Batch5

Subject CB2
Revision Notes
For the 2019 exams

Costs, revenues, profits and

market structures
Booklet 2

covering

Module 6 Background to supply

Module 7 Perfect competition and monopoly
Module 8 Monopolistic competition and oligopoly
Module 9 Pricing strategies

The Actuarial Education Company

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CONTENTS

Contents Page
Links to the Course Notes and Syllabus 2
Overview 4
Past Exam Questions 7
Solutions to Past Exam Questions 74
Final comments 127
Checklist 128
Exam Preparation Checklist 147

Copyright agreement

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Faculty Education Ltd, a subsidiary of the Institute and Faculty of Actuaries.
The material is sold to you for your own exclusive use. You may not hire out,
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Legal action will be taken if these terms are infringed. In addition, we may
seek to take disciplinary action through the profession or through your
employer.

These conditions remain in force after you have finished using the course.

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LINKS TO THE COURSE NOTES AND SYLLABUS

Material covered in this booklet

Module 6 Background to supply

Module 7 Perfect competition and monopoly
Module 8 Monopolistic competition and oligopoly
Module 9 Pricing strategies

The module numbers refer to the 2019 edition of the ActEd Course Notes.

Syllabus objectives covered in this booklet

2.4 Discuss the production function, costs of production, revenue and profit
in order to understand a firm’s price and output decisions.

1. Explain how the production function reflects the relationship

between inputs and outputs in the short and long run.
2. Define average and marginal physical product.
3. Describe the meaning and measurement of costs and explain how
these vary with output in the short and long run.
4. Define total, average and marginal costs.
5. Describe what is meant by ‘economies of scale’ and explain the
reasons for such economies and how a business can achieve
efficiency in selecting the level of its inputs.
6. Describe revenue and profit and explain how both are influenced by
market conditions.
7. Define and calculate average and marginal revenue.
8. Describe how profit is measured and explain how the firm arrives at
its profit-maximising output.
9. Explain what is meant by the ‘shut-down’ point in the short and long
run.

2.5 Discuss profit maximisation under perfect competition and monopoly.

1. Explain what determines the market power of a firm.

2. Describe the main features of a market characterised by perfect
competition.

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3. Explain how output and price are determined in such markets in the
short and long run.
4. Describe how monopolies emerge, how a monopolist selects its
profit-maximising price and output and how much profit a
monopolist makes.
5. Describe the barriers to entry in an industry and a contestable
market and explain how these affect a monopolist’s profit.

2.6 Discuss profit maximisation under imperfect competition.

1. Describe the behaviour of firms under monopolistic competition and

explain why in this type of market only normal profits are made in
the long run.
2. Describe the main features of an oligopoly and explain how firms
behave in an oligopoly.
3. Discuss what determines competition and collusion of firms in an
oligopoly and how the strategic decisions of such firms can be
explained by game theory.
4. Discuss if firms in an oligopoly act in consumers’ interest.

2.7 Assess various pricing strategies that firms can adopt.

1. Describe how prices are determined in practice and factors that

affect the ability of a firm to determine its prices.
2. Describe average cost pricing and price discrimination.
3. Discuss pricing strategy for multiple products and explain how
pricing varies with the stage in the life of a product.

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OVERVIEW

This booklet continues from Booklet 1 in our study of microeconomics.

Recall that microeconomics is the study of individual markets and individual
decision-makers in the economy, such as firms and consumers. In Booklet 1
we looked at how markets work in general and we also studied how
individuals make consumption choices. We now study the behaviour of firms
and the operation of specific market structures.

Module 6 covers the key issues faced by firms in making their supply
decisions. Economists typically assume that firms aim to maximise profits,
which are equal to revenues less costs. In this module we therefore:
 build up a theory of production and costs in both the short run and the
long run
 consider revenues
 put costs and revenues together to determine profit and the level of
output at which it is maximised
 consider the circumstances under which it is better for a firm not to
produce anything at all.

Different firms face different costs, which are often highly dependent on the
type of market in which they operate. Modules 7 and 8 consider four
different types of market structure, namely:
1. perfect competition
2. monopoly
3. monopolistic competition
4. oligopoly.

These modules apply the concepts developed in the previous module to firms
operating in the different types of market. They also discuss their main
characteristics, such as:
 the number of firms
 the degree of competition that exists
 the equilibrium price and output levels
 the level of profits made by the firms
 the degree of efficiency.

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Module 7 first looks at the two extremes of:

1. perfect competition – in which there are effectively infinitely many firms
2. monopoly – in which there is only one firm.

In addition, the concept of the optimal output level is introduced here. This is
also covered in Module 10 on market failure.

Module 8 then goes on to consider the market structures that lie between the
extremes of perfect competition and monopoly, namely monopolistic
competition and oligopoly. These are collectively referred to as imperfect
competition.

Key features of monopolistic competition include:

 a large number of firms
 freedom of entry into the industry
 product differentiation.

Key features of oligopoly include:

 a small number of firms
 barriers to entry
 the interdependence of firms.

It might be useful to revisit the definitions (and examples) of monopolistic

competition and oligopoly from Module 7 before reading on.

When a firm has just a few competitors, as in oligopoly, it considers the likely
behaviour of these competitors when making its own decisions. In
particular, it must decide whether to collude with the other firms, or to
compete with them. Several different models of oligopolistic firm behaviour
have therefore been developed, including collusive models (eg cartels, price
leadership) and non-collusive models (eg Cournot, Bertrand and kinked
demand). Alternatively, game theory may be used to model the strategic
interaction between firms.

This section of the course contains many diagrams, some of which have
appeared frequently on past exam papers. It is therefore important to both
understand what the diagrams show and also to be able to reproduce them
clearly and accurately.

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The traditional theory of the firm (as described in the previous modules)
requires the firm to determine its profit-maximising price and output level by
equating marginal cost and marginal revenue. In practice, however, a firm is
unlikely to know its exact costs and revenues, and so a variety of other
strategies are used to determine the price to charge.

In addition, the price a firm charges for a good may vary:

 between customers (price discrimination)
 over the life cycle of the good (inter-temporal pricing)
 according to:
– the aims of the firm, eg maximising sales or profits
– the level of competition faced
– the information held on demand and costs.

This module therefore considers the different pricing strategies that firms use
in practice, having regard to the above factors and also a number of other
relevant issues. Bear in mind that a combination of pricing strategies could
be used for a particular product.

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PAST EXAM QUESTIONS

This section contains all the past exam questions from 2008 to 2017 that are
related to the topics covered in this booklet. These questions are taken from
the exam papers for Subject CT7. The questions are divided into three
sections – multiple-choice questions, short-answer questions and long-
answer questions.

Solutions are given later in this booklet. Answers only are provided for
multiple-choice questions. Other solutions give enough information for you
to check your answer, including working, and also show you what an
adequate examination answer should look like. Further information may be
available in the Examiners’ Report, ASET or Course Notes.

We first provide you with a checklist of all exam questions split by

module. You can use this, if you wish, to select the questions that relate
just to those topics that you may be particularly interested in reviewing.
Alternatively you can choose to ignore the checklist, and instead attempt the
questions without having any clues as to their content.

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Exam question checklist by module

Module Multiple-choice Short-answer Long-

answer

6 1-5, 7, 9, 10, 12, 17, 22, 24, 28, 2-4, 10, 11,
30-33, 35-37, 39, 41, 46, 49, 51, 12, 17, 20, 22,
52, 56, 57, 59, 60, 62, 63, 69, 24, 25, 30, 31,
70, 72-75, 78, 79, 82, 83, 89, 94, 34, 37, 38, 43,
95, 99, 101, 106, 107, 112-114, 44, 46, 48
119
7 14, 16, 18-20, 23, 34, 40, 42, 44, 5, 7, 26, 27, 2, 3
45, 47, 48, 53, 54, 68, 84, 85, 29, 36, 40, 41
88, 90, 96, 100, 102, 103, 109,
115-117, 122
8 8, 11, 13, 15, 21, 25, 26, 38, 43, 1, 9, 13, 14, 16 1
55, 58, 61, 64, 66, 76, 77, 81, 19, 23, 28, 32,
86, 92, 97, 104, 111, 123, 124 33, 45, 49, 50
7&8 6, 50, 71, 91, 105, 110, 121 6, 8, 18, 35 4
9 27, 29, 65, 67, 80, 87, 93, 98, 15, 21, 39, 42,
108, 118, 120 47

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Multiple-choice questions

1 Subject CT7, April 2008, Question 7

The impact of a decrease in the fixed costs of production on a firm’s

marginal costs is that:

A marginal costs will be unaffected.

B marginal costs will rise by more than the decrease in fixed costs.
C marginal costs will fall by more than the decrease in fixed costs.
D marginal costs will fall by the same amount as the decrease in fixed
costs.

2 Subject CT7, April 2008, Question 8

A firm selling only one good has positive marginal revenue where:

A the demand for its product is zero.

B the demand for its product is elastic.
C the demand for its product is inelastic.
D the demand for its product is no more than 1.

3 Subject CT7, April 2008, Question 10 (amended)

A firm faces the following relationships between capital, labour and output:

Labour employed Capital employed Output

10 5 20
20 10 28
30 15 35
40 20 41
50 25 45

Which of the following concepts does the firm experience?

A decreasing returns to scale

B constant returns to scale
C increasing returns to scale
D the law of diminishing marginal returns

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4 Subject CT7, April 2008, Question 11

In the short run, a firm should shut down when:

A average costs exceed average revenue.

B it can no longer cover its fixed costs.
C it can no longer cover its variable costs.
D expanding output narrows the gap between marginal revenue and
marginal cost.

5 Subject CT7, April 2008, Question 12 (amended)

A firm is part of a monopolistically competitive market.

Output Total revenue Total cost

100 500 600

200 1,000 700
300 1,200 900
400 1,900 1,200
500 2,000 2,300

From the information given in the table what will be the output of the firm?

A Greater than 100 but less than 200

B Greater than 200 but less than 300
C Greater than 300 but less than 400
D Greater than 400 but less than 500

6 Subject CT7, April 2008, Question 13

Which of the following statements is TRUE of monopoly, but NOT of

monopolistic competition?

A Profit is maximised where MC = MR.

B The firm faces a downward-sloping demand curve for normal goods.
C The firm can set price or quantity, but not both.
D Supernormal profits are experienced in the long run.

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7 Subject CT7, September 2008, Question 7

Which one of the following statements about short-run costs of production is

FALSE?

A Marginal cost is equal to average variable cost when average variable

cost is at a minimum.
B Average fixed cost always falls as output rises.
C Marginal cost cannot exceed average total cost.
D Average total cost exceeds average variable cost by an amount that
declines with increasing output.

8 Subject CT7, September 2008, Question 8

In a monopolistically competitive market profits will be driven to their normal

level because of:

A product differentiation.
B the large number of firms operating in the industry.
C ease of entry into the industry.
D cost minimisation.

9 Subject CT7, September 2008, Question 9

A profit-maximising monopolist with positive marginal costs and a

downward-sloping demand curve will set its price in the region of the
demand curve where the price elasticity of demand is:

A inelastic.
B elastic.
C equal to unity.
D indeterminate.

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10 Subject CT7, September 2008, Question 10 (amended)

The following data relate to a perfectly competitive firm producing Good X in

the short run.

Number of Number of Total output of

machines workers Good X

5 7 100
5 8 140
5 9 170
5 10 190

Which one of the following statements is TRUE?

A The marginal physical product of the 8th worker is lower than the
marginal physical product of the 10th worker.
B The marginal physical product of the 8th worker is higher than the
marginal physical product of the 9th worker.
C The marginal physical product of the 9th worker is lower than that of the
10th worker.
D The marginal physical product of the 10th worker is negative.

11 Subject CT7, September 2008, Question 11

In the long run, a firm operating under conditions of monopolistic competition

will produce at an output at which:

A average total cost equals average revenue.

B average total cost is less than average revenue.
C average total cost is at a minimum.
D marginal cost is equal to average total cost.

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12 Subject CT7, September 2008, Question 12

Which of the following describes a situation in which there are constant

returns to scale?

A If more labour is added to a given amount of capital, the marginal

product of labour remains unchanged.
B If the ratio of labour to capital doubles, the output of the firm also
doubles.
C If the input of both capital and labour doubles, the output of the firm
remains constant.
D If the input of capital and labour doubles, the output of the firm also
doubles.

13 Subject CT7, April 2009, Question 13

Which of the following is a feature of an oligopolistic market structure?

A There are many firms supplying the market.

B There are no barriers to entry.
C Supernormal profits can be made in the long run.
D A firm need not consider the reaction of other firms in the industry.

14 Subject CT7, April 2009, Question 14

A profit-maximising monopolist is currently operating at a level of output

where marginal revenue is greater than marginal cost. The monopolist
should:

A increase output and reduce price.

B reduce price and output.
C increase price and output.
D reduce output and increase price.

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15 Subject CT7, April 2009, Question 15

In long-run equilibrium under monopolistic competition:

A each firm’s marginal revenue curve is tangential to the average total

cost curve.
B each firm’s marginal revenue curve is tangential to the marginal cost
curve.
C each firm’s demand curve is tangential to the marginal cost curve.
D each firm’s demand curve is tangential to the average total cost curve.

16 Subject CT7, September 2009, Question 4

Which one of the following is NOT a barrier to entry into a monopoly market?

A significant economies of scale

B heavy potential advertising costs
C large capital requirements
D constant returns to scale

17 Subject CT7, September 2009, Question 5

In the short run, a firm’s average fixed costs of production will:

A increase as its output increases.

B decrease as its output increases.
C remain constant as its output increases.
D always be greater than its average variable costs of production.

18 Subject CT7, September 2009, Question 6

Assuming that the marginal and average cost curves are unchanged,
following an increase in demand, firms in a perfectly competitive market
may:

A raise their price in the short run but the price will fall back to its original
level in the long run.
B keep their price constant both in the short and in the long run.
C raise price in both the short run and the long run.
D keep price constant in the short run but raise their price in the long run.

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19 Subject CT7, September 2009, Question 7

Other things being equal, a fall in a monopolist’s fixed costs of production,

which does not lead to new entrants, causes:

A the market price to fall but quantity supplied to increase.

B the market price to rise but quantity supplied to fall.
C both market price and quantity supplied to rise.
D no change to the market price or quantity supplied.

20 Subject CT7, September 2009, Question 9

A profit-maximising monopolist would reduce its price if:

A its marginal costs of production decrease.

B it is making excess profits.
C its fixed costs of production decrease.
D it is making a loss.

21 Subject CT7, September 2009, Question 10

Which of the following is NOT a prediction of the theory of monopolistic

competition?

A When the monopolistically competitive industry achieves a long-run

equilibrium, price is greater than marginal cost.
B Monopolistically competitive firms offer differentiated products and face
a downward-sloping demand curve.
C Under monopolistic competition, the price charged to the consumer is
equal to the average revenue of the firm.
D Monopolistically competitive firms can earn supernormal profits in the
long run.

22 Subject CT7, September 2009, Question 12 (amended)

Under conditions of diminishing marginal physical product with marginal

physical product being positive, a firm will find that as it employs more of a
variable factor of production in the short run total physical product will:

A fall at an increasing rate.

B fall at a decreasing rate.
C rise at an increasing rate.
D rise at a decreasing rate.

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23 Subject CT7, April 2010, Question 11

If firms in a perfectly competitive industry are making excess profits in the

short run, then the long-run effect will be to:

A increase the output of the existing firms and the industry.

B reduce the output of the existing firms and the industry.
C reduce the output of the industry and increase the output of the existing
firms.
D reduce the output of the existing firms and increase the output of the
industry.

24 Subject CT7, April 2010, Question 12

A monopolist can sell 25 units of output per day for a price of £11.50 each
and 26 units of output per day for a price of £11.25 each. The marginal
revenue earned from the 26th unit sold is:

A £11.50.
B £11.25.
C £5.00.
D £0.25.

25 Subject CT7, April 2010, Question 13

For a firm in long-run equilibrium in an industry characterised by

monopolistic competition:

A average total cost equals marginal cost.

B average revenue is greater than marginal cost.
C price is greater than average total cost.
D average total cost is less than marginal cost.

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26 Subject CT7, April 2010, Question 14

The kinked demand curve model of oligopoly is based upon the assumption
that:

A a firm’s competitors match both its price increases and price reductions.
B one firm in the industry sets the price for all other firms.
C a firm’s competitors match its price reductions but not its price
increases.
D the price charged by a firm can either rise or fall depending on what
happens to its competitors’ prices.

27 Subject CT7, April 2010, Question 24 (amended)

Third-degree price discrimination refers to the situation where:

A a firm charges customers different prices according to how much they

purchase.
B consumers are grouped into independent markets and a separate price
is charged in each market.
C a firm charges each customer the maximum price he/she is prepared to
pay.
D different firms charge different prices for the same product.

28 Subject CT7, April 2010, Question 25

The total output and the average physical product of the variable factor
increase as long as the marginal physical product of the variable factor is:

A positive.
B above its average physical product.
C increasing.
D below its average physical product.

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29 Subject CT7, September 2010, Question 2

A firm that produces a main product and a by-product will maximise profits if
it:

A decides on the viability of producing the by-product after it has made the
decision to produce the main product.
B selects the level of output of the by-product where marginal cost of the
by-product equals its marginal revenue.
C selects the combined output where the combined marginal cost equals
the combined marginal revenue.
D uses cost-based pricing for the main and the by-product.

