demand for its product is equal to unity.
What has the firm achieved?
A normal profit B maximum profits
C maximum revenue D maximum sales volume
J/16/32/11
21 A firm wishes to eliminate competition and become a monopoly.
What should it do?
A maximise output B maximise profit C reduce prices
D reduce the number of its suppliers J/16/32/13
22 What is likely to have its cause in the separation of ownership and control in a firm?
A contestable markets B diseconomies of scale C principal-agent problem D prisoner‟s dilemma
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Understanding Economics 196 13- Price Discrimination
Section: 13 Price Discrimination
Price discrimination is the process of charging different prices from different customers or for different units sold, for reasons unrelated to costs. Price discrimination can only be successful if:
Discriminating firms have some monopoly power
Firm are able to identify and separate different market segments with different elasticities of demand. Market segments are sub-groups comprising customers with similar characteristics such as age, income or gender. Separating different market segments implies that re-sale is impossible- those obtaining the product at lower prices cannot earn profits by re-selling it in segments where higher prices are charged. This condition explains why examples of price discrimination are most commonly found in the services sector, as services cannot be resold.
Keeping these conditions in mind, consider some of the following examples of price discrimination:
Time: We typically experience high prices from phone companies, airlines, rail/bus operators, electricity firms etc during peak hours and lower rates in off peak hours.
Age: Children and elderly people for instance, may be charged lower prices in theme parks, restaurants or libraries etc.
Timing of purchase: Fabulous discounts can be won if an airline or a train ticket is purchased well in advance or at the last minute. Making reservations just before the departure of a train or flight can make unsold tickets available at much discounted prices.
Quantity: Discounts encouraging bulk buying may be an example of price discrimination as long as price reductions are not attributed to reduced packaging and handling costs.
Place: Cinemas, theatres and live concerts cost more for people occupying seats with a better view whereas people with a restricted view generally have to pay less. A more contentious example is that of business class travelers paying higher fares versus economy class. It could be argued that the price differential is related to costs- the cost of serving a business class traveller is high as better services are provided both on ground as well as on plane, seats have extra leg space and customers are allowed to carry more weight. However, this exercise may still be regarded as price discrimination if the difference in fares is not fully explained by the difference in airlines‟ costs.
Though the difference in costs of serving a business class traveller compared to an economy class passenger is almost the same on London-New York and London-Delhi routes, the difference in business and economy class fares is much higher on London-New York route. The reason is high purchasing power and lower price elasticity of demand for business travellers on the London-New York route, thus making it an example of price discrimination.
Frequency of purchase: Day passes or monthly cards for frequent commuters cost much less per journey than the ticket for a single travel.
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Understanding Economics 197 13- Price Discrimination
Executing price discrimination
Given that the cost of selling the product to different customers and in different segments is the same, profits are maximized when Marginal Revenue (MR) is equated in all market segments. Thus, price discrimination is the process of equating MR in all segments. The following equation (derived in section 8) explains that firms charge different prices in different segments only when price elasticities of demand differ.
P Ed
MR 1
1
Marginal revenue must be equated in both segments („a‟ and „b‟) for maximizing profits MRa = MRb
b
a Pb Ed
Pa Ed 1
1 1 1
Assuming elasticities of demand are equal in both segments;
b
a Ed
Ed
1 1 1 1
In a situation as above, Marginal Revenue can only be equated by charging same price in both segments i.e. Pa = Pb. Firms find it profitable to charge high prices in segments with price inelastic demand and lower prices in segments where demand is price elastic.
Now assume that demand in segment „a‟ is more price elastic than demand in segment „b‟.
b a
b
a Ed Ed Ed
Ed 1 1
b
a Ed
Ed
1
1 1 1
In such a situation, Marginal Revenue can only be equated by charging a lower price in segment
„a‟ and a higher price in segment „b‟ i.e. PaPb
The following example provides a graphical representation of successful price discrimination by an airline operator.
Diagram 13.1
AR=P=D Price
No. of Seats AR=P=D MR P1
P2
P3
P1
MR a
b c
No. of Seats c
Price
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Understanding Economics 198 13- Price Discrimination
The panel on the left shows a price inelastic demand curve for business travelers, compared to a flatter demand curve for tourists, shown in the figure on the right. Initially, the price charged in both the segments is the same, P1. At this price, revenue generated from selling an extra seat to a business traveler, „a‟ is smaller than that generated by offering the same seat to a tourist, „b‟. A profit maximizing monopolist may therefore decide to reduce the number of seats for business travellers and offer the same to tourists. Increased Total Revenues and unchanged Total Costs imply greater profits for the monopolist. The monopolist continues to sell more seats to tourists till the revenue generated from the sale of an extra seat becomes equal in both segments. This happens at point “c” in the given figure. Eventually, the airline operator charges a higher price, P2
in the segment where demand in price inelastic and a lower price, P3 from tourists, whose demand is price elastic. Once MR is equated in all market segments, there is no further possibility of increasing total revenues and profits by selling more or less in a certain segment.
Perfect Price Discrimination
Perfect price discrimination occurs when each unit is sold at a different price. In such a case, the divergence between sale price and MR disappears and revenue generated from selling an extra unit equal the sale price charged.
Consider the following demand schedule:
Price Q TR MR
10 1 10 10
9 2 19 9
8 3 27 8
7 4 34 7
6 5 40 6
Assuming the monopolist can sell all units at different prices, total revenue from selling 2 units would be 19 (10 from selling the 1st unit and 9 from selling the 2nd), 27 from selling 3 units (10 + 9 + 8) and so on. MR is equal to price.
The following diagram shows the revenue curves for the perfectly price discriminating monopolist.
Diagram 13.2
P
AR=P=D=MR MC
O Q
*
Q