New Global Vision College

School of post Graduate

MASTERS OF BUSINESS ADMINISTRATION (MBA)

MANAGERIAL ECONOMICS ONLINE PROGRAM
INDIVIDUAL ASSIGNMENT

NAME ID No
BEMNET GOSSAYE NGVC/MBA/7590/24

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 Part I. Clearly discuss the following questions:

i. Briefly describe the types of market structures and their characteristics. Discuss the
advantage and disadvantage of each market structure. Which types of market structure
more prominent in our county (better to classify in each sector like; import exporters,
bank industries, beer industries and others).

Market Structures and Their Characteristics

1. Perfect Competition:

 Characteristics:
o Many Sellers and Buyers: Large number of participants, none of
which can influence the market price.
o Homogeneous Products: All firms sell identical products.
o Free Entry and Exit: No barriers to enter or leave the market.
o Perfect Information: All participants have full knowledge of market
conditions.
 Advantages:
o Efficiency: Firms produce at the lowest possible cost and prices
reflect the true cost of production.
o Consumer Benefit: Consumers get products at the lowest price.
 Disadvantages:
o Lack of Innovation: Minimal profit margins reduce incentives for
innovation.
o Undifferentiated Products: Limited choice for consumers since
products are identical.
 Prominence: Rare in reality, but some agricultural markets (e.g., wheat,
corn) may approximate perfect competition.

2. Monopoly:

 Characteristics:
o Single Seller: One firm controls the entire market.
o Unique Product: No close substitutes for the product.
o High Barriers to Entry: Significant obstacles prevent new firms
from entering the market.
o Price Maker: The monopolist can set the price.
 Advantages:
o Economies of Scale: The monopolist can achieve lower costs through
large-scale production.
o Innovation Incentives: High profits can fund research and
development.
 Disadvantages:
o Higher Prices: Consumers pay more due to lack of competition.
o Inefficiency: The monopolist may not produce at the lowest cost or
offer the