30 Subject CT7, September 2010, Question 6

If a firm incurs a total cost of £874 when it produces 10 units of output and a
total cost of £950 when it produces 11 units of output, the marginal cost of
the 11th unit is:

A 1,824
B 950
C 54
D 76

31 Subject CT7, September 2010, Question 7

Suppose that in a firm the amount of capital and plant size are fixed. If with
10 workers, the firm can produce 180 units of output and with 11 workers
190 units of output, then the:

A average product of labour when 10 workers are hired is lower than when
11 workers are hired.
B 11th worker has a higher average product of labour than marginal
product of labour.
C firm has not yet passed the point of diminishing returns to labour.
D marginal product of the 11th worker is negative.

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32 Subject CT7, September 2010, Question 8

Increasing long-run average costs are associated with:

A constant returns to scale.

B decreasing returns to scale.
C increasing returns to scale.
D the law of diminishing returns.

33 Subject CT7, September 2010, Question 9 (amended)

A firm operating in a perfectly competitive industry uses the least-cost

combination of the two factors of production capital and labour to produce its
output. The price per unit of labour and capital are £8 and £200
respectively. If the marginal physical product of labour is 10, then the
marginal physical product of capital is:

A 20
B 250
C 160
D 25

34 Subject CT7, September 2010, Question 20

In a perfectly competitive market, the typical firm cannot affect the price of its
output, and so it maximises profits or minimises losses when marginal cost
is:

A less than the price.

B greater than the price.
C equal to the price.
D below average variable cost.

35 Subject CT7, September 2010, Question 21

A firm is producing 1,000 units of output at a price of £20, with a marginal

cost of £5 and average cost of £8 at that level of output. What is the
supernormal profit that the monopoly firm is making?

A £20,000
B £15,000
C £7,000
D £12,000

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36 Subject CT7, September 2010, Question 22

A firm producing carpets has average variable costs of production of £420,

marginal costs of production of £500 and operates in a perfectly competitive
market. A decrease in the demand for carpets which reduces the price from
£600 to £400 will mean that the firm will do which of the following in the short
run?

A shut down its production

B decrease its level of output but continue to produce carpets
C reduce its fixed costs of production
D increase its level of output

37 Subject CT7, September 2010, Question 23

5,000 bottles of a soft drink are demanded when the price for each bottle is
£5. When the price is £6 only 4,000 bottles are demanded. The marginal
revenue from increasing the price is:

A +£1,000
B £1,000
C +£1
D £1

38 Subject CT7, September 2010, Question 26

An implicit or explicit agreement amongst firms in an industry not to compete

with each other is known as:

A the dominant firm hypothesis.

B collusion.
C non-cooperative oligopoly.
D product differentiation.

39 Subject CT7, April 2011, Question 10

In which situation will a firm cease production in the short run?

A Total revenue is less than total costs.

B Total revenue is less than total fixed costs.
C Average revenue is less than average fixed cost.
D Average revenue is less than average variable cost.

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40 Subject CT7, April 2011, Question 11

Which assumption is essential for a market to be contestable?

A Firms are free to enter and leave the market.

B Firms produce differentiated products.
C Firms cannot earn abnormal profits in the short run.
D There must be a large number of small firms.

41 Subject CT7, April 2011, Question 12

Given that a firm’s fixed costs are £1,000, the average total cost of its output
is £4 and its average variable cost is £3.50, which one of the following will
represent its total output per period?

A 2,000 units
B 1,750 units
C 250 units
D None of the above

42 Subject CT7, April 2011, Question 13

If firms in a perfectly competitive industry are making a loss in the short run
then in the long run firms will:

A increase their price and increase output.

B lower their price and increase output.
C increase their price and lower output.
D lower their price and lower output.

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43 Subject CT7, September 2011, Question 3

Under the Cournot model of duopoly a firm:

A attempts to maximise sales after assuming that the other firm will
attempt to maximise sales.
B assumes the other firm will produce a given output and then chooses its
profit-maximising output.
C assumes the other firm’s price is given and then chooses its
profit-maximising price.
D will attempt to collude with the other firm so as to set a price and output
level which will maximise industry-level profits.

44 Subject CT7, September 2011, Question 4

Which one of the following is NOT a barrier to entry into a monopoly market?

A significant economies of scale

B heavy potential advertising costs
C large capital requirements
D constant returns to scale

45 Subject CT7, September 2011, Question 6

The managing director of a monopoly firm is given the following data:

Marginal revenue = £9, Marginal cost = £10
Average cost = £11, Average revenue = £15

To maximise profits the firm should:

A reduce price and increase output.

B reduce price and reduce output.
C increase price and increase output.
D increase price and reduce output.

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46 Subject CT7, September 2011, Question 7

Global Airways, which is a profit-maximising firm, has to decide whether or

not to run an extra daily flight between London and Paris. The total daily
fixed costs of the airline are £3,000, the total variable costs of the extra flight
are £2,000 and the expected revenue from the extra flight is £2,500. In such
circumstances Global Airways will:

A not run the extra flight as it will expect to lose £2,500 from its profits.
B not run the extra flight as its expected profit of £500 is insufficient to
cover its fixed costs.
C run the extra flight as it will add £500 to its profits.
D not run the extra flight as the expected revenue of £2,500 is less than its
fixed costs.

47 Subject CT7, September 2011, Question 8

A perfectly contestable market is a market where the:

A costs of entry and exit are zero and potential entrants can enter the
market quickly.
B existing companies charge identical prices.
C the barriers to entry are substantial but the existing firms compete so
hard that industry profits are kept to the normal level over both the short
and long run.
D existing firms compete on price and quality so as to maximise industry
abnormal profits in the long run.

48 Subject CT7, September 2011, Question 9

A monopolist facing a downward-sloping demand curve for its product will

set its price in the region of the demand curve where the demand:

A has price elasticity equal to minus unity.

B is price inelastic.
C is price elastic.
D has price elasticity equal to zero.

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49 Subject CT7, September 2011, Question 12

Consider the following table:

Units of capital Units of labour Output

10 1 100
10 2 190
10 3 270
10 4 340
10 5 400

The table illustrates which one of the following:

A economies of scale
B constant returns to scale
C diseconomies of scale
D diminishing marginal productivity

50 Subject CT7, September 2011, Question 13

Which one of the following statements about market structure is TRUE?

A Under perfect competition, in the long run only some firms can make
excess profits.
B Under oligopoly all firms make decisions without taking into account the
possible reactions of their competitors.
C For a monopolist facing a linear demand curve, average revenue is
always less than marginal revenue.
D Firms under monopolistic competition charge a price above their
marginal revenue.

51 Subject CT7, April 2012, Question 9

Which one of the following is TRUE when economies of scale are present?

A The short-run average cost declines.

B If inputs are doubled then output less than doubles.
C An increase in the variable factor of production holding the fixed factor
of production constant leads to a higher increase in output.
D The long-run average cost curve declines.

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52 Subject CT7, April 2012, Question 10

Which of the following statements is TRUE?

A Marginal physical product is equal to total physical product divided by

average product.
B Average physical product is always greater than marginal physical
product.
C Marginal physical product can never become negative.
D Average physical product can never become negative.

53 Subject CT7, April 2012, Question 11

A perfectly competitive firm is producing at a level of output where short-run

marginal cost is rising and exceeds marginal revenue. What should the firm
do to maximise its short-run profits?

A reduce its output

B raise its output
C raise its price
D reduce its price

54 Subject CT7, April 2012, Question 12

For a monopoly, price exceeds marginal revenue because:

A the firm has to charge a price higher than the marginal cost of producing
the last unit.
B any decision by the monopolist to sell an additional unit of output does
not affect price.
C the firm has to reduce price on all units sold in order to sell an additional
unit.
D of the law of diminishing returns.

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55 Subject CT7, April 2012, Question 14

A profit-maximising oligopolistic firm has marginal cost of £3 at all levels of

output and operates under the belief that the demand curve for its output is
kinked at a price of £10. Provided its marginal costs are between £2 and £4,
it sells its commodity at a price of £10. If new technology reduces its
marginal cost to £1.50 at all levels of output the firm should:

A lower the price and raise output.

B maintain the existing price and output.
C lower the price but maintain existing output.
D maintain the existing price and raise output.

56 Subject CT7, April 2012, Question 15

The range of output over which average variable cost falls will be the same
as the range over which:

A average physical product falls.

B average physical product rises.
C marginal physical product falls.
D marginal physical product rises.

57 Subject CT7, October 2012, Question 3

Which of the following statements about short-run costs of production is

incorrect?

A Marginal cost is equal to average variable cost when average variable

cost is at a minimum.
B Average fixed cost always falls as output rises.
C Marginal cost cannot exceed average total cost.
D Average total cost exceeds average variable cost by an amount that
declines with increasing output.

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58 Subject CT7, October 2012, Question 4

Which of the following is NOT a feature of an industry characterised by

monopolistic competition?

A There are many firms.

B Firms sell differentiated products.
C In the long run monopolistic powers enable firms to make excess profits.
D A firm can raise its price without losing all its customers.

59 Subject CT7, October 2012, Question 5 (amended)

A profit-maximising monopolist with positive marginal costs and a

downward-sloping demand curve will be able to make most profit if demand
is:

A price-inelastic.
B price-elastic.
C of unit price elasticity.
D of infinite price elasticity.

60 Subject CT7, October 2012, Question 6 (amended)

The following data is for a perfectly competitive firm producing Good X in the
short run:

Number of Number Total output

Machines of workers of Good X

5 7 100
5 8 140
5 9 170
5 10 190

Which one of the following statements is correct?

A The marginal physical product of the 8th worker is lower than the
marginal physical product of the 10th worker.
B The marginal physical product of the 8th worker is higher than the
marginal physical product of the 9th worker.
C The marginal physical product of the 9th worker is lower than that of the
10th worker.
D The marginal physical product of the 10th worker is negative.

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61 Subject CT7, October 2012, Question 7

In the long run, a firm operating under conditions of monopolistic competition

will produce at an output at which:

A average total cost equals average revenue.

B average total cost is less than average revenue.
C average total cost is at a minimum.
D marginal cost is equal to average total cost.

62 Subject CT7, October 2012, Question 8

Which one of the following is TRUE?

A The long-run average total cost curve is derived by joining all the
minimum points of the short-run average total cost curves.
B The minimum efficient scale is the point at which long-run average costs
must begin to fall.
C In the long run a firm cannot alter its fixed costs of production.
D If a firm trebles all its inputs and its output doubles then this is indicative
of diseconomies of scale.

63 Subject CT7, October 2012, Question 9

Total costs of production for a firm producing 100 units of output are $5,000
and fixed costs are $2,000. If output is increased by 1 unit in the short run,
the total costs of production are $5,030. Which one of the following
statements is TRUE with respect to the extra unit of output?

A The marginal cost of production is less than the average fixed cost of
production.
B The average cost of production is rising.
C The average fixed cost of production is rising.
D The average cost of production exceeds the marginal cost of production.

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64 Subject CT7, October 2012, Question 10

The idea that an oligopolistic firm faces a kinked demand curve is based
upon the assumption that:

A a firm’s competitors match both its price increases and price decreases.
B one firm in the industry sets the price for all other firms.
C a firm’s competitors match its price decreases but ignore its price
increases.
D prices can either rise or fall; it depends on what happens to a firm’s
competitors’ prices.

65 Subject CT7, October 2012, Question 11

First-degree price discrimination refers to the situation where:

A a firm charges customers different prices according to how much they

purchase.
B consumers are grouped into independent markets and a separate price
is charged in each market.
C a firm charges each customer the maximum price he/she is prepared to
pay.
D different firms charge different prices for the same product.

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66 Subject CT7, October 2012, Question 12

The profit payoffs to Firm X from various strategies 1 to 4 and the presumed
responses of the other firm in a duopoly industry is given below:

Other Firm’s Response

A B C D

1 90 15 90 100
Strategy of 2 40 70 –20 –80
Firm X 3 25 50 120 130
4 10 40 70 60

Which one of the following represents the maximin strategy of Firm X?

A Strategy 1
B Strategy 2
C Strategy 3
D Strategy 4

67 Subject CT7, April 2013, Question 6

Second-degree price discrimination refers to the situation where:

A a firm charges customers different prices according to how much they

purchase.
B consumers are grouped into independent markets and a separate price
is charged in each market.
C a firm charges each customer the maximum price he/she is prepared to
pay.
D different firms charge different prices for the same product.

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68 Subject CT7, April 2013, Question 8

For a monopoly, price exceeds marginal revenue because:

A the firm has to charge a price higher than the marginal cost of producing
the last unit.
B any decision by the monopolist to sell an additional unit of output does
not affect product price.
C the firm has to reduce the price on all units sold in order to sell an
additional unit.
D of the law of diminishing returns.

69 Subject CT7, April 2013, Question 9

Which of the following is an example of economies of scope?

A A firm doubles its inputs of capital and labour and its output more than
doubles.
B A firm doubles the number of products it produces and also doubles its
research budget.
C A firm produces a new product and in so doing lowers the average cost
of producing its existing products.
D A firm produces a new product and in so doing lowers the price it
charges on its existing products.

70 Subject CT7, April 2013, Question 11

Which of the following is NOT a feature of the short-run average variable

cost curve according to the law of diminishing returns?

A The average variable cost curve is U-shaped.

B The average variable cost curve cuts the marginal cost curve at the
minimum of the marginal cost curve.
C The average variable cost curve is an increasing proportion of average
total costs as output rises.
D The average variable cost curve lies below the average fixed costs of
production.

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71 Subject CT7, April 2013, Question 13

Which of the following statements is FALSE?

A For a firm under perfect competition in the short run, marginal revenue
will be equal to the average revenue.
B In an oligopoly industry, firms make decisions taking into account the
possible reactions of their competitors.
C For a monopolist facing a linear demand curve, average revenue is
always less than marginal revenue.
D A profit-maximising monopoly firm with positive marginal costs of
production charges a price in the region of the demand curve where
demand is price-elastic.

72 Subject CT7, April 2013, Question 14

During the winter season, a hotel has fixed costs of £4,000 per week, total
variable costs of £5,000 per week and prospective total revenue of £4,500
per week. In such circumstances a profit-maximising hotel will:

A close down during the winter season since it would make a loss of
£4,500 during the winter season.
B close down during the winter season since its revenue is insufficient to
cover its fixed costs.
C stay open during the winter season as it will add £500 per week to its
profits.
D stay open during the winter season as the expected revenue of £4,500
is greater than its fixed costs.

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73 Subject CT7, September 2013, Question 10

Consider the following table:

Units of labour Units of capital Output

1 1 100
2 2 190
3 3 270
4 4 340
5 5 400

The price of labour is £100 per unit; the price of capital is £200 per unit.

The table illustrates which one of the following?

A increasing returns to scale

B constant returns to scale
C decreasing returns to scale
D the law of diminishing marginal returns

74 Subject CT7, September 2013, Question 11

Which of the following statements regarding the productivity of labour is

correct?

A Average physical product is maximised when average physical product

equals marginal physical product.
B Average physical product is maximised when marginal physical product
is maximised.
C Marginal physical product increases when average physical product is
above marginal physical product.
D Average physical product increases when marginal physical product is
below average physical product.

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75 Subject CT7, September 2013, Question 12

A perfectly competitive firm is producing at a level of output for which

short-run marginal cost exceeds marginal revenue. What should the firm do
to maximise its short-run profits?

A raise its price

B reduce its price
C raise its output
D reduce its output

76 Subject CT7, September 2013, Question 13

Which of the following is NOT a prediction of the theory of monopolistic

competition?

A When the monopolistically competitive industry achieves a long-run

equilibrium, price is greater than marginal cost.
B Monopolistically competitive firms offer differentiated products and face
a downward-sloping demand curve.
C Under monopolistic competition, the price charged to the consumer is
equal to the average revenue of the firm.
D Monopolistically competitive firms can earn supernormal profits in the
long run.

77 Subject CT7, September 2013, Question 14

The kinked demand curve model of oligopoly is based upon the assumption
that:

A a firm’s competitors match both its price increases and price reductions.
B one firm in the industry sets the price for all other firms.
C a firm’s competitors match its price reductions but not its price
increases.
D the price charged by a firm can either rise or fall depending on what
happens to its competitors’ prices.

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78 Subject CT7, April 2014, Question 6

A firm’s total costs are £150 when 10 units are produced and the marginal
cost of the 10th unit is £40. The marginal cost of the 11th unit is £15. Which
of the following is TRUE?

A The average cost for 11 units is greater than that for 10 units.
B The total fixed costs for 11 units are £165.
C The average fixed cost for 11 units is the same as the marginal cost of
the 11th unit.
D The average fixed cost for 11 units is less than the marginal cost of the
11th unit.

79 Subject CT7, April 2014, Question 9

The total output and the average physical product of the variable factor of
production both always increase as long as the marginal physical product of
the variable factor is:

A positive.
B above its average physical product.
C negative.
D falling.

80 Subject CT7, April 2014, Question 10

Second-degree price discrimination refers to a situation where:

A A firm charges customers different prices according to how much they

purchase.
B Consumers are grouped into independent markets and a separate price
is charged in each market.
C A firm charges each customer the maximum price he/she is prepared to
pay.
D Different firms charge different prices for the same product.

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81 Subject CT7, April 2014, Question 11

The profit payoffs to Firm X from combining the various strategies of X

(1,2,3,4) and the presumed response of the other firm (S,P,Q,R) in a
duopoly industry is given below:
Other firm’s response
S P Q R
1 90 40 –10 100

Strategy of 2 40 70 –20 –80

Firm X 3 25 50 120 130
4 10 40 70 60

Which one of the following represents the maximin strategy of Firm X?

