Principles of

Microeconomics
MECO111
Session 27

Dr. Ummad Mazhar

SDSB, LUMS

1
MECO111Fall2021
 Identifying market structure
• Economists often use a measure called the Herfindahl–Hirschman
Index, or HHI to determine the structure of a market
• HHI for an industry is the square of each firm’s market share
summed over the firms in the industry
• Firm’s market share is measured through its share of sales
• If an industry contains only three firms and their market shares are
60%, 25%, and 15%, then the HHI for the industry is HHI = +

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 HHI and market structure
• An HHI below 1,500 indicates a strongly competitive market,
• An HHI between 1,500 and 2,500 indicates a somewhat
competitive market,
• An HHI over 2,500 indicates an oligopoly

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Decide market type

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Market structures comparison

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 Problems: 1
• A firm in a competitive industry receives $500 in total revenue
and has a marginal revenue of $10. What is the average revenue
and how many units were sold?
• Sol: TR = PQ = 500
• In perfect competition: MR = P = 10
• Using MR in PQ we get Q = 50
• AR = TR/Q = 10

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 Problems: 2
• Consider total cost and total revenue given in the following table:

a. Calculate MR and MC for each quantity.

b. Can you tell whether this firm is in a competitive industry?
c. Using the rule MC = MR the industry produces Q = 6. Can you tell
whether the industry is in a long run equilibrium at Q = 6?
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Q TC TR MR MC AR AC
0 8 0 - - 0 0
1 9 8 8 1 8 9
2 10 16 8 1 8 5
3 11 24 8 1 8 3.7
4 13 32 8 2 8 3.25
5 19 40 8 7 8 3.8
6 27 48 8 8 8 4.5
7 37 56 8 10 8 5.27

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• B. for non-competitive firms MR is less than P and is not
constant. This is not the case here, so the firm is in a
competitive industry
• C. In the long run, a competitive firm has P = MR = MC =
AR = AC. In the case of this firm we have MR = MC = 8,
and price can also be assumed to be equal 8. But AC at Q = 6
is less than the P which means that firm is earning positive
economic profits. It is not in a long run equilibrium

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 Problems: 3
• A profit maximizing firm in a competitive market is currently
producing 100 units of output. It has average revenue of $10
average total cost of $8, and fixed costs of $200.
a. What is firm’s profit?
b. What is MC?
c. What is average variable cost?
d. Is the efficient scale of the firm more than, less than, or
exactly 100 units?

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 Problems: 4
• A monopolist producing with a constant average cost and
marginal cost of $6 has the following demand schedule:
Q P
1 10
2 9
3 8
4 7
5 6
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• A. Calculate total cost and revenue for each output level.
• B. Find the optimal output and price.
• C. Based on your answer on part (b), determine the profit or loss
for the firm.

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 Problems: 5
• Consider a monopolist who faces a
constant average and marginal cost of
$5 and a linear demand curve of P = 20
– 2Q, where P is the price the
monopolist charges and Q is the
quantity consumers purchase.
• Find monopolist MR, optimal output,
and price.
• Using MR and demand curve, find the
range of monopolist output and price.
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 Problems: 6

• A large share of the world supply of diamonds comes from Russia and
South Africa. Suppose that the MC of mining diamonds is constant at $2
per diamond, and the demand for diamonds is described on the next slide.
a. If there were many suppliers of diamond, what would be the price and
quantity?
b. If there were only one supplier of diamonds, what would be the price
and quantity.
c. If Russia and South Africa formed a cartel, what would be the price and
quantity?
d. If the countries split the market evenly what would be South Africa’s
production and profit? What would happen to South Africa’s profit if it
increased its production by 1 while Russia stuck to the cartel agreement.
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P Q
8 5
7 6
6 7
5 8
4 9
3 10
2 11
1 12
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 Problem 7
• A firm in a monopolistically competitive market with N
firms is described as follows:
• Demand:
• Marginal Revenue:
• Total Cost: and MC = 2Q
• How does N, the number of firms in the market, affect
each firm’s demand curve? Why?

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• How many units does each firm produce? (The answer to
this and the next two questions depend on N)
• What price does each firm charge?
• How much profit does each firm make?
• In the long run, how many firms will exist in this market?

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 Sol
• Affect of N on each firm’s demand curve. Suppose price is zero.
Then demand of firm k would be 20 units if N = 5 but only 2 units
if N = 50. We can say that higher number of firms in this industry
reduces firm k’s demand
(b) Let N as it is and solve
• Using the rule MR = MC

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• Profit = TR – TC
• Long run number of firms? In the long run firms earn zero
economic profit

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 Problems: 8
• Decent Store is a small grocery shop that is considering entering
a market dominated by Big Mall. Each company’s profit depends
on whether Decent enters and whether Big Mall set a high or low
price. Big Mall threatens Decent a low price if it enters.
a. Is there a dominant strategy for Decent? For Big Mall?
b. Do you think Decent should believe the threat? Why or why
not?
SOLUTION: Players? Strategies? Payoff?

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 Big Mall

High price Low price

Decent Enter 2m \ 3m -1m \ 1m

Don’t enter 0 \ 7m 0 \ 2m

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• Decent has no dominant strategy: If Big Mall plays high
price it is better for Decent to enter. If Big Mall plays low
price it is better for Decent don’t enter.
• Big Mall has a dominant strategy: High Price.
• Decent should not believe the threat. Because Big Mall has
a dominant strategy of high price. Given its dominant
strategy, Decent is better off playing Enter. So Nash
Equilibrium of the game is Enter, High Price.
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 Problems: 9
• Following matrix shows the profit and losses of two firms.
Determine
• (a) whether firm A has a dominant strategy; (b) whether
firm B has a dominant strategy; (c) Nash equilibrium, if
any.

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 Firm B

Low price High price

Firm A Low price

1 1 3 -1

High price
-1 3 4 2

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See you next time

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