Important Questions and Answers (Economics: Micro & Macro)
Q1. Explain the four types of market structures with examples.
Answer:
There are four types of market structures:
- Perfect competition: Many small firms sell identical products (e.g., wheat farmers).
- Monopoly: One firm controls the market without close substitutes (e.g., local electricity supply).
- Monopolistic competition: Many firms sell slightly different products (e.g., clothing brands).
- Oligopoly: Few large firms dominate and influence each other (e.g., Pepsi and Coca-Cola).
Q2. How do firms maximize profits?
Answer:
Firms maximize profits by producing the quantity where Marginal Revenue (MR) = Marginal Cost (MC).
Q3. Why are firms in perfect competition called 'price takers'?
Answer:
Firms accept the market price because there are many sellers with identical products. Raising prices would
make customers switch to other sellers.
Q4. What happens to profits in perfect competition in the long run?
Answer:
In the long run, profits disappear because new firms enter the market, increasing supply and pushing prices
down until firms only make normal profits.
Q5. Define price discrimination and explain how it benefits monopolists.
Answer:
Price discrimination means charging different customers different prices for the same product. It benefits
monopolists by allowing them to earn more profit from different groups based on how much they are willing to
pay.
Important Questions and Answers (Economics: Micro & Macro)
Q6. What are the key features of monopolistic competition?
Answer:
- Many sellers
- Slightly different products
- Some control over prices
- Easy entry and exit from the market
- Heavy use of advertising and product variety
Q7. What is the 'kinked demand curve' in oligopoly?
Answer:
In an oligopoly, firms believe that if they lower prices, competitors will follow, but if they raise prices,
competitors won't follow. This leads to price stability or 'rigidity'.
Q8. What is the role of game theory in understanding oligopoly behavior?
Answer:
Game theory explains that firms must think strategically about their competitors' possible actions before
making decisions on price, output, or advertising.
Q9. How do firms compete in monopolistic competition?
Answer:
Firms compete by differentiating their products through branding, quality, design, or features rather than just
lowering prices.
Q10. Why do monopolies have barriers to entry?
Answer:
Monopolies are protected by high startup costs, legal rights like patents, or control of key resources, making it
difficult for new firms to enter the market.
Important Questions and Answers (Economics: Micro & Macro)
Q11. Why is perfect competition considered the most efficient market structure?
Answer:
It leads to the best use of resources because firms produce at the lowest possible cost and prices reflect true
demand and supply.
Q12. Explain 'economic profit' in a monopoly.
Answer:
Economic profit occurs when a monopolist earns revenue greater than all its costs (including opportunity
costs), and it can last even in the long run.
Q13. What is a cartel, and why are they illegal in many countries?
Answer:
A cartel is a group of firms that formally agree to fix prices or limit production. They are illegal because they
reduce competition and harm consumers by keeping prices high.
Q14. How does a perfectly competitive firm react if market prices fall below average variable cost?
Answer:
If the market price falls below average variable cost, the firm will shut down immediately in the short run to
avoid further losses.
Q15. Describe the prisoners' dilemma and its relation to oligopoly.
Answer:
The prisoners' dilemma shows how firms might not cooperate even if it is in their best interest. In an oligopoly,
firms fear competitors' actions and may end up in worse situations by not trusting each other.
Q16. What is meant by 'allocative efficiency' and 'productive efficiency'?
Answer:
- Allocative efficiency: Resources are used where they are most valued.
Important Questions and Answers (Economics: Micro & Macro)
- Productive efficiency: Goods are produced at the lowest cost.
In perfect competition, both are achieved in the long run.
Q17. Why do monopolies cause 'deadweight loss'?
Answer:
Monopolies set prices higher and output lower than perfect competition, causing a loss of total welfare that
nobody benefits from, called 'deadweight loss'.
Q18. How do oligopolies create interdependence among firms?
Answer:
In an oligopoly, a firm's pricing or output decision directly affects and is affected by the actions of other firms,
making firms dependent on each other's strategies.
Q19. What happens in the long run to profits in monopolistic competition?
Answer:
In the long run, new firms enter if profits exist, increasing competition and reducing profits to normal levels.
Q20. Why can't firms in perfect competition advertise to increase sales?
Answer:
All products are identical, so advertising wouldn't make one firm's product better than another's. It would only
increase costs without gaining customers.