A Strategy 1
B Strategy 2
C Strategy 3
D Strategy 4

82 Subject CT7, April 2014, Question 12

Global Airways, which is a profit-maximising firm, has to decide whether or

not to run an extra daily flight between London and Edinburgh. The total
daily fixed costs of the airline are £4,000, the total variable costs of the extra
flight are £5,000 and the expected revenue from the extra flight is £5,500. In
such circumstances Global Airways will:

A not run the extra flight as it will expect to lose £4,500 from its profits.
B not run the extra flight as its expected profit of £500 is insufficient to
cover its fixed costs.
C run the extra flight as it will add £500 to its profits or reduce losses by
£500.
D run the extra flight as the expected revenue of £5,500 is more than its
fixed costs.

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83 Subject CT7, September 2014, Question 8

Diseconomies of scale means:

A short-run average total cost falls as output rises.

B long-run average total cost falls as output rises.
C long-run average total cost rises as output rises.
D short-run average total cost rises as output rises.

84 Subject CT7, September 2014, Question 9

Which of the following does NOT necessarily apply to a perfectly competitive

firm producing in both the short run and the long run?

A The firm will equate its marginal costs to its average revenue.
B The firm will equate its marginal costs to its marginal revenue.
C The firm’s average revenue exceeds its average variable costs of
production.
D The firm will make only normal profits.

85 Subject CT7, September 2014, Question 10

When a monopolist maximises profits, price exceeds marginal revenue. The

difference between price and marginal revenue occurs because:

A the firm has to charge a price higher than the marginal cost of producing
the last unit.
B any decision by the monopolist to sell an additional unit of output does
not affect the price.
C the firm has to reduce the price on all previous units sold in order to sell
the additional unit.
D the law of diminishing returns directly affects the price of an imperfectly
competitive firm’s product.

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86 Subject CT7, September 2014, Question 11

The prisoners’ dilemma, applied to a situation involving the only two firms in
an oligopoly industry, illustrates that:

A each firm will not take account of its rival’s reactions when making its
decision.
B the price set by one firm will not influence the price of the other firm.
C in avoiding the worst possible outcome the firms will fail to reach the
best possible outcome.
D in avoiding the worst possible outcome the firms will succeed in
reaching the best possible outcome.

87 Subject CT7, September 2014, Question 13

Third-degree price discrimination refers to the situation where:

A a firm charges customers different prices according to how much they

purchase.
B consumers are grouped into independent markets and a separate price
is charged in each market.
C a firm charges each customer the maximum price he/she is prepared to
pay.
D different firms charge different prices for the same product.

88 Subject CT7, April 2015, Question 4

Under perfect competition:

A short-run excess profits are competed away by firms leaving the

industry.
B short-run excess profits are competed away by new firms entering the
industry.
C short-run excess profits lead to price rises.
D short-run excess profits are caused by barriers to entry and exit.

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89 Subject CT7, April 2015, Question 8

Which of the following statements regarding the productivity of labour is

correct?

A Average physical product is maximised when average physical product

equals marginal physical product.
B Average physical product is maximised when marginal physical product
is maximised.
C Marginal physical product increases when average physical product is
above marginal physical product.
D Average physical product increases when marginal physical product is
below average physical product.

90 Subject CT7, April 2015, Question 9

The short-run supply curve for a firm in a perfectly competitive industry is its:

A average cost curve.

B average variable cost curve.
C marginal cost curve above the lowest point of the average variable cost
curve.
D marginal cost curve above the lowest point of the average total cost
curve.

91 Subject CT7, April 2015, Question 10

Which one of the following statements about market structure is TRUE?

A Perfect competition is distinguished from all other market structures

because of the assumption of no barriers to entry/exit from the industry.
B Firms under monopolistic competition face horizontal demand curves for
their products.
C A monopoly will find that its average revenue is always greater than its
average costs.
D Under perfect competition, in the long run, each firm will find that its
marginal cost is equal to its average cost of production.

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92 Subject CT7, April 2015, Question 11

Which of the following is NOT a prediction of the theory of monopolistic

competition?

A When the monopolistically competitive industry achieves a long-run

equilibrium, price is greater than marginal cost.
B Monopolistically competitive firms offer differentiated products and face
a downward-sloping demand curve.
C Under monopolistic competition, the price charged to the consumer is
equal to the average revenue of the firm.
D Monopolistically competitive firms can earn supernormal profits in the
long run.

93 Subject CT7, April 2015, Question 12

A necessary condition for a firm being able to engage in price discrimination

is that:

A it faces a perfectly elastic demand curve.

B consumers of its product are willing and able to resell their purchase.
C it faces a downward-sloping demand curve.
D it is a price taker.

94 Subject CT7, October 2015, Question 8

A firm’s fixed costs are £1,000 per period, the average total cost of its output
is £4 and its average variable cost is £3.50. Which one of the following will
represent its total output per period?

A 250 units
B 1,750 units
C 2,000 units
D none of the above

95 Subject CT7, October 2015, Question 9

Increasing long-run average costs are associated with:

A constant returns to scale.

B increasing returns to scale.
C decreasing returns to scale.
D the law of diminishing returns.

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96 Subject CT7, October 2015, Question 10

The short-run supply curve for a firm in a perfectly competitive industry is its:

A average total cost curve.

B average variable cost curve.
C marginal cost curve above the lowest point of the average variable cost
curve.
D marginal cost curve above the lowest point of the average total cost
curve.

97 Subject CT7, October 2015, Question 11

In the long run, profit-maximising firms operating under conditions of

monopolistic competition will produce at a level of output where price equals:

A marginal cost.
B average total cost.
C average fixed cost.
D average variable cost.

98 Subject CT7, October 2015, Question 13

Third-degree price discrimination refers to the situation where:

A different firms charge different prices for the same product.

B a firm charges each customer the maximum price he/she is prepared to
pay.
C a firm charges customers different prices according to how much they
purchase.
D consumers are grouped into independent markets and a separate price
is charged in each market.

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99 Subject CT7, April 2016, Question 4

In the short run, the range of output over which average total cost falls will
be the same as the range over which:

A average physical product falls.

B average physical product rises.
C marginal physical product falls.
D marginal physical product rises.

100 Subject CT7, April 2016, Question 6

A market is defined as perfectly contestable if entry to it:

A and exit from it are both costless.

B is costly, but exit from it is costless.
C is costless, but exit from it is costly.
D and exit from it are both costly.

101 Subject CT7, April 2016, Question 8

Which one of the following reveals constant returns to scale?

A If more labour is added to a given amount of capital, the marginal

product of labour remains unchanged.
B If the ratio of labour to capital doubles, the output of the firm also
doubles.
C If both the input of capital and labour doubles, output remains constant.
D If the input of capital and labour doubles, the ratio of output to inputs is
unchanged.

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102 Subject CT7, April 2016, Question 9

The managing director of a monopoly firm is given the following data:

Marginal revenue = £11, Marginal cost = £10

Average cost = £13, Average revenue = £15

To maximise profits the firm should:

A reduce price and increase output.

B reduce price and reduce output.
C increase price and increase output.
D increase price and reduce output.

103 Subject CT7, April 2016, Question 10

The short-run supply curve for a firm in a perfectly competitive industry is its:

A average total cost curve.

B average variable cost curve.
C marginal cost curve above the lowest point of the average total cost
curve.
D marginal cost curve above the lowest point of the average variable cost
curve.

104 Subject CT7, April 2016, Question 11

Which one of the following is NOT a feature of an industry characterised by

monopolistic competition?

A Some degree of monopoly power ensures that in the long run firms can
make supernormal profits.
B There is freedom of entry and exit into the industry in the long run.
C Firms in the industry produce differentiated products.
D Firms in the industry charge prices above their marginal costs of
production.

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105 Subject CT7, April 2016, Question 12

Which one of the following statements about market structure is TRUE?

A Under perfect competition, in the long run only some firms can make
excess profits.
B Under oligopoly all firms make decisions without taking into account the
possible reactions of their competitors.
C For a monopolist facing a linear demand curve, average revenue is
always less than marginal revenue.
D Firms under monopolistic competition charge a price above their
marginal revenue.

106 Subject CT7, April 2016, Question 13

Go Global Airways, which is a profit-maximising firm, has to decide whether

or not to run an extra daily flight between London and Berlin. The total daily
fixed costs of the airline are £6,000, the total variable costs of the extra flight
are £3,000 and the expected revenue from the extra flight is £4,500. In such
circumstances, Go Global Airways, which is overall a profitable firm, will:

A not run the extra flight as it will expect to lose £4,500 from its profits.
B not run the extra flight as its expected profit of £1,500 is insufficient to
cover its fixed costs.
C run the extra flight as it will add £1,500 to its profits.
D not run the extra flight as the expected revenue of £4,500 is less than its
fixed costs.

107 Subject CT7, September 2016, Question 8

Which of the following reveals constant returns to scale?

A When the input of both capital and labour doubles, output doubles.
B When the input of both capital and labour doubles, output remains
constant.
C When the ratio of labour to capital doubles, the output of the firm also
doubles.
D When more labour is added to a given amount of capital, the marginal
physical product of labour remains unchanged.

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108 Subject CT7, September 2016, Question 9

A firm that produces a main product and a by-product will maximise profits if
it:

A uses cost-based pricing for the main and the by-product.

B selects the combined output where the combined marginal cost equals
the combined marginal revenue.
C decides on the viability of producing the by-product after it has made the
decision to produce the main product.
D selects the level of output of the by-product where the marginal cost of
the by-product equals its marginal revenue.

109 Subject CT7, September 2016, Question 10

A perfectly competitive firm has fixed and variable costs of production. It

produces output at the long-run profit-maximising level. Which of the
following statements is correct?

A Marginal cost exceeds average total cost.

B Marginal cost equals average variable cost.
C Marginal cost exceeds average variable cost.
D Marginal cost is less than average variable cost.

110 Subject CT7, September 2016, Question 11

Which of the following statements is FALSE?

A Collusion may occur between firms in oligopolistic competition.

B A firm in perfect competition faces a perfectly inelastic demand curve.
C In monopolistic competition, supernormal profits cannot be made in the
long run.
D Price discrimination would allow the monopolist to produce the socially
efficient level of output.

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111 Subject CT7, September 2016, Question 12

Which of the following is NOT a barrier to entry in an oligopolistic industry?

A product proliferation
B constant returns to scale
C investment in spare capacity
D high advertising expenditure

112 Subject CT7, April 2017, Question 6

Which of the following is an example of economies of scope?

A A firm doubles its inputs of capital and labour and its output more than
doubles.
B A firm doubles the number of products it produces and also doubles its
research budget.
C A firm produces a new product and in so doing lowers the average cost
of producing its existing products.
D A firm produces a new product and in so doing lowers the price it
charges on its existing products.

113 Subject CT7, April 2017, Question 7

Increasing long-run average costs are associated with:

A constant returns to scale.

B decreasing returns to scale.
C increasing returns to scale.
D the law of diminishing returns.

114 Subject CT7, April 2017, Question 8

In which situation will a firm cease production in the short run?

A Total revenue is less than total costs.

B Total revenue is less than total fixed costs.
C Average revenue is less than average fixed cost.
D Average revenue is less than average variable cost.

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115 Subject CT7, April 2017, Question 9

Which one of the following characteristics does NOT apply to a firm in an

industry characterised by perfect competition?

A The firm can make only normal profits in the long run.
B There are no barriers to entry into the market.
C The firm can make only normal profits in the short run.
D Marginal revenue is equal to average revenue.

116 Subject CT7, April 2017, Question 10

A monopoly firm faces a linear demand schedule and has positive but
constant marginal costs which are currently below its marginal revenue. If
the firm wishes to maximise profits then it should:

A lower its price and increase output.

B raise its price and increase output.
C lower its price and decrease output.
D raise its price and decrease output.

117 Subject CT7, April 2017, Question 11

A perfectly contestable market is a market where the:

A costs of entry and exit are zero and potential entrants can enter the
market quickly.
B existing companies charge identical prices.
C the barriers to entry are substantial but the existing firms compete so
hard that industry profits are kept to the normal level over both the short
and long run.
D existing firms compete on price and quality so as to maximise industry
supernormal profits in the long run.

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118 Subject CT7, October 2017, Question 3

Third-degree price discrimination refers to the situation where:

A a firm charges customers different prices according to how much they

purchase.
B consumers are grouped into independent markets and a separate price
is charged in each market.
C a firm charges each customer the maximum price that he/she is
prepared to pay.
D different firms charge different prices for the same product.

119 Subject CT7, October 2017, Question 8

Which of the following statements about short-run costs of production is

FALSE?

A Marginal cost cannot exceed average total cost.

B Marginal cost is equal to average variable cost when average variable
cost is at a minimum.
C Average fixed cost always falls as output rises.
D Average total cost exceeds average variable cost by an amount that
declines with increasing output.

120 Subject CT7, October 2017, Question 9

A firm that produces a main product and a by-product will maximise profits if
it:

A decides on the viability of producing the by-product after it has made the
decision to produce the main product.
B selects the level of output of the by-product where marginal cost of the
by-product equals its marginal revenue.
C selects the combined output where the combined marginal cost equals
the combined marginal revenue.
D uses cost-based pricing for the main product and the by-product.

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121 Subject CT7, October 2017, Question 10

Which of the following statements is FALSE?

A In monopolistic competition, supernormal profits cannot be made in the

long run.
B Price discrimination is impossible under perfect competition.
C Collusion may occur between firms in oligopolistic competition.
D A firm in perfect competition faces a perfectly inelastic demand curve.

122 Subject CT7, October 2017, Question 11

When a monopolist maximises profits, price exceeds marginal revenue. The

difference between price and marginal revenue occurs because:

A the firm has to charge a price higher than the marginal cost of producing
the last unit.
B any decision by the monopolist to sell an additional unit of output does
not affect price.
C the firm has to reduce the price on all units sold in order to sell the
additional unit.
D the law of diminishing returns directly affects the price of an imperfectly
competitive firm’s product.

123 Subject CT7, October 2017, Question 12

Which one of the following characteristics applies to an oligopolistic market

structure?

A There is a large number of firms.

B There is an absence of barriers to entry into the market.
C Demand for each firm is infinitely price-elastic.
D The output decisions of one firm may exert a significant influence on
other firms in the industry.

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124 Subject CT7, October 2017, Question 13

An implicit or explicit agreement amongst firms in an industry NOT to

compete with each other is known as:

A the dominant firm hypothesis.

B collusion.
C non-cooperative oligopoly.
D product differentiation.

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Short-answer questions

1 Subject CT7, April 2008, Question 29

Using appropriate diagrams for a firm operating in a monopolistically

competitive market illustrate:
(a) a short-run position where a seller is making supernormal profits. [3]
(b) a long-run position. [3]
[Total 6]

2 Subject CT7, April 2008, Question 31

Consider a firm in a perfectly competitive market where the market price is

£3 per unit and the firm’s cost data are as below:

Output Total cost

0 10
10 45
20 75
30 100
40 120
50 145
60 175
70 210

(i) State the firm’s fixed costs of production. [1]

(ii) Construct three further columns showing the average variable costs,
marginal costs and total revenue for each level of output. [3]

(iii) State the profit-maximising level of output and the amount of profit at
that level of output. [1]
[Total 5]

3 Subject CT7, September 2008, Question 28

Explain the difference between the law of diminishing marginal returns and
diseconomies of scale. [4]

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4 Subject CT7, September 2008, Question 29

A manufacturer of Good X can sell all of its output of X produced at the

market price of £50 each. When the firm is operating efficiently, the total
cost of production per day is as follows:

Output per day Total cost (£)

0 50
1 60
2 78
3 105
4 140
5 195
6 264

(i) Construct a table which gives marginal cost and average total cost at
each level of output. [2]

(ii) State the level of output at which profit will be maximised. [1]

(iii) Calculate the profit at the profit-maximising level of output. [1]

[Total 4]

5 Subject CT7, September 2008, Question 31

(i) Draw a diagram to show a firm in a perfectly competitive industry

making normal profits. Use the following labels: AC1 for the average
cost curve, MC1 for the marginal cost curve, MR1 for marginal revenue
curve, AR1 for the average revenue curve, P1 for Price and Q1 for
Quantity. [2]

(ii) Explain and illustrate on this diagram the short-run and long-run effects
of a permanent fall in the fixed costs of production facing all of the firms
in the perfectly competitive industry. Use the number 2 (AC2 etc), for
any new cost curves, new revenue curves or price and quantity where
appropriate. [2]
[Total 4]

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6 Subject CT7, September 2008, Question 36

(i) Outline the characteristics of an oligopolistic market structure. [2]

(ii) Explain how the characteristics of an oligopolistic market structure differ

from the characteristics of a monopoly market structure. [3]
[Total 5]

7 Subject CT7, April 2009, Question 30

Draw a diagram which illustrates the argument that monopolies are bad for
society. Show clearly consumer surplus, producer surplus and social cost. [4]

8 Subject CT7, April 2009, Question 31

Given the diagram below, state:

(a) what type of market this might represent
(b) the profit-maximising level of output
(c) the output where revenue is maximised
(d) the price where the firm would maximise profit
(e) the largest output that can be produced without incurring a loss
(f) the area of total revenue at profit-maximising output and price.

