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Business Economics

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Consider the statement “Total output starts falling when diminishing returns occurs.” Explain.

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“Total output starts falling when diminishing returns occur,” is a false statement. Instead, diminishing returns occurs when marginal output begins to fall. This is because when diminishing returns occur, marginal physical product (MPP) remains positive. As a result, total output increase at a diminishing rate. Consequently, diminishing returns decreases MPP due to the declining productivity of additional labor unit.

Suppose a perfectly competitive firm’s demand curve is below its average total cost curve. Explain the conditions under which a firm continues to produce in the short run.

It is difficult or impossible to maintain a horizontal demand curve in a perfectly competitive market. If a firm’s demand curve falls below its average cost curve, the firm will continue to produce in the short-run as long as its price stands above average variable cost. The firm will maximizes its profit by producing at a level where market price equal marginal cost (P=MC). In this case, the firm disposes its products at a price below its average total cost and earns a negative economic return. However, the firm earns sufficient revenue to cover its variable and fixed costs.

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Explain why a monopolist would never produce in the inelastic range of the demand curve.

In a monopoly, prices within the inelastic range do not result into profits. Profit maximization occurs at the output level, where MR= MC. In a monopoly, the MC is positive and, profit maximization happens at the elastic range.

Why is mutual interdependence important under an oligopoly, but not so important under perfect competition, monopoly, or monopolistic competition? Address the importance to an oligopoly and explain why the question may be true for each of the other market types.

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Mutual interdependence is more important under an oligopoly than in perfect competition conditions. This is because firms under an oligopoly need to consent on pricing decisions. Interdependence is critical since it sustain the market in a near monopoly conditions. On the other hand, mutual interdependence is irrelevant in perfect competition market, since firms strive to outdo each other. In a monopolistic environment, concerned firms do not have needs for interdependence, since they are the sole producers. In an oligopoly market, interdependence between firms eliminates unnecessary competitions, thus lowering the cost of production.

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