Quantity (Scale 1 =10 units)

[6]

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9 Subject CT7, September 2009, Question 27

(i) Draw a diagram to illustrate the profit-maximising price and output for an
oligopolist with a kinked demand curve. Use the following labels: AR1
for the average revenue curve, MR1 for the marginal revenue curve,
AC1 for the average cost curve, MC1 for the marginal cost curve, P1 for
price and Q1 for quantity. [2]

(ii) Use the diagram drawn in part (i) to show an increase in the marginal
and average costs of production which does not affect the firm’s
profit-maximising price and output. Use the labels MC2 and AC2 for the
new cost curves. [2]

(iii) Explain what you would expect to happen to total revenue if the firm
decided to raise its price above P1. [1]
[Total 5]

10 Subject CT7, September 2009, Question 28

A perfectly competitive firm manufactures Good X which sells at £35 per

unit. The total costs of production for different levels of output per day are
given below:

Output Total cost (£)

0 30
1 40
2 58
3 84
4 120
5 170

(i) Construct a table to provide the following information at each level of

output:
(a) total fixed cost
(b) marginal cost
(c) average total cost. [3]

(ii) State the level of output that will maximise profit. [1]
[Total 4]

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11 Subject CT7, September 2009, Question 32 (part, amended)

Company A incurs fixed costs of £200 per week to produce Good X. The
table below shows how the weekly production of Good X increases as more
workers are employed. The weekly wage rate is £120 per worker. Company
A can sell all it produces of Good X at a price of £25 per unit.

Number of workers per week Total production per week

0 0
1 3
2 10
3 20
4 33
5 39
6 42
7 40

(i) Construct a table to show the following at each level of employment:

(a) the marginal physical product of labour
(b) the marginal cost of producing Good X. [2]

(ii) Determine the output level at which profits are maximised. [1]
[Total 3]

12 Subject CT7, April 2010, Question 31

(i) Describe two reasons for firms experiencing ‘economies of scale’. [2]

(ii) Describe two reasons for firms experiencing ‘diseconomies of scale’.

[2]
[Total 4]

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13 Subject CT7, April 2010, Question 32

In a country two electricity generating companies, Company X and

Company Y supply electricity to the whole country. The companies have
been operating for a long period of time in a stable market. Assume that
Company X believes its rival will produce QY units of electricity.

(i) Draw a diagram to illustrate the total market demand curve Dm and the
demand curve facing Company X, D X . Add to the diagram, the
marginal revenue curve facing Company X, MR X and the marginal cost
curve MC . [3]

(ii) Denote the output Q X Company X will produce and the price PX that it
will charge in order to maximise its profit. [1]

Assume now that Company X believes that Company Y will double its
output to 2QY .

(iii) Show on your diagram the new demand curve facing Company X D X 2
and the new marginal revenue curve facing Company X, MR X 2 . [2]

(iv) Denote the new output Q X 2 that Company X will produce and the new
price PX 2 that it will charge in order to maximise its profit. [1]
[Total 7]

14 Subject CT7, September 2010, Question 28

In a country the banking sector is dominated by a single large Bank X with a

positive-sloping marginal cost curve MC, with the sum of other firms’
marginal costs being identical to that of Bank X. Assume that the other
banks adopt exactly the same mortgage interest rate as set by Bank X and
that changes in the mortgage interest rates are initiated by Bank X.

(i) Draw a diagram to show the market demand curve for loans at different
mortgage interest rates and label it DM . On the same diagram draw the
demand curve facing Bank X and its marginal revenue curve MR X .
Add the marginal cost curve MC of Bank X and depict Bank X’s
profit-maximising mortgage interest rate r1 and the quantity of
mortgages sold by Bank X as Q X . [2]

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(ii) Show on your diagram the mortgage amount provided by the rest of the
banking sector as Q X QR . [1]

(iii) Bank X takes over all the other banks and becomes the sole provider in
the mortgage market. Bank X has the same marginal cost as before the
takeover. Show on your diagram the new marginal revenue curve
facing the new monopoly firm MRM , the new mortgage interest rate r2
and the new quantity of mortgages offered by Bank X as Q X 2 . [2]
[Total 5]

15 Subject CT7, September 2010, Question 31

(i) Draw a graph showing the four stages of the product life cycle. [2]

(ii) Describe the stages of the life cycle of basic mobile phones. [2]

(iii) Explain the pricing policies of the basic mobile phone companies during
the cycle, including the later introduction of more sophisticated smart
phones. [2]
[Total 6]

16 Subject CT7, September 2010, Question 36

There are two companies, Iceberg and Easifreeze, producing a single model
of identical freezers in a country. Both companies face identical demand
curves and costs and do not collude in deciding their pricing strategy. The
following table shows the possible prices they could charge and the profits
they could make.

Iceberg price
£ 200 £250
£120,000 Easifreeze
£200 £80,000 each
Easifreeze £50,000 Iceberg
price £50,000 Easifreeze
£250 £100,000 each
£120,000 Iceberg

(i) Determine the price for each firm when the equilibrium outcome of the
game is a Nash equilibrium. [2]

(ii) Describe the likely result of a Nash equilibrium outcome in the context of
expenditure on advertising. [2]
[Total 4]

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17 Subject CT7, April 2011, Question 29

Explain each of the following:

(i) the law of diminishing marginal returns [2]

(ii) diseconomies of scale. [2]

[Total 4]

18 Subject CT7, April 2011, Question 30

(i) Draw one fully labelled diagram to illustrate the long-run equilibrium
position of a firm under perfect competition and a firm under
monopolistic competition. Assume that both firms have the same
long-run average total cost curve. [2]

(ii) Identify, with reference to your diagram, the excess capacity relating to
the firm in monopolistic competition. [1]

(iii) Explain how, compared to perfect competition, the price and output
decision under monopolistic competition affects the consumer. [1]
[Total 4]

19 Subject CT7, September 2011, Question 27

Read parts (i), (ii) and (iii) before answering:

(i) Draw a diagram to illustrate the profit-maximising price and output for an
oligopolist with a kinked demand curve. Use the following labels: AR1
for the average revenue curve, MR1 for the marginal revenue curve,
AC1 for the average cost curve, MC1 for the marginal cost curve, P1 for
price and Q1 for quantity. [2]

(ii) Using the diagram drawn in part (i) show an increase in the marginal
and average costs of production at each output level which do not affect
the firm's profit-maximising price and output. Use the labels MC2 and
AC2 for these new cost curves. [2]

(iii) Explain what you would expect to happen to the firm’s total revenue if
the firm decided to raise the price above P1. [1]
[Total 5]

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20 Subject CT7, September 2011, Question 29

You are given the following data concerning the production costs and the
average revenue of a profit-maximising firm that produces Good X. The
fixed costs of production are £100.

Output of Good X Short-run average Average revenue

variable costs (£s) (£s)

1 110 300
2 95 250
3 80 210
4 75 180
5 82 150
6 85 120
7 90 100
8 100 90
9 110 80
10 120 70

(i) Calculate the profit-maximising output of the firm. [1]

(ii) State the level of output at which average total costs are minimised. [1]

(iii) State what will happen to the production in the short run if the fixed
costs of production rise from £100 to £400. [1]

(iv) Calculate the smallest rise in total variable costs (to the nearest pound)
that would force the firm to cease production in the short run. [2]
[Total 5]

21 Subject CT7, September 2011, Question 31

(i) Using supporting diagrams show how a profit-maximising firm will

practise third-degree price discrimination by dividing its market into two
distinct markets A and B with different demand elasticities. Show the
price in the market with inelastic demand (Market A) and in the market
with a more elastic demand (Market B) and the overall output of the firm
made up of demand in both Market A and Market B. [3]

(ii) Give an example of second-degree and third-degree price

discrimination. [2]
[Total 5]

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22 Subject CT7, April 2012, Question 28

A perfectly competitive firm sells Good X at a market price of £18 per unit.
The firm’s short-run total fixed cost is £450 per day and the daily wage rate
paid by the firm is £130 per employee. No other costs are involved in
production.

The output of the firm varies with the level of employment as follows:

Number of employees Units of output per day

0 0
1 22
2 42
3 58
4 66
5 67

If the firm employs three workers per day, determine the firm’s daily:

(i) total revenue [1]

(ii) total cost [1]

(iii) economic profit. [1]

[Total 3]

23 Subject CT7, April 2012, Question 30

Draw a diagram to represent a firm operating in monopolistic competition in

the short run.

Use your diagram to show:

(a) the firm’s profit-maximising price and level of output
(b) the area representing total profit
(c) the effect of an increase in fixed costs. [5]

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24 Subject CT7, October 2012, Question 27

A manufacturer of Good X can sell all of Good X produced at the market

price of ¥50 per unit.

When the firm is operating efficiently, the total cost of production per day is
as follows:

Output per day Total cost (¥)

0 50
1 60
2 78
3 105
4 140
5 185
6 264

(i) Construct a table which gives marginal cost and average total cost at
each level of output. [2]

(ii) State the level of output at which profit will be maximised. [1]

(iii) State the level of maximum profit at the profit-maximising output. [1]
[Total 4]

25 Subject CT7, October 2012, Question 28

Outline the major factors which explain the shape of a firm's average cost
curve in the short and the long run. [4]

26 Subject CT7, October 2012, Question 29

Read both parts (i) and (ii) before answering the question.

(i) Draw a diagram for a profit-maximising monopoly making excess profits

using the following labels: AC1 for the average cost curve, MC1 for the
marginal cost curve, MR1 for the marginal revenue line, AR1 for the
average revenue line. Show on the average revenue line a point A at
which profits will be maximised and the corresponding profit-maximising
price (P1) and output (Q1). [2]

(ii) Show on the average revenue line a point N at which only normal profits
will be made and the corresponding price (P2) and output (Q2). [2]
[Total 4]

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27 Subject CT7, April 2013, Question 28

(i) Explain what is meant by a perfectly contestable market. [2]

(ii) Explain what the implications for a monopoly firm in a perfectly

contestable market are with respect to its price and output decisions,
compared to being in a non-contestable market. [2]

(iii) Explain what is meant by ‘sunk costs’ and comment on how sunk costs
can be a barrier to entry. [2]
[Total 6]

28 Subject CT7, April 2013, Question 29

(i) Explain with the aid of a diagram how, in the Cournot model of duopoly,
Firm A which has positive marginal costs will decide on its equilibrium
price and output for a given output level of its rival Firm B. [3]

(ii) Comment on how in the Cournot equilibrium for a duopoly industry, the
price and output compares with that of a monopoly industry. [2]
[Total 5]

29 Subject CT7, April 2013, Question 30

The diagram below shows a firm’s short-run cost and revenue curves.

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(i) State at what level of output the total revenues of the firm are
maximised. [1]

(ii) State all levels of output where supernormal profits are being made. [1]

(iii) If the above diagram were to depict a monopoly, state at what level of
output it would be making normal profits. [1]

(iv) State all levels of output at which the absolute value of the price
elasticity of demand is greater than one. [1]

(v) State all levels of output where the firm would be making an overall loss.
[1]
[Total 5]

30 Subject CT7, September 2013, Question 27

The owner of an orchard can choose to grow apples or pears on their land.
Apples sell for £200 per tonne. Pears sell for £350 per tonne. The costs of
seed, fertiliser, labour and storage costs are £140 per tonne for both goods.
Calculate the owner’s cost and profit per tonne if the orchard owner decides
to grow pears instead of apples on their land. [2]

31 Subject CT7, September 2013, Question 28

Describe how a firm that manufactures cars may experience economies of

scale. [4]

32 Subject CT7, September 2013, Question 29

(i) Draw a diagram to show a typical monopolistically competitive firm, such

as a coffee shop, which is wishing to operate but is making a loss. Your
diagram should show all the relevant cost and revenue curves and the
area corresponding to the firm’s losses. [3]

(ii) Now assume that consumer demand for hot drinks increases. Show,
with the use of a new diagram, the effect this will have on the market
price and quantity traded in the short run, assuming that the firm now
makes a profit. [2]
[Total 5]

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33 Subject CT7, September 2013, Question 30

List four factors which favour collusion amongst oligopolistic firms. [2]

34 Subject CT7, April 2014, Question 27

You are given the following data concerning the average product of labour,
which along with 4 units of capital are the only two factors of production used
in the short-run production process.

Units of labour Average product of

employed labour in units of
output
0 –
1 70
2 80
3 90
4 100
5 90
6 80
7 70

Each unit of capital costs £100 and each unit of labour costs £75.

(i) Calculate the marginal product of the 4th unit of labour. [1]

(ii) State whether the average product of labour in the above table is always
greater than or equal to the marginal product of labour. [1]

(iii) Calculate the average cost of production if 4 units of labour are

employed in the short run. [1]

(iv) Calculate the total cost of production when output is 490 units. [1]
[Total 4]

35 Subject CT7, September 2014, Question 30

Discuss the types of market structure that would make it difficult for firms to
experience economies of scale. [3]

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36 Subject CT7, September 2014, Question 31

For each of the following, explain whether it represents a potentially

contestable market.
(a) airline routes
(b) savings accounts
(c) hospital catering [6]

37 Subject CT7, September 2014, Question 34

Firm A produces Good X, has fixed costs of £10,000 per year and has a
variable cost of £5,000 per year for each worker. Firm A can sell all of
Good X produced at a price of £200 per ton. The table below shows the
total production of Good X per year as additional workers are employed.

Number of workers Total production in

per year tons per year

0 0
1 25
2 75
3 127
4 179
5 212
6 225

(i) Draw a table to illustrate at each level of employment the firm’s:

(a) marginal product of labour per year (in tons).
(b) marginal revenue product of labour per year (in £s). [3]

(ii) Calculate the total revenue, total cost and profit/loss per year when four
workers are employed. [3]
[Total 6]

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38 Subject CT7, April 2015, Question 32

The information on costs for a firm operating in a perfectly competitive

market are provided in the table below. The company charges a price of
$14 per unit of its product.

Quantity Total cost ($)

0 10
1 20
2 26
3 30
4 38
5 50
6 72
7 105

(i) Calculate the average cost and marginal cost of production at each level
of output. [2]

(ii) Determine the level of output at which the average and marginal cost of
production are equal. [1]

(iii) Determine the profit-maximising level of output and the maximum profit.
[2]

(iv) Explain why achieving economies of scale is not compatible with perfect
competition. [1]
[Total 6]

39 Subject CT7, April 2015, Question 36 (part, amended)

The company Toshisoni sells a memory stick in Japan for ¥700 but it offers
three memory sticks for ¥1800 and five memory sticks for ¥2500.

(i) Identify the type of price discrimination strategy that the company is
exercising. [1]

Assume now that Toshisoni sells the memory stick at a single price of ¥600
in Japan and at a price equivalent to ¥900 in pounds in the UK.

(iii) Comment on the type of price discrimination that the company exercises
in this case. [2]
[Total 3]

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40 Subject CT7, October 2015, Question 30

A monopoly firm is making losses but has sufficient revenue to continue

production in the short run.

(i) Draw a diagram to illustrate the short-run profit-maximising price and

output for the firm.

Label the diagram as follows:

 AC1 average cost curve, MC1 marginal cost curve
 P1 price, Q1 quantity
 AVC1 average variable cost curve, C1 average cost
 MR1 marginal revenue curve, AR1 average revenue curve. [4]

(ii) Show the total loss on the diagram. [1]

[Total 5]

41 Subject CT7, October 2015, Question 31

Outline FIVE different forms of barriers to entry that enable monopolies to

maintain their position as sole supplier to the market. [5]

42 Subject CT7, October 2015, Question 32

Explain with the use of appropriate examples the difference between first-
and second-degree price discrimination. [4]

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43 Subject CT7, April 2016, Question 28

Consider the following data for a perfectly competitive firm, where the market
price for the good is £30:

Output Total
per week cost (£s)
0 5
1 45
2 78
3 99
4 114
5 132
6 162
7 210

(i) Prepare a table showing the marginal cost and average variable cost at
each level of output. [2]

(ii) Calculate the profit-maximising level of output of the firm. [1]

(iii) Calculate the profit at the profit-maximising level of output. [2]

[Total 5]

44 Subject CT7, April 2016, Question 30

Consider the following options A to E. Each option relates to an individual

firm operating under a certain market structure in the short run.

OPTION Marginal Average Average Marginal

cost cost revenue revenue
A 25 20 20 10
B 20 20 20 20
C 24 18 24 24
D 15 18 20 15
E 9 14 20 14

(i) State ALL the options that indicate the firm is neither seeking to
maximise its profits nor minimise its losses. [1]

(ii) State ALL the options that indicate that the firm is making excess profits.
[2]

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(iii) State ALL the options that indicate that the firm could increase its output
and increase its profits. [1]

(iv) State ALL the options which could correspond to the firm operating in a
long-run perfectly competitive environment. [1]
[Total 5]

45 Subject CT7, April 2016, Question 31

(i) Draw a diagram for a monopolistically competitive firm making normal

profits including the following curves: AR for average revenue, MR for
marginal revenue, AC1 for average cost and MC1 for marginal cost.
Denote the equilibrium price as P1, average cost as C1 and quantity as
Q1. [2]

(ii) Demonstrate on the diagram you have drawn in part (i) above, the
short-run impact of a fall in wages using new cost curves AC2 and MC2.
Indicate the new price P2, new average cost C2 and new quantity Q2.[2]

(iii) Explain the effect of the fall in wages in (ii) above on profits in the short
run. [1]

(iv) Explain what will happen to the demand and profits in the long run. [2]
[Total 7]

46 Subject CT7, September 2016, Question 29

(i) Draw a diagram with a downward-sloping demand curve, to show the

short-run shut-down point. Label average cost as AC, average variable
cost as AVC and average revenue as AR. [4]

(ii) Describe the difference between the short-run and long-run shut-down
points. [2]
[Total 6]

47 Subject CT7, September 2016, Question 31

(i) Describe the term ‘loss leader’ and the main factor that a firm should
consider in using a ‘loss leader’ as a successful pricing strategy. [2]

(ii) Discuss how a sports clothing store may use a successful ‘loss leader’
pricing strategy. [2]
[Total 4]

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48 Subject CT7, April 2017, Question 28

Company ABC faces a downward-sloping (straight-line) demand curve as

shown in the table below. Its fixed costs of production are zero and the
marginal costs of production are £5 per unit produced.

Price per unit Quantity Demanded Total Profit Marginal

(£) (units) (£) Revenue (£)
20 0 - -
18 1 ……… ………
16 2 ……… ………
14 3 ……… ………
12 4 ……… ………
10 5 ……… ………
8 6 ……… ………
6 7 ……… ………

(i) Prepare a table showing the total profit and marginal revenue at each
price level. [2]

(ii) Calculate the price elasticity of demand using the average formula when
the price falls from £10 to £8. [2]

(iii) State over what price range the absolute value of the price elasticity of
demand is equal to, or greater than, 1. [1]
[Total 5]

49 Subject CT7, April 2017, Question 29

The table below shows the annual profits for Company A and Company B
which produce Good X. The profits vary according to whether each charges
£15 or £10.

B’s price
£15 £10
£6 million for Company A
£15 £12 million each £18 million for Company B
price
A's

£18 million for Company A

£10 £6 million for Company B £8 million each

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(i) State the price Company A should charge if it were to renege on an

agreement previously reached with Company B to maximise their joint
profits. [1]

(ii) State the price Company A should charge if it makes its pricing decision
completely independently of Company B. [1]

(iii) Explain why this situation is known as a dominant strategy game. [2]

(iv) State the Nash equilibrium in terms of the price and profits of both firms,
if the game is played only once. [1]
[Total 5]

50 Subject CT7, April 2017, Question 32 (part)

(ii) (a) Explain, with the aid of a diagram, how a price-leading oligopoly
firm that seeks a constant market share will set its price assuming it
faces a linear market demand curve.

Label your diagram as follows:

 D – the market demand curve
 AR – the average revenue of the leader firm
 MR – the marginal revenue of the leader firm
 MC – the marginal cost of the leader firm.

Label the price set by the leader firm PL , the output of the leader
firm QL and the total market demand QD .

(b) Identify the amount produced by the follower firms. [3]

[Total 6]

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Long-answer questions

1 Subject CT7, April 2009, Question 34

In a large city there are many pizza restaurants serving similar but not the
same products. Initially the market is in long-run equilibrium, then a change
in taste and fashion increases demand for eating out at pizza restaurants.

(i) State the market structure and use diagrams to illustrate:

(a) initial equilibrium in this market
(b) the short-run impact of a change in demand
(c) the long-run impact of a change in demand. [8]

(ii) Explain what you would expect to happen to economic profit, price and
output in the short run and long run assuming no change in costs. [6]
[Total 14]

2 Subject CT7, April 2012, Question 38

In a large city there are many taxi firms which can provide identical services.

(i) State the type of market structure under which the city’s taxi firms
operate. [1]

(ii) Explain and show on a diagram the possible changes in a taxi firm’s
economic profit, price and output given the following events. Use
diagrams which are initially in long-run equilibrium and take each event
separately.

(a) The city council decides to ease traffic congestion by banning cars
from inner city areas but not taxis.

(b) The price of petrol and diesel fuel increases.

(c) A new licence fee for all taxis is introduced. [9]

[Total 10]

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3 Subject CT7, September 2014, Question 37

In a large city there is only one inner city public transport system, Cititravel,
which provides bus services only, operates under a free licence from the
government and does not exercise price discrimination.

(i) State the type of market structure in which Cititravel is operating,

explaining your reason. Use a diagram to illustrate the long-run
equilibrium in this market. [3]

(ii) If the city council imposes an annual licence fee on Cititravel, use a
diagram to explain what you would expect to happen to Cititravel’s
economic profit, price and quantity. [4]

(iii) Assume that the market for bus travel is deregulated, reducing the
barriers to entry and enabling new firms to enter the market to provide
bus services. Assume further that Cititravel, as the established leader in
the market, sets the price and maintains 50% of the market, with other
firms following the price it sets. Use a diagram to explain how
Cititravel’s price and quantity are determined. [3]
[Total 10]

4 Subject CT7, April 2017, Question 37 (part)

(i) Describe in words the differences between a market structure

characterised by monopolistic competition and one characterised by
monopoly. In your answer refer to both the short and the long run. (No
diagrams are required in your answer.) [5]

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SOLUTIONS TO PAST EXAM QUESTIONS

Multiple-choice questions

1 A 11 A 21 D 31 B 41 A
2 B 12 D 22 D 32 B 42 A
3 A 13 C 23 D 33 B 43 B
4 C 14 A 24 C 34 C 44 D
5 C or D 15 D 25 B 35 D 45 D
6 D 16 D 26 C 36 A 46 C
7 C 17 B 27 B 37 C 47 A
8 C 18 A 28 B 38 B 48 C
9 B 19 D 29 C 39 D 49 D
10 B 20 A 30 D 40 A 50 D

51 D 61 A 71 C 81 C 91 D
52 D 62 D 72 A 82 C 92 D
53 A 63 D 73 C 83 C 93 C
54 C 64 C 74 A 84 D 94 C
55 A 65 C 75 D 85 C 95 C
56 B 66 C 76 D 86 C 96 C
57 C 67 A 77 C 87 B 97 B
58 C 68 C 78 B 88 B 98 D
59 B 69 C 79 B 89 A 99 B
60 B 70 B or D 80 A 90 C 100 A

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101 D 111 B 121 D

102 A 112 C 122 C
103 D 113 B 123 D
104 A 114 D 124 B
105 D 115 C
106 C 116 A
107 A 117 A
108 B 118 B
109 C 119 A
110 B 120 C

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Short-answer questions

1 Subject CT7, April 2008, Question 29

(a) Short-run position where a seller is making supernormal profits

£ MC
AC

p*

supernormal
profit

MR AR

Q* output

(b) Long-run position

£
MC
AC

p*

MR AR

Q* output

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2 Subject CT7, April 2008, Question 31

(i) Fixed costs

When output is zero, total cost is £10, therefore the fixed costs of production
are £10.

(ii) Average variable costs, marginal costs and total revenue

Output Total cost Average Marginal cost (of Total

variable cost last 10 units) revenue
0 10 – – 0
10 45 3.50 35 30
20 75 3.25 30 60
30 100 3.00 25 90
40 120 2.75 20 120
50 145 2.70 25 150
60 175 2.75 30 180
70 210 2.86 35 210

(iii) Profit-maximising output and profit

Output Total cost Total revenue Profit

0 10 0 –10
10 45 30 –15
20 75 60 –15
30 100 90 –10
40 120 120 0
50 145 150 5
60 175 180 5
70 210 210 0

From the table, profit is maximised at 50 and 60 units. The profit at these
output levels is £5. If it is possible to produce single units of output, profit
might be higher at an output level between 50 and 60 units.

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3 Subject CT7, September 2008, Question 28

The short run is the period of time in which at least one of the factors of
production is fixed. The long run is the period of time in which all factors of
production are variable, (however the factors are of fixed quality).

The law of diminishing marginal returns states that as increasing quantities of

a variable factor of production are added to a fixed quantity of the fixed factors,
the extra output gained from employing each successive unit of the variable
factor may increase at first, but will ultimately decline.

Since the law of diminishing returns depends on at least one factor of

production being fixed, it must only be applicable in the short run and its
implication is that, assuming constant labour costs, short-run marginal costs
and average costs must eventually increase.

In the long run, all factor inputs can be varied and hence the scale of
production is variable. If factor inputs are all increased by x%, ie the scale of
production is increased by x%, but output increases by less than x%, then
the firm is said to experience decreasing returns to scale.

If, in addition, factor costs do not change with the level of output, then the
firm experiences diseconomies of scale, ie the long-run average costs
increase. Diseconomies of scale can occur for a number of reasons,
eg managerial problems of co-ordination and communication.

4 Subject CT7, September 2008, Question 29

(i) Marginal cost and average total cost at each level of output

Output per day Marginal cost of the last Average total cost (£)
unit (£)
0 – –
1 10 60
2 18 39
3 27 35
4 35 35
5 55 39
6 69 44

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(ii) Profit-maximising level of output

The profit-maximising output level occurs when MC = MR (with MC rising /

MR falling). Here MR = 50 at all output levels, so profit maximisation occurs
at a level of output of 4 units.

Alternatively, profit can be calculated as total revenue minus total cost:

Output per day Total revenue (£) Total cost (£) Profit
0 0 50 –50
1 50 60 –10
2 100 78 +22
3 150 105 +45
4 200 140 +60
5 250 195 +55
6 300 264 +36

(iii) Profit at the profit-maximising level of output

At the profit-maximising output level of four units:

 total revenue = 4  50 = 200
 total costs = 140.

So: profit = total revenue – total costs = £60.

5 Subject CT7, September 2008, Question 31

(i) Firm in a perfectly competitive industry making normal profits

AC1
£ MC
supernormal AC2
profit

P1 AR1 = MR1

P2 AR2 = MR2

Q2 Q1 output

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(ii) The short-run and long-run effects of a permanent fall in the fixed
costs

If the firm’s fixed costs fall, its average fixed cost falls and so the average
cost curve falls to AC2. However, the marginal cost curve will not be
affected since it reflects variable costs and not fixed costs.

Short run

As neither the marginal cost nor the marginal revenue changes, in the short
run the firm will continue to produce Q1 at price P1. As average revenue
exceeds average cost at this level of output, the firm will make supernormal
profits, indicated by the shaded area.

Long run

In the long run, the existence of supernormal profits in the market will induce
new firms to enter the industry. The resulting increased market supply will
reduce prices.

Long-run equilibrium will be reached at price P2 where:

 MR2 = MC1 and
 AR2 = AC2

so that normal profits are once more being made.

6 Subject CT7, September 2008, Question 36

(i) Characteristics of an oligopolistic market structure.

 There is a small number of interdependent firms in the industry. Each

firm believes its own actions will lead to a reaction from the other firms.
 Barriers to entry exist so that firms within the market are able to make
supernormal profits in the long run.
 The firms within the market produce differentiated products and
consequently enjoy some element of control over the prices that they
charge and face a downward-sloping demand curve.
 Oligopolistic firms do not produce at the socially optimal output level, at
which price is equal to marginal cost.
 Oligopoly tends to be characterised by price-stickiness and non-price
competition, eg advertising.

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 Instead of competing, the firms may collude by jointly setting price

and/or output levels in order to increase their profits.

(ii) Oligopolistic market compared to a monopoly

An oligopoly:
 has a larger number of firms and needs to consider the effect of its
policies on other firms
 will have less control over the prices that it charges than a monopolist
 will typically face a higher elasticity of demand (and flatter demand
curve) for their products
 is likely to spend more on advertising in order to steal customers from its
rivals
 has a greater incentive (due to competition) to invest in research and
development, to reduce costs and hence prices.

A monopoly:
 has only one firm and hence faces the market demand curve
 typically experiences stronger barriers to entry than firms in oligopoly,
giving it greater power to make supernormal profits in the long run
 may produce at the socially optimal output level if it is able to practise
first-degree price discrimination or if forced to do so by regulation
 may be better placed to exploit economies of scale, leading to lower
costs and prices.

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7 Subject CT7, April 2009, Question 30

MC
£

a b
PM
c d e
PPC g h
f

MR AR=D

QM Q*=QPC output

The consumer surplus under monopoly is equal to a + b .

The producer surplus under monopoly is equal to c + d + f + g .

The social cost to society from the actions of the monopolist is therefore
equal to the area e + h .

8 Subject CT7, April 2009, Question 31

(a) Type of market

The diagram might represent either:

 a monopoly firm, in either a short-run or a long-run position
 a firm operating under monopolistic competition in the short run.

(b) Profit-maximising level of output

The profit-maximising level of output is 31 units.

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(c) The output where revenue is maximised

Revenue is maximised when output is equal to 40 units.

(d) Price where the firm would maximise profit

The price where the firm would maximise profit is approximately 5.5.

(e) Largest output that can be produced without incurring a loss

The largest output that can be produced without incurring a loss is 51.

(f) Area of total revenue at profit-maximising output and price

The total revenue at the profit-maximising output and price is approximately

170.5.

9 Subject CT7, September 2009, Question 27

(i) and (ii) The kinked-demand model of oligopoly

M C2
£ M C1
AC2
P1
AC1

M R1 AR1

Q1 quantity

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(iii) The effect of a rise in price on total revenue

The kinked-demand model of oligopoly assumes that competitors will not

follow a price increase and therefore, a firm that increases its price will lose a
lot of customers. The demand curve above price P1 is assumed to be
elastic, so an increase in price will result in a decrease in total revenue.

10 Subject CT7, September 2009, Question 28

(i) Table of costs

Output per day Total cost (£) Total fixed Marginal cost of Average
cost (£) the last unit (£) cost (£)
0 30 30
1 40 30 10 40
2 58 30 18 29
3 84 30 26 28
4 120 30 36 30
5 170 30 50 34

(ii) The profit-maximising level of output

Output per Total cost (£) Total revenue Profit (£)

day (£)
0 30 0 – 30
1 40 35 –5
2 58 70 + 12
3 84 105 + 21
4 120 140 + 20
5 170 175 +5

The profit-maximising level of output is 3 units per day.

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11 Subject CT7, September 2009, Question 32 (part, amended)

(i) Table of productivity and costs

Number of Total production Marginal physical Marginal cost of

workers per week per week product of labour the last units (£)
0 0
1 3 3 40.00
2 10 7 17.14
3 20 10 12.00
4 33 13 9.23
5 39 6 20.00
6 42 3 40.00
7 40 –2

(ii) The profit-maximising level of output

Total production Total cost (£) Total revenue (£) Profit (£)
per week
0 200 0 – 200
3 320 75 – 245
10 440 250 – 190
20 560 500 – 60
33 680 825 + 145
39 800 975 + 175
42 920 1,050 +130
40 1,040 1,000 – 40

The profit-maximising level of output is 39 units per week.

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12 Subject CT7, April 2010, Question 31

(i) Reasons for economies of scale

Possible reasons for economies of scale include:

 specialisation and the division of labour – work is broken down into
smaller tasks in which workers specialise, increasing efficiency
 indivisibilities – the impossibility of dividing factors into smaller units
 the ‘container’ principle – the average cost of goods produced by capital
equipment that contains things falls with the size of the equipment
 the greater efficiency of large machines
 the production of by-products in sufficient amounts that they can be sold
 multistage production, saving time/cost of moving unfinished goods
between locations
 organisational – reorganising production to reduce waste/duplication
 spreading overhead costs, (costs associated with running a business
that are only loosely related to output level)
 financial economies, eg discounts for bulk purchases
 economies of scope – increasing the range of goods produced reduces
the cost of producing each good.

(ii) Reasons for diseconomies of scale

Possible reasons for diseconomies of scale:

 managerial problems – may occur as the firm grows in size: it becomes
difficult to co-ordinate the activities of the firm and lines of
communication become longer and more complex
 excessive specialisation and division of labour – might lead to boring
and repetitive jobs; workers may feel alienated and insignificant, leading
to poor motivation, poor quality, low productivity and industrial unrest
 poor industrial relations – arising from the above
 problems in one area holding up all production – arising from the
complex interdependencies of large-scale production.

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13 Subject CT7, April 2010, Question 32

(i), (ii), (iii), (iv) The diagram

MC

PX1

PX2

DX2 DX1 Dm
MRX2 MRX1
QX2 QX1 Q
QY1
QY2 = 2QY1

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14 Subject CT7, September 2010, Question 28

(i), (ii) and (iii) The diagram

mortgage
rate MCX

r2
r1

MRX MRM DX DM

QX QX2 QR quantity of mortgages

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15 Subject CT7, September 2010, Question 31

(i) The product life cycle

sales
per period

product doesn't
become obsolete

product becomes
obsolete

launch growth maturity decline time

(ii) The product life cycle of basic mobile phones

Launch: Few firms in the mobile phone market; adventurous consumers

(‘early adopters’) will buy the first mobile phones.

Growth: Rapid sales growth as early problems are ironed out and customers
gain confidence in mobile phones; firms make supernormal profit and
therefore new firms are attracted into the market.

Maturity: Growth in sales slows down and the market becomes saturated;
non-primary uses for mobile phones (eg texting) might be promoted to
extend the life of the phone; competition intensifies and firms engage in
promotions and offer discounts.

Decline: Sales decline and profitability declines; further promotions and

discounts are offered; rejuvenation policies may be introduced to extend the
life of the phone (eg new versions), however, the life of the basic mobile
phone might be over and more sophisticated phones might take over.

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(iii) Pricing policies during the product life cycle of basic mobile
phones

Launch: The price was high as there was little competition and the early
adopters had a relatively inelastic demand for the product.

Growth: Although new firms entered the market, demand was growing
rapidly and prices remained high. Price competition was weak and firms
tended to compete in other ways (eg various payment schemes).

Maturity: Competition intensified and pricing became more aggressive.

Decline: This is probably where the basic mobile phone is now, as more
people are buying the new generation mobile phone, the smart phone.
Further price reductions on the basic mobile phones may occur in order to
retain some customers, although companies that also produce the smart
phone might aim to reduce the price differential between the smart phone
and the basic phone in order to make the smart phone more attractive.

16 Subject CT7, September 2010, Question 36

(i) Nash equilibrium

A Nash equilibrium exists when, given the other firm’s decision, neither firm
could improve its payoff and therefore neither firm would change its decision.

Since both firms have a dominant strategy (to charge £200), the dominant
equilibrium and hence the Nash equilibrium is that they both charge a price
of £200.

(ii) The result of a Nash equilibrium in the context of advertising

expenditure

Firms are likely to get caught in a dominant and Nash equilibrium position in
which both spend large amounts on advertising. Given the high amount
spent by the other firm(s), each firm would not have any incentive to reduce
the amount spent. If they did reduce the amount spent, they would lose
market share and lose profit.

Since they all spend a large amount on advertising, advertising does not
achieve any change in market share (though it might increase market
demand). It becomes an onerous fixed cost for oligopolists, who get caught
in a prisoners’ dilemma, spending more than is optimal on advertising.

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If firms colluded, and agreed to spend a lower amount on advertising, market

shares would be unchanged (though total market demand might be lower)
and each firm’s profit would be higher. However, such a position is insecure.
Firms would either be tempted to cheat or be worried about other firms being
tempted to cheat.

17 Subject CT7, April 2011, Question 29

(i) The law of diminishing marginal returns

In the short run, according to the law of diminishing returns, as increasing

units of the variable factor (usually labour) are added to the fixed factors
(usually capital and land), then ultimately the marginal physical product of
the variable factor will fall and total output will increase less than
proportionately.

(ii) Diseconomies of scale

Diseconomies of scale occur if long-run average costs rise as the scale of

production is increased. If all factor costs are constant, then decreasing
returns to scale will result in diseconomies of scale. Diseconomies of scale
can arise from problems of co-ordination and communication in a large
enterprise, alienation of the workforce, poor industrial relations and problems
in one area holding up all production.

18 Subject CT7, April 2011, Question 30

(i) Equilibrium of perfect competition vs monopolistic competition

On the diagram below:

 LRAC is the long-run average cost curve
 DPC = ARPC is the demand or average revenue curve of the individual
firm under perfect competition
 DMC = ARMC is the demand or average revenue curve of the individual
firm under monopolistic competition

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price LRAC

P MC
DPC = ARPC
P PC

DMC = ARMC

qMC qPC quantity

excess capacity

(ii) Excess capacity for firm in monopolistic competition

In the long run, firms under monopolistic competition will maximise profit and
produce at an output qMC, which is below the cost-minimising output, qPC
(which will be produced under perfect competition). The shortfall of actual
output below the cost-minimising output is known as the excess capacity.

(iii) How the price and output decision affects the consumer

Compared to perfect competition, under monopolistic competition firms are

likely to charge a higher price and produce a lower level of output. However:
 the price difference may well be small, as firms under monopolistic
competition are likely to face elastic demand curves, due to the large
number of substitute products available
 the consumer may benefit from having a number of different products to
choose from, rather than just the single, identical product supplied by
firms under perfect competition.

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19 Subject CT7, September 2011, Question 27

(i) and (ii) The kinked-demand model of oligopoly

M C2

P1 M C1 AC2

AC1

AR1
M R1

Q1 Q

(iii) The effect of a rise in price on total revenue

The kinked-demand model of oligopoly assumes that competitors will not

follow a price increase and therefore, a firm that increases its price will lose a
lot of customers. The demand curve above price P1 is assumed to be
elastic, so an increase in price will result in a decrease in total revenue.

20 Subject CT7, September 2011, Question 29

(i) Profit-maximising output level

Output SRAVC SRTVC SRTC SRAC AR TR Profit

1 110 110 210 210.0 300 300 90

2 95 190 290 145.0 250 500 210
3 80 240 340 113.3 210 630 290
4 75 300 400 100.0 180 720 320
5 82 410 510 102.0 150 750 240
6 85 510 610 101.7 120 720 110
7 90 630 730 104.3 100 700 –30
8 100 800 900 112.5 90 720 –180
9 110 990 1090 121.1 80 720 –370
10 120 1200 1300 130.0 70 700 –600

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Profit is maximised when the output is 4 units.

(ii) Output level at which average total costs are minimised

Average total costs are minimised when output is 4 units.

(iii) Impact on production in the short run if fixed costs increase

Output will remain unchanged at 4 units.

(iv) Smallest rise in total variable costs that would force production to
cease in the short run

If total variable costs increase by £421, then at 4 units of output (which is the
profit-maximising level of output), the firm would not be covering its variable
costs and so would cease production in the short run.

21 Subject CT7, September 2011, Question 31

(i) Diagram for third-degree price discrimination

£ £ £

PX
P*
PY DM

MC
DY
DX MRM
MRX MRY

QX Q QY Q Q* Q

Market X Market Y Total (Market X + Market Y)

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(ii) Examples of second- and third-degree price discrimination

Examples of second-degree price discrimination include:

 ‘buy-one-get-one-free’ and ‘3 for the price of 2’ offers

 electricity (and other utilities companies), which may charge a higher

price for the first x kilowatts and then a much lower rate for additional
kilowatts
 coupons and vouchers offering discounts to those consumers prepared
to take the time to find and use them.

Examples of third-degree price discrimination include:

 different-priced seats on buses/in cinemas for adults, children and
pensioners
 different prices charged for the same product in different countries
(assuming the costs of provision are identical).

22 Subject CT7, April 2012, Question 28

(i) Total revenue

Total revenue = Number of units of output ¥ Revenue per unit

= 58 ¥ £18 = £1,044

(ii) Total cost

Total cost = Total fixed cost + Total variable cost

= 450 + 3 ¥ £130 = £840

(iii) Economic profit

Economic profit = Total revenue - Total cost

= £1,044 - £840
= £204

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23 Subject CT7, April 2012, Question 30

loss MC
£
AC2 AC2

P1 AC1
AC1

supernormal
profit
MR D = AR
q1 q

24 Subject CT7, October 2012, Question 27

(i) Marginal cost and average total cost at each level of output

Output per day Marginal cost of the last Average total cost (¥)
unit (¥)
0 – –
1 10 60
2 18 39
3 27 35
4 35 35
5 45 37
6 79 44

(ii) Profit-maximising level of output

The profit-maximising output level is 5 units.

(iii) Profit at the profit-maximising level of output

At 5 units, the profit is ¥65.

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25 Subject CT7, October 2012, Question 28

Short run

In the short run, some factors of production are fixed, so if a firm wants to
increase output in the short run, then it can only do this by increasing the
use of the variable factor of production, which is usually taken to be labour.

As the level of output increases in the short run, it is likely that workers will
be able to specialise, which should cause the short-run average cost to fall
as output increases.

However, as output continues to increase, ultimately, the firm is likely to

suffer from the law of diminishing returns, whereby each extra worker
becomes less and less productive, ie the marginal physical product of labour
and average physical product of labour both fall, and so (assuming wages
are fixed) output becomes more and more expensive. This means that
short-run average costs rise as output increases.

Long run

In the long run, all factors of production are variable, so if a firm wants to
increase output in the long run, it can change all its factors of production, ie it
can change the whole scale of operation.

As the level of output increases in the long run, it is likely that firms will
initially benefit from economies of scale, such as the benefits of
specialisation and bulk-buying. These economies cause the long-run
average cost to fall as output increases.

As output continues to increase, ultimately, the firm is likely to suffer from

diseconomies of scale, such as communication and co-ordination problems.
These diseconomies cause the long-run average cost to rise as output
increases.

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26 Subject CT7, October 2012, Question 28

(i) and (ii) Diagram

P
MC1
AC1
A
P1
N
P2

MR1 AR1
Q1 Q2 Q

27 Subject CT7, April 2013, Question 28

(i) Perfectly contestable market

A perfectly contestable market is a market where there is free and costless

entry and exit.

Potential rivals will therefore be able to enter / exit markets quickly and
easily.

(ii) Implications with respect to price and output decisions

In order to discourage potential rivals from entering the market, the

monopoly firm in a perfectly contestable market will:
 keep prices down and output up so that it is making only normal profits
 produce as efficiently as possible.

In contrast, a monopoly firm in a non-contestable market is likely to:

 charge higher prices and restrict output
 make supernormal profits
 produce efficiently in some circumstances (eg to maximise returns to
shareholders), but not others (as they are not driven to by the
competition).

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(iii) Sunk costs and how they can be a barrier to entry

Sunk costs are costs that cannot be recouped. If a firm buys a machine that
has no alternative use, then its cost cannot be recouped and it is a sunk
cost.

If high sunk costs are required in order for a firm to be successful, eg high
advertising costs are required in order to generate sales, then the firm may
be reluctant to enter the market. This is because it will fear that it might fail
and then be unable to recoup these (high) costs.

28 Subject CT7, April 2013, Question 29

(i) The Cournot model – price and output for Firm A

Price

MCA

PA

Dindustry = ARindustry
DA = ARA
QA Quantity
QB
MRA

Firm A assumes that Firm B produces a certain level of output (regardless of

the price). This is the quantity QB . Firm A then deducts QB from the
industry demand curve to determine its demand curve ( DA = ARA ).

Firm A will choose its quantity in order to maximise its profits. This is where
MRA = MCA , ie at quantity QA .

It will determine its equilibrium price ( PA ) using QA and the demand curve
( DA ).

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(ii) Duopoly industry vs monopoly industry – price and output

Price

MCA
PM
PA

Dmonopoly = ARmonopoly
MRM = Dindustry = ARindustry
DA = ARA
QA QM QA+B Quantity
QB
MRA

Under the Cournot model of duopoly, the total output for the industry is
QA + QB ie QA + B in the diagram above and the price charged by Firm A is
PA . It is likely that Firm B will charge a similar price.

If instead the industry is a monopoly industry, then the industry demand

curve would just be the demand curve for the monopoly firm, and the
marginal revenue curve for the monopoly firm would be MRM .

Assuming the monopoly firm experiences the same marginal costs as

Firm A, the profit-maximising quantity for the monopoly firm will be QM and
the corresponding profit-maximising price will be PM .

Therefore under the Cournot model, it is very likely that prices will be lower
and output higher than under a monopoly industry.

29 Subject CT7, April 2013, Question 30

(i) Level of output at which total revenues are maximised

Total revenue is maximised at Q5.

(ii) Levels of output where supernormal profits are made

Supernormal profits are being made at Q1, Q2, Q3, Q4 and Q5.

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(iii) Level of output at which normal profits are made

Normal profits are being made at Q6.

(iv) Levels of output where demand is elastic

Price elasticity of demand is greater than one (in absolute terms) at Q1, Q2,
Q3 and Q4.

(v) Levels of output where the firm is making an overall loss

The firm is making an overall loss at Q7.

30 Subject CT7, September 2013, Question 27

If the owner decides to grow pears rather than apples:

 the revenue per tonne of pears is £350
 the cost per tonne of pears is £140 + £60 = £200
where the £60 is the normal profit from growing apples

 the profit per tonne of pears is £350 – £200 = £150.

31 Subject CT7, September 2013, Question 28

A car manufacturer might experience the following economies of scale:

1. Specialisation and division of labour

In large car plants, assembly-line production allows workers to specialise in

specific, often very repetitive, tasks, thus increasing proficiency at the task,
saving training costs and saving supervisory costs. Since the cars move
through the stages of production rather than the workers, time is saved as
workers do not have to switch from one activity to the next.

2. Indivisibilities

Some equipment, such as a car assembly line, and some processes, such
as research and development, have to be of a certain minimum size. A
small firm would not be able to make full use of such equipment and
processes but large firms benefit from the lower average costs that such
facilities allow.

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3. Greater efficiency of large machines

A larger machine, such as a spray-painting machine, that has twice the

output of a smaller machine may not cost twice as much to build or run.
Also, it might still only need one person to operate it and it might make more
efficient use of raw materials, eg paint.

4. Economies of scope

A large car manufacturer will probably produce a large range of cars and this
might enable the cost per car to be lower than it would be if it were a
single-car producer. For example, technology that it develops for one car is
transferable to other cars; experience gained in marketing one car in a
particular country makes it easier to market other cars in that country.

Other economies of scale that you could have discussed include: the
container principle, multi-stage production, by-products, organisational
economies, spreading overheads, financial economies.

32 Subject CT7, September 2013, Question 29

(i) Diagram of a monopolistically competitive firm making a loss

£ AC
loss MC
AVC
AC1

P1
AVC1

AR
MR
Q1 quantity

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(ii) The short-run effect of an increase in demand

£ supernormal
AC
profit MC

P2
AC2
P1
AR2

MR2 AR1

Q1 Q2 MR1 quantity

33 Subject CT7, September 2013, Question 30

Factors favouring collusion include the following:

 there are no government controls on collusion
 the firms know each other well

 the firms produce similar products

 the firms use similar production methods and experience similar costs
 the market is stable with respect to prices, outputs and products (and
therefore more predictable)
 there are barriers to entry (and therefore little fear of disruption by new
firms)
 there is a dominant firm
 the firms are open with each other (about costs, production methods
and products)
 the risks of not colluding are high, eg price war.

Credit was also given for listing the benefits of collusion to the firms involved
since the question was open to this interpretation. The major benefit is, of
course, likely to be increased profits.

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34 Subject CT7, April 2014, Question 27

(i) Marginal product of the 4th unit of labour

The total output from four units of labour is:

100 ¥ 4 = 400 units

The total output from 3 units of labour is:

90 ¥ 3 = 270 units

The marginal product of the 4th unit of labour is therefore:

400 – 270 = 130 units

(ii) Average vs marginal product of labour?

Units of labour Average product Marginal product

employed of labour in units of labour in units
0 – –
1 70 70
2 80 90
3 90 110
4 100 130
5 90 50
6 80 30
7 70 10

No, the average product of labour isn’t always greater than or equal to the
marginal product of labour, ie at 2, 3 and 4 units of labour.

(iii) Average cost of production if 4 units of labour are employed

The total output from four units of labour is 400 units and the total cost of
producing these units is:

75 ¥ 4 + 100 ¥ 4 = £700

The average cost of production per unit is therefore:

700
= £1.75
400

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(iv) Total cost of production when output is 490 units

Units of labour Average product Total product of

employed of labour in units labour in units
0 – –
1 70 70
2 80 160
3 90 270
4 100 400
5 90 450
6 80 480
7 70 490

Seven units of labour at a cost of £75 each (together with the four units of
capital at a cost of £100 each) are required to produce an output of 490
units.

The total cost of producing 490 units of output is therefore:

7 ¥ 75 + 4 ¥ 100 = £925

35 Subject CT7, September 2014, Question 30

Economies of scale refers to the situation where long-run average costs fall
as the scale of production is increased. Economies of scale are therefore
associated with large firms.

Possible causes of economies of scale include:

 specialisation and the division of labour – where work is broken down
into smaller and smaller tasks in which workers specialise, thereby
becoming more efficient and productive
 indivisibilities – which refers to the impossibility of dividing some factors
(eg large machinery) into smaller units.

Firms operating under perfect competition and monopolistic competition tend

to be small, with little market power, and are therefore unlikely to experience
economies of scale.

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36 Subject CT7, September 2014, Question 31

(a) Airline routes

For new firms entering the airline industry, there would be very high entry
costs (eg planes) and high sunk costs, as it may be difficult to transfer its
investments to other uses.

However, for existing firms, the costs of switching to new routes should be
relatively low. Similarly, the cost of switching from existing routes should be
low (ie low sunk costs).

Given that airlines already exist, and could therefore switch to new routes
fairly easily, potential competition exists for all airline routes (whether new or
not!).

Therefore airline routes are a potentially contestable market.

(b) Savings accounts

The cost of offering savings products for the first time will be high as there
will be high costs of investing in computer systems, an administrative
infrastructure, and expertise. Furthermore, these costs will generally be
sunk costs, because they will generally not be able to be transferred to other
uses if the firm decided to exit the industry. In this sense, this market is not
a potentially contestable market.

However, for existing lenders, the entry and exit costs of offering a new type
of savings account should be fairly low.

Similarly, for very large service-based firms, it may be possible to start

offering savings products (possibly by outsourcing the administration), and
so for such firms the market may be potentially contestable.

(c) Hospital catering

The costs of setting up a catering facility may not be particularly large, so it

should be relatively easy for firms to enter the market.

Furthermore, it may be possible to sell on equipment if the firm left the

industry, so sunk costs should also be low.

However, the firm that has the current contract with a particular hospital or
group of hospitals is likely to have a local monopoly, at least in the short run.
Therefore, in the short run, the market is not potentially contestable.

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In the long run, if the service provided by the current firm is seen to be poor
value for money and/or of poor quality, then the hospital is likely to seek a
new supplier. Therefore in the long run, the market is likely to be potentially
contestable.

37 Subject CT7, September 2014, Question 34

(i) Marginal product of labour and marginal revenue product of labour

per year

Number of Total Marginal Marginal

workers per production per product of revenue product
year year (tons) labour per year of labour per
(tons) year (£s)
0 0 – –
1 25 25 5,000
2 75 50 10,000
3 127 52 10,400
4 179 52 10,400
5 212 33 6,600
6 225 13 2,600

(ii) Total revenue, total cost and profit/loss when four workers are
employed

When four workers are employed, total revenue per year is:

179 ¥ £200 = £35, 800

and total cost per year is:

£10, 000 + 4 ¥ £5, 000 = £30, 000

So, the profit per year is:

£35, 800 - £30, 000 = £5, 800

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38 Subject CT7, April 2015, Question 32

(i) Average cost and marginal cost of production

Quantity Average cost (£) Marginal cost (£)

0 – –
1 20 10
2 13 6
3 10 4
4 9.5 8
5 10 12
6 12 22
7 15 33

(ii) Output at which average cost and marginal cost are equal

Four units

NB If we were to draw a diagram, we would plot the MC of the nth unit at

halfway between n–1 and n units, so the MC of the fourth unit (8) would be
plotted at 3.5 and the MC of the fifth unit (12) would be plotted at 4.5, so the
MC would cross the AC at four units (in whole units).

(iii) Profit-maximising level of output and the maximum profit

Here MR = 14 at all output levels, so increasing output by one unit increases

profit as long as MC < 14, Hence, profit maximisation occurs when output is
five units.

The maximum profit is:

TR - TC = price ¥ quantity - TC = 14 ¥ 5 - 50 = 20

(iv) Why achieving economies of scale is not compatible with perfect

competition

Economies are scale, which arise when long-run average cost falls with
output, are not possible as the industry consists of a very large number of
very small firms, each of which too small to exploit economies of scale.

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39 Subject CT7, April 2015, Question 36 (part, amended)

(i) The type of price discrimination strategy and the reason for it

Toshisoni is pursuing a strategy of second-degree price discrimination, as it

charging a different price to the consumer depending on the number of units
purchased. In fact, the price is lower if more memory sticks are purchased.

This is being done to encourage consumers to buy more memory sticks, so

as to increase the overall sales of memory sticks and thereby to raise the
total revenue received from supplying the good.

(ii) The type of price discrimination

Toshisoni is exercising third-degree price discrimination, as it is charging a

different price to consumers in Japan and the UK, but the same price to all
consumers within each country.

It will do this because the elasticity of demand is different in the two markets.
In fact, the higher price charged in the UK will be due to demand being more
inelastic in the UK than in Japan.

40 Subject CT7, October 2015, Question 30

loss
MC
price AC1
C1 AVC1

P1

MR D = AR
Q1 quantity

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41 Subject CT7, October 2015, Question 31

Any five of the following forms of barriers to entry:

Economies of scale, eg due to specialisation or lower financing costs

If average costs fall significantly as output increases, new entrants will find it
very difficult to enter the market, as the existing firm will be able to charge a
lower price. This is especially true in markets in which the minimum efficient
scale is large.

Economies of scope

Firms that produce a larger range of products also tend to experience lower
average costs, as they can pool some of their activities and costs such as
research, marketing, storage and transport across a range of products and
so reduce their average costs of production on each individual product.
Again this makes it very difficult for new entrants to enter the market.

Lower costs for an established firm

Compared to new firms, established monopolies are more likely to have

specialised production and marketing skills and may be better placed in
terms of selecting the most efficient means of production and the most
reliable (and cheapest) suppliers. They may also have better access to
cheaper sources of finance and therefore operate on a lower cost curve.

Product differentiation and brand loyalty

In cases where a firm produces a differentiated product which consumers

then associate with the brand it is very difficult to enter into such a market.
The brand and the product are one and the same thing. Brand loyalty may
be reinforced by advertising, which means that new firms will need to spend
large sums on advertising, which increases the cost of entry.

Ownership of, or control over, key inputs or outlets

A firm that has a high degree of control over inputs (eg by owning a
components supplier) and/or outlets (eg by owning a chain of retailers) will
be able to prevent others from using them.

Mergers and takeovers

An existing monopolist may seek to takeover a potential rival and such a

threat may prevent new entrants.

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Aggressive tactics

A large existing firm may be able to sustain losses for a longer time period
than a new entrant. Hence it may choose to threaten a price war, expensive
advertising campaigns or after-sales packages that would deter new
entrants.

Legal protection

An existing firm’s monopoly position may be protected by patent, copyright

or licensing laws or by the use of tariffs or other trading restrictions.

42 Subject CT7, October 2015, Question 32

Under first-degree price discrimination (FDPD), the firm charges each

consumer the maximum price that he or she is prepared to pay for a good or
service.

FDPD can occur in any market where there is some scope for bargaining
over the price, eg buying a car, negotiating fees for legal services.

In contrast, second-degree price discrimination (SDPD) is where the firm

offers customers a range of different pricing options for the same or similar
product. Consumers are then free to choose whichever option they wish,
but the price is often dependent on the quantity of the product purchased.

This approach is often used to entice consumers to buy more units of small
discretionary items, such as packets of crisps or bars of chocolate, and
sometimes takes the form of ‘buy-two-get-one-free’ type offers.

Unlike FPDP, it aims to encourage consumers to purchase more units than

they would otherwise choose to do and so can be used to increase profits
when the firm’s average costs decrease with output.

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43 Subject CT7, April 2016, Question 28

(i) Marginal cost and average variable cost

Output Total Marginal Average variable

per week cost (£s) cost (£s) cost (£s)
0 5 – –
1 45 40 40.00
2 78 33 36.50
3 99 21 31.33
4 114 15 27.25
5 132 18 25.40
6 162 30 26.17
7 210 48 29.29

(ii) Profit-maximising level of output

MR = P = 30 at all output levels and MC of producing 6th unit is 30. So, 5 or

6 units.

(iii) Profit at profit-maximising level of output

When Q = 5, profit = 30 × 4 – 132 = 18.

When Q = 6, profit = 30 × 5 – 162 = 18.

44 Subject CT7, April 2016, Question 30

(i) Firm neither seeking to maximise profits nor minimise losses

A and E (as MC  MR)

(ii) Firm making excess profits

C, D and E (as AR > AC)

(iii) Firm could increase output and increase profit

E (as MR > MC)

(iv) Firm in long-run equilibrium in perfect competition

B (as MC = AC = AR = MR)

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45 Subject CT7, April 2016, Question 31

(i)(ii) Monopolistically competitive firm making normal profits (1)

and short-run impact of fall in wages (2)

(iii) Short-run effect on profits of fall in wages

A fall in wages will lower the marginal cost and average cost and so shift
these curves downwards. The result is the new higher output, Q2, the lower
price, P2, and the lower average cost, C2. As P2 > C2, the firm makes
supernormal profit.

(iv) Demand and profits in long run

The absence of barriers to entry means that in the long run, new firms will
enter the market, attracted by the supernormal profits to be earned.

The increase in the number of firms will reduce the market share of, and
hence the demand for goods produced by, each existing firm.

In addition, the increased market supply will reduce the price each firm
receives until they are once more making normal profits.

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46 Subject CT7, September 2016, Question 29

(i) Diagram: short-run shut-down point

£ AC
AVC

P=AVC

D = AR

Q Q

(ii) Short-run and long-run shut-down points

In the short run, a firm should continue to produce provided it can cover its
variable costs, ie AR > AVC, so it is making some contribution to its fixed
costs. This is because if it were to stop producing, although it would have no
variable costs, it would still have to pay the fixed costs (in the short run).

The short-run shut-down point therefore occurs where AVC = AR.

In the long run, however, the firm must cover all of its costs, both fixed and
variable, otherwise, it will make a loss and will need to exit the industry.

The long-run shut-down point is therefore where AC = AR. Since AC > AVC,
it must also be the case that AR > AVC.

47 Subject CT7, September 2016, Question 31

(i) Loss leader: description and main factor in its successful use

A loss leader is a good that has had its price cut – often to below its average
cost – specifically in order to attract consumers into a store. The idea is that
once in the store, consumers will also buy lots of full-price products.

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The main factor the firm needs to consider is whether the use of a loss
leader will increase overall profit across a range of products, which in turn
depends on:
 the loss leader having a price-elastic demand, so that additional
customers are actually attracted into the store
 whether these customers will also buy a sufficient number of other
goods at full price.

(ii) How a sports clothing store may use a loss leader

A sports clothing store may use one item (eg running shoes) as a loss
leader, which it sells at a very low price to attract additional customers into
its store.

It hopes that once in the store, these customers will buy the reduced price
item, and also a selection of other (often complementary) goods at full price,
(eg running tops and bottoms, or GPS watches).

If successful, the loss leader strategy enables the store to increase its total
sales, and more specifically, its total profits. In addition, the promotion of a
loss leader might be used to increase awareness of the shop’s brand,
leading to increased long-run sales and profits.

48 Subject CT7, April 2017, Question 28

(i) Table showing total profit and marginal revenue

Price per Quantity Total Total Total Marginal

unit (£) Demanded Revenue Costs (£) Profit (£) Revenue
(units) (£) (£)
20 0 – – – –
18 1 18 5 13 18
16 2 32 10 22 14
14 3 42 15 27 10
12 4 48 20 28 6
10 5 50 25 25 2
8 6 48 30 18 –2
6 7 42 35 7 –6

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(ii) Price elasticity of demand (PED) using the average formula

The price elasticity of demand is:

DQ average Q +1 5.5
e= = = -0.82
DP average P -2 9

(iii) Price range where the absolute value of the PED is greater than or
equal to 1

The price range in which the absolute value of the PED is greater than or
equal to 1 is £20 – £10.

This can be found in two ways:

1. where the percentage increase in quantity demanded is greater than or
equal to the percentage decrease in price
2. where the total revenue doesn’t decrease as the price decreases and
quantity demanded increases (ie where marginal revenue is positive or
zero).

The second method is probably easier.

49 Subject CT7, April 2017, Question 29

(i) The price Company A should charge if it were to renege

Company A should charge £10.

If Company A and B agreed to each charge £15, they would make total
profits of £24m, which is greater than the £16m total profit they would make
if they each charged only £10. Company A could renege on this agreement
by starting to charge £10. Assuming Company B continued to charge £15,
this would increase Company A’s profits from £12m to £18m.

(ii) The price Company A should charge if pricing independently

Company A will charge £10.

This is Company A’s dominant strategy (see below).

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(iii) Why this is a dominant strategy game

A dominant strategy game is one in which each player has a dominant

strategy (ie a strategy that is best for the firm regardless of what the other
firm is assumed to do). Both firms will adopt these strategies and a
dominant equilibrium will occur.

For example, charging £10 is a dominant strategy for Company A, since it

yields higher profits than charging £15, no matter what price Company B
charges.

Similarly, charging £10 is a dominant strategy for Company B, since it yields

higher profits than charging £15, no matter what price Company A charges.

(iv) The Nash equilibrium

The Nash equilibrium is for each firm to charge £10 and make a profit of £8m.

If both firms are charging £10, there is no incentive for either firm to change
strategy. All dominant equilibria are Nash equilibria.

50 Subject CT7, April 2017, Question 32 (part)

(ii)(a) Price setting by a price-leading oligopolist that seeks a constant

market share

£
MC

PL
D

AR

QL QD Q

MR

The leader wishes to maximise profit so produces at the level of output

where MR = MC . The leader’s output is QL and the price is set at PL .

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Other firms adopt the same price and the industry level of output is
determined by the market demand curve D , ie at QD .

(ii)(b) Amount produced by the follower firms

The follower firms produce: QD - QL

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Long-answer questions

1 Subject CT7, April 2009, Question 34

(i) The market structure

Monopolistic competition.

(i)(a) Initial equilibrium in the market

£
MC
AC

P*

MR D = AR

Q* quantity

Each restaurant produces a profit-maximising output level of Q*, sells it at a

price P* and makes normal profits.

(i)(b) Short-run impact of a change (increase) in demand

Suppose the initial long-run equilibrium is at output level Q1, with the
restaurant selling its product at price P1.

MC
£
AC

P2
P1

AC2 AR2 = D2

MR2

MR1 AR1 = D1

Q1 Q2 quantity

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The change in taste and fashion will increase the demand for the pizzas
produced by each individual restaurant, with the result that both the average
revenue and marginal revenue curves faced by the individual restaurant shift
to the right, from AR1 and MR1 to AR2 and MR2 respectively. The profit-
maximising output level therefore increases to Q2, with a corresponding
price P2.

(i)(c) Long-run impact of a change in demand

MC
£
AC

P2
P3

AR2 = D2

M R2

MR3 AR3 = D3

Q3 Q2 quantity

In the long run, the existence of supernormal profits, together with the
absence of barriers to entry, means that new pizza restaurants will open and
enter the market. The resulting increase in market supply will reduce the
demand for the pizzas produced by each individual restaurant, with the
result that both average revenue and marginal revenue curves shift to the
left, from AR2 and MR2 to AR3 and MR3 respectively. The profit-
maximising output level therefore decreases to Q3, with a corresponding
price P3.

(ii) Economic profit, price and output in the short run and long run

Initial equilibrium

As average cost equals average revenue, the restaurant is making normal

profits (as illustrated in diagram in part (i)(a)).

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Short run

The change in taste and fashion will result in an increase in the total market
demand for pizzas. In the short run, this will in turn increase the demand for
the pizzas produced by each restaurant. The profit-maximising output level
of each restaurant consequently increases, from Q1 to Q2. At the same
time, the corresponding price charged by each restaurant will rise from P1 to
P2. Finally, as average revenue exceeds average total cost at Q2, so the
restaurant will make supernormal profits in the short run (equal to the area
(P2 – AC2)  Q2 on the diagram in part (i)(b) above).

Long run

In the long run, the opening of new pizza restaurants will increase the total
market supply, which means that the existing restaurants will lose market
share and so face reduced demand. New restaurants will continue to open
until it is no longer possible to make supernormal profits, so in the long run,
normal profits only will again be made. Consequently, the profit-maximising
output level for each restaurant will reduce from Q2 to Q3, with a
corresponding fall in price from P2 to P3.

In addition, if costs are assumed not to change at any point, then the new
long-run profit-maximising price and output, P3 and Q3, will be the same as
the original equilibrium price and output, P1 and Q1. Consequently each
original restaurant must end up with a smaller share of the larger total
market.

2 Subject CT7, April 2012, Question 38

(i) Market structure

Perfect competition.

(ii) Changes in profit, price and output

(ii)(a) Cars are banned from the inner city areas

There will be an increase in the demand for taxis, and so the industry
demand curve will shift to the right (represented by D1 to D2 in the diagram
below).

Prices will increase from P1 to P2, and since firms are price takers, their
demand (ie average revenue (AR) curves) and hence marginal revenue
(MR) curves will shift upwards.

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The firm will maximise its profits by producing where MR = MC, and since
the MR curve has shifted upwards, the firm will maximise its profits by
increasing production from q1 to q2.

This will mean that it will make a supernormal profit in the short run.

Industry Firm
S MC
P P supernormal
profit
AC

P2 AR2
AR2 = MR2
AR1
P1 AR1 = MR1
D1 D2

Q1 Q2 Q q1 q2 q

In the long run, new firms will be attracted by the supernormal profits and will
enter the industry (as there are no barriers to entry). The market supply
curve will therefore shift to the right, which will reduce prices until all
supernormal profits have been competed away. So, if costs remain
unchanged, then the market price and the output of each firm will both return
to their original level.

(ii)(b) Increase in price of petrol and diesel

An increase in the price of fuel will increase both marginal and average costs
and the MC and AC curves will shift upwards.

The firm will maximise its profits by producing where MR = MC, and since
the MC curve has shifted upwards, the firm will maximise its profits by
reducing production from q1 to q2.

As the price is unchanged but average cost has increased, firms will make a
loss in the short-run.

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Industry Firm MC2

P P MC1 AC2
S2 loss
S1
AC1

P2 AR2 AR2 = MR2

AR1
P1 AR1 = MR1
D

Q2 Q1 Q q2 q1 q

As a result of this, some firms will exit the industry. The industry supply
curve will therefore shift to the left (from S1 to S2 ) and the price will
increase from P1 to P2 , so that losses fall to zero and the remaining firms
make normal profits again.

(ii)(c) Introduction of new licence fee for taxis

A new licence fee will increase the average costs and the AC curve will shift
upwards.

The firm will maximise its profits by producing where MR = MC, and since
neither the MR or the MC curve has shifted, there will be no change in price
or output.

However, as costs have increased, firms will make a loss in the short run.
Industry Firm

P P MC AC2
S2 loss
S1
AC1
P2 AR2 AR2 = MR2

AR1
P1 AR1 = MR1
D

Q2 Q1 Q q1 q2 q

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As a result of this, firms will exit the industry. The industry supply curve will
therefore shift to the left (from S1 to S2) and the price will increase from P1 to
P2, so that losses fall to zero and firms make normal profits again. The
quantity produced by each firm will increase from q1 to q2.

3 Subject CT7, September 2014, Question 37

(i) Type of market structure and long-run equilibrium diagram

This is a monopoly market structure because there is only one firm.

£ supernormal
profit MC
AC

P1

AC1

MR D = AR

Q1 Q

(ii) How annual licence fee affects price, quantity and economic profit

supernormal
£ profit
MC AC2
AC
P1

AC1

MR D = AR

Q1 Q

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The annual licence fee is a fixed cost and so it will increase Cititravel’s
average costs but not its marginal cost. As marginal cost and marginal
revenue are both unchanged, so will be the equilibrium quantity ( Q1 ) and the
corresponding equilibrium price ( P1 ).

Consequently, the increase in average cost will lead to a fall in the level of
supernormal profit. This is represented by a fall in profits from the larger
shaded rectangle to the smaller, upper rectangle.

(iii) How Cititravel’s price and quantity are determined

£
MC

PCiti
Dind = ARind

DCiti = ARCiti

QCiti Qind Q

MRCiti
Without barriers to entry, new firms will enter the market. However, the new
firms will take the price set by Cititravel.

Assuming that it maintains 50% of the market, the demand (AR) curve for
Cititravel will be twice as steep as the market demand curve, and Cititravel’s
marginal revenue curve will be twice as steep again.

Cititravel will maximise its profits by producing where its marginal revenue
equals its marginal cost and will price accordingly (ie it will charge PCiti). This
price, which the other firms are assumed to follow, is lower than under the
monopoly market structure.

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4 Subject CT7, April 2017, Question 37 (part)

(i) Differences between monopoly and monopolistic competition

Monopoly Monopolistic competition

Number of One firm in the market Many firms in the market
firms
Barriers to Barriers to entry exist No barriers to entry
entry
Product The firm either sells a Firms will differentiate their
differentiation single product or a range of products from those of
products competitors
Level of profits The presence of barriers to The lack of barriers to entry
entry means a monopoly means firms can make only
can make supernormal normal profits in the long
profits in the long run as run. Firms can make
well as the short run supernormal profits in the
short run
Shape of the Downward sloping. Downward sloping
demand curve Perhaps more price
inelastic than firms in
monopolistic competition
Efficiency Lower competition means Intense competition means
the firm may be able to be firms must be as efficient
inefficient. However, being as they can be.
efficient increases profits.
Economies of Monopolies may gain Firms are unlikely to
scale economies of scale, which achieve economies of
may lead to lower prices for scale
consumers

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FINAL COMMENTS

Finally, we set out a checklist of the definitions, formulae and explanations

that we think you most need to know for this topic. We have based this upon
past exam papers in this subject and on what we feel are likely questions in
the future, bearing in mind the contents of the syllabus and Core Reading.

This list, however, cannot be considered exhaustive. In particular, you must

always remember that the examiners can ask a question on any part of the
Core Reading. So there is always a possibility that some ‘new’ area – ie one
that has not been examined before – might come up, particularly on the
topics that were first introduced to the Subject CB2 Syllabus in 2019.

There is a lot to learn for Subject CB2. One useful way of learning lists of
ideas is via acronyms and mnemonics, and the best ones are probably those
that you create yourself. Beware though that you don’t just write down what
you have learned without considering carefully the specific situation given in
the question. The examiners are keen to see that you can apply your
knowledge intelligently to the question. By intelligently, we mean that only
those points from the list that are relevant to the specific question being
asked should be included in your answer. It is by selection that you
demonstrate understanding to the examiner, rather than just the ability to
memorise lists of facts.

We also stress that learning definitions, formulae etc is not a substitute for
understanding. Many of the explanations we have described in this booklet
(and in the course) become ‘obvious’ once you have fully understood the
concepts involved. So, if you do not feel that the subject has become
‘obvious’ to you, then it may be that you need to take a step back and revisit
the Course Notes, or maybe do some more Q&A Bank questions.

Finally we stress again how useful and important it is to do some exam

questions, including preferably a complete past paper or Mock Exam, under
examination conditions. Only by completing questions successfully in the
time and conditions available in the exam room will you know if you are fully
prepared to sit the exam.

We hope that you have found this booklet to be a useful revision aid. If you
have any comments that might help us to improve this set of booklets then
please email your ideas to CB2@bpp.com.

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CHECKLIST

This checklist can be used as a detailed set of learning objectives that you
need to have mastered for this part of the Subject CB2 exam. Note that the
objectives listed below correspond to those in the checklists in Modules 6 to
9 of the Course Notes.

You can use the boxes that follow each item to indicate when you have first
understood the objective (a), and when you have become fully fluent with it
(z) (ie you have reached exam speed – being able to perform the task
required under exam conditions and in the time available).

1 Define the following key terms:

 rational producer behaviour (a): ______(z): ______
 theory of the firm (a): ______(z): ______
 fixed factor (a): ______(z): ______
 variable factor (a): ______(z): ______
 short run (a): ______(z): ______
 long run (a): ______(z): ______
 total physical product (TPP) (a): ______(z): ______
 average physical product (APP) (a): ______(z): ______
 marginal physical product (MPP) (a): ______(z): ______
 production function (a): ______(z): ______
 technical efficiency. (a): ______(z): ______

2 State the law of diminishing marginal returns. (a): ______(z): ______

3 State the relationship between averages and marginals.

(a): ______(z): ______

4 Calculate numerical values for TPP, APP and MPP. (a): ______(z): ______

5 Draw the typical TPP, APP and MPP curves. (a): ______(z): ______

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6 Define the following key terms:

 explicit costs and implicit costs (a): ______(z): ______
 sunk costs (a): ______(z): ______
 historic costs (a): ______(z): ______
 fixed costs (or total fixed cost, TFC) (a): ______(z): ______
 variable costs (or total variable cost, TVC) (a): ______(z): ______
 total cost (TC) (a): ______(z): ______
 average total cost (AC) (a): ______(z): ______
 average fixed cost (AFC) (a): ______(z): ______
 average variable cost (AVC) (a): ______(z): ______
 marginal cost (MC). (a): ______(z): ______

7 Explain how to measure the opportunity cost of any production decision for a
firm. (a): ______(z): ______

8 State the bygones principle. (a): ______(z): ______

9 Draw diagrams showing the typical relationships between:

 TC, TFC and TVC (a): ______(z): ______
 AC, AFC, AVC and MC. (a): ______(z): ______

10 Calculate numerical values for the different types of costs.

(a): ______(z): ______

11 Define the following key terms:

 economies of scale (a): ______(z): ______
 specialisation and division of labour (a): ______(z): ______
 indivisibility (a): ______(z): ______
 plant economies of scale (a): ______(z): ______
 rationalisation (a): ______(z): ______
 overheads (a): ______(z): ______
 economies of scope (a): ______(z): ______
 diseconomies of scale (a): ______(z): ______

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 external economies of scale (a): ______(z): ______

 industry’s infrastructure (a): ______(z): ______
 external diseconomies of scale (a): ______(z): ______
 productive efficiency (a): ______(z): ______
 Cobb-Douglas production function. (a): ______(z): ______

12 Distinguish between increasing, constant and decreasing returns to scale.

(a): ______(z): ______

13 Describe six factors that lead to plant economies of scale.

(a): ______(z): ______

14 Describe four other possible economies of scale. (a): ______(z): ______

15 Describe four factors that may lead to diseconomies of scale.

(a): ______(z): ______

16 State two factors that will influence the choice of location.

(a): ______(z): ______

17 State the condition for the cost-minimising combination of factors in both the
two-factor and multi-factor case. (a): ______(z): ______

18 Distinguish between the very short run, the short run, the long run and the
very long run. (a): ______(z): ______

19 Define the following key terms:

 long-run average cost (LRAC) curve (a): ______(z): ______
 long-run marginal cost (LRMC) (a): ______(z): ______
 envelope curve. (a): ______(z): ______

20 Describe how long-run average costs typically vary with output.

(a): ______(z): ______

21 Outline three assumptions underlying long-run average cost curves.

(a): ______(z): ______

22 Explain, with the aid of a diagram, the relationship between short-run and
long-run average costs. (a): ______(z): ______

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23 Explain what is meant by the term minimum efficient scale (MES).

(a): ______(z): ______

24 Define the following key terms:

 total revenue (TR) (a): ______(z): ______
 average revenue (AR) (a): ______(z): ______
 marginal revenue (MR) (a): ______(z): ______
 price taker (and price maker). (a): ______(z): ______

25 Draw typical TR, AR and MR curves for both a price taker and a firm with a
downward-sloping, straight-line demand curve. (a): ______(z): ______

26 Explain the relationship between elasticity and revenue for a firm with a
downward-sloping, straight-line demand curve. (a): ______(z): ______

27 Define the following key terms:

 profit-maximising rule (a): ______(z): ______
 normal profit (a): ______(z): ______
 supernormal profit (or pure profit, economic profit or profit)
(a): ______(z): ______
 short-run and long-run shut-down points. (a): ______(z): ______

28 Determine the profit-maximising output level and corresponding profit using

T P = TR - TC and MR = MC and draw diagrams illustrating each.
(a): ______(z): ______

29 State the two components of normal profit (%). (a): ______(z): ______

30 Draw a diagram to illustrate the loss-minimising output.

(a): ______(z): ______

31 Explain how a firm decides whether or not to produce in the short run and
the long run. (a): ______(z): ______

32 Draw a diagram to show the short-run shut-down point.

(a): ______(z): ______

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33 Define and describe the four types of market structure, namely:

 perfect competition (a): ______(z): ______
 monopolistic competition (a): ______(z): ______
 oligopoly (a): ______(z): ______
 monopoly. (a): ______(z): ______

34 Define the following key term:

 imperfect competition. (a): ______(z): ______

35 Explain the factors that determine the firm’s degree of control over price,
ie its market power. (a): ______(z): ______

36 Define the following key terms:

 short run and long run under perfect competition (a): ______(z): ______
 rate of profit (a): ______(z): ______
 increasing-cost industry (a): ______(z): ______
 constant-cost industry (a): ______(z): ______
 decreasing-cost industry (a): ______(z): ______
 consumer sovereignty. (a): ______(z): ______

37 State the four assumptions under perfect competition.

(a): ______(z): ______

38 Sketch industry supply and demand curves for perfect competition.

(a): ______(z): ______

39 Sketch the firm’s cost and revenue curves for perfect competition.
(a): ______(z): ______

40 Explain and illustrate how perfectly competitive firms determine the

equilibrium price and output in the short run and the long run.
(a): ______(z): ______

41 Explain and illustrate the derivation of the short-run supply curve for the firm
and the three possible long-run supply curve for the industry.
(a): ______(z): ______

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42 Describe why perfect competition is incompatible with substantial economies

of scale. (a): ______(z): ______

43 Explain why producing where price equals marginal cost is regarded as an

optimal (or allocatively efficient) position. (a): ______(z): ______

44 Discuss the extent to which perfectly competitive firms are productively

efficient. (a): ______(z): ______

45 Outline the benefits and possible disadvantages of perfect competition for

society. (a): ______(z): ______

46 Define the following key terms:

 barrier to entry (a): ______(z): ______
 natural monopoly (a): ______(z): ______
 switching costs (a): ______(z): ______
 network externalities or network economies (a): ______(z): ______
 limit pricing (a): ______(z): ______
 competition for corporate control. (a): ______(z): ______

47 Describe the main features of a monopoly. (a): ______(z): ______

48 Describe the barriers to entry that may exist. (a): ______(z): ______

49 Explain and illustrate how monopolists determine the equilibrium price and
output. (a): ______(z): ______

50 Discuss how much profit may be made by a monopolist.

(a): ______(z): ______

51 Discuss whether or not monopolists might be productively efficient

(ie produce at minimum cost) and allocatively efficient (ie produce optimal
output). (a): ______(z): ______

52 Compare perfect competition and monopoly in terms of price and output

levels. (a): ______(z): ______

53 Discuss the advantages and disadvantages of monopoly for the public.

(a): ______(z): ______

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54 Define the following key terms:

 perfectly contestable market (a): ______(z): ______
 hit and run. (a): ______(z): ______

55 Describe how the following are affected in a perfectly contestable market:

 price and profit (a): ______(z): ______
 efficiency. (a): ______(z): ______

56 Distinguish between actual competition and potential competition.

(a): ______(z): ______

57 Discuss the importance of costless exit in perfectly contestable markets.

(a): ______(z): ______

58 Discuss the strengths and limitations of the theory of contestable markets.

(a): ______(z): ______

59 Discuss whether contestable markets are good for the public interest both in
theory and in practice. (a): ______(z): ______

60 Define the following key terms:

 independence (of firms in a market) (a): ______(z): ______
 product differentiation (a): ______(z): ______
 non-price competition (a): ______(z): ______
 excess capacity (under monopolistic competition).
(a): ______(z): ______

61 State the assumptions of monopolistic competition. (a): ______(z): ______

62 Sketch the firm’s cost and revenue curves for monopolistic competition.
(a): ______(z): ______

63 Explain and illustrate how monopolistically competitive firms determine price

and output in the short run and in the long run. (a): ______(z): ______

64 Discuss the limitations of the monopolistic competition model.

(a): ______(z): ______

65 Discuss the two major elements of non-price competition.

(a): ______(z): ______

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66 Compare monopolistic competition and perfect competition in terms of:

 price and output levels (a): ______(z): ______
 productive and allocative efficiency (a): ______(z): ______
 product choice. (a): ______(z): ______

67 Compare monopolistic competition and monopoly in terms of:

 price (a): ______(z): ______
 productive and allocative efficiency. (a): ______(z): ______

68 Define the following key terms:

 interdependence (under oligopoly) (a): ______(z): ______
 collusive oligopoly (a): ______(z): ______
 non-collusive oligopoly (a): ______(z): ______
 cartel (a): ______(z): ______
 quota (set by a cartel) (a): ______(z): ______
 tacit collusion (a): ______(z): ______
 dominant firm price leadership (a): ______(z): ______
 barometric firm price leadership (a): ______(z): ______
 average cost pricing (a): ______(z): ______
 price benchmark (a): ______(z): ______
 duopoly (a): ______(z): ______
 Cournot model (a): ______(z): ______
 Cournot equilibrium (a): ______(z): ______
 Nash equilibrium (a): ______(z): ______
 residual demand curve (a): ______(z): ______
 reaction function (or curve) (a): ______(z): ______
 takeover bid (a): ______(z): ______
 kinked demand theory (a): ______(z): ______
 countervailing power (a): ______(z): ______
 oligopsony. (a): ______(z): ______

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69 State the two key features of oligopoly. (a): ______(z): ______

70 Distinguish between competition and collusion. (a): ______(z): ______

71 Describe and illustrate the industry equilibrium for a cartel.

(a): ______(z): ______

72 Describe the different forms of tacit collusion:

 price leadership (a): ______(z): ______
 rules of thumb.

73 Draw the equilibrium diagram for a price leadership model that assumes
that:
 the dominant leader takes the part of the market not taken by the other
firms (a): ______(z): ______
 the dominant or barometric leader takes a constant market share.
(a): ______(z): ______

74 State the conditions under which collusion is more likely.

(a): ______(z): ______

75 Discuss the reasons for collusion breaking down. (a): ______(z): ______

76 State the assumptions underlying the Cournot model.

(a): ______(z): ______

77 Sketch the cost and revenue curves for the Cournot model of duopoly and
illustrate and explain the Cournot equilibrium. (a): ______(z): ______

78 State the assumptions underlying the Bertrand model.

(a): ______(z): ______

79 Discuss the likely industry profits under the Cournot and Bertrand models.
(a): ______(z): ______

80 State the assumptions underlying the kinked demand curve model.

(a): ______(z): ______

81 Describe and illustrate the equilibrium position in the kinked demand curve
model. (a): ______(z): ______

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82 Discuss the link between the kinked demand model and price stability and
state the two major limitations of the theory. (a): ______(z): ______

83 Discuss whether oligopoly is beneficial to society. (a): ______(z): ______

84 Define the following key terms:

 game theory (a): ______(z): ______
 simultaneous single-move game (a): ______(z): ______
 dominant strategy and dominant-strategy game (a): ______(z): ______
 normal-form game. (a): ______(z): ______

85 Define the following key terms:

 prisoners’ dilemma (a): ______(z): ______
 trigger strategy (a): ______(z): ______
 backwards induction (a): ______(z): ______
 sequential-move game (a): ______(z): ______
 decision tree (or game tree) (a): ______(z): ______
 first-mover advantage (a): ______(z): ______
 credible threat (or promise) (a): ______(z): ______
 maximin (a): ______(z): ______
 maximax. (a): ______(z): ______

86 Identify and discuss the different strategies that firms might adopt.
(a): ______(z): ______

87 Identify and discuss the dominant and Nash equilibrium positions of a game.
(a): ______(z): ______

88 Sketch a decision tree for a given sequential-move game.

(a): ______(z): ______

89 Discuss the benefits and limitations of game theory. (a): ______(z): ______

90 Define the following key terms:

 average cost or mark-up pricing (a): ______(z): ______
 limit pricing. (a): ______(z): ______

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91 Outline the factors affecting the mark-up. (a): ______(z): ______

92 Explain and illustrate limit pricing using cost and revenue curves.
(a): ______(z): ______

93 Define the following key terms:

 price discrimination (a): ______(z): ______
 first-degree price discrimination (also known as perfect price
discrimination or personalised pricing) (a): ______(z): ______
 second-degree price discrimination (a): ______(z): ______
 third-degree price discrimination (a): ______(z): ______
 peak-load pricing (a): ______(z): ______
 predatory pricing. (a): ______(z): ______

94 Discuss how each of the three types of price discrimination are applied in
practice. (a): ______(z): ______

95 Outline the three conditions necessary for price discrimination.

(a): ______(z): ______

96 State the main advantages to the firm of using price discrimination.

(a): ______(z): ______

97 Illustrate how the firm (a) increases total revenue and (b) determines the
profit-maximising prices and total output, under:
 first-degree price discrimination (a): ______(z): ______
 third-degree price discrimination (a): ______(z): ______
 peak-load pricing. (a): ______(z): ______

98 Discuss whether or not price discrimination is in the public interest.

(a): ______(z): ______

99 Define the following key terms:

 loss leader (a): ______(z): ______
 full-range pricing (a): ______(z): ______
 by-product. (a): ______(z): ______

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100 Give examples of situations in which a firm considers the pricing of its
products as a whole rather than as individual products.
(a): ______(z): ______

101 Describe the four stages of the product life cycle. (a): ______(z): ______

102 Explain and illustrate how pricing varies with each stage in the life of a
product. (a): ______(z): ______

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NOTES

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EXAM PREPARATION CHECKLIST

Past Exam Questions

We recommend that you work through as many questions as possible under

exam conditions. By doing so, you’ll get used to the style of question asked,
the style of answers required and to working under time pressure. Keep a
note of which questions you have attempted and when. Watch your
multiple-choice score improve!

Multiple-choice questions (1½ marks per question)

Attempt Date Score (max 186)

1
2
3

Short-answer (S) and long-answer (L) questions

Q Date Q Date Q Date

S1 S11 S21
S2 S12 S22
S3 S13 S23
S4 S14 S24
S5 S15 S25
S6 S16 S26
S7 S17 S27
S8 S18 S28
S9 S19 S29
S10 S20 S30

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Q Date Q Date Q Date

S31 S41 L1
S32 S42 L2
S33 S43 L3
S34 S44 L4
S35 S45
S36 S46
S37 S47
S38 S48
S39 S49
S40 S50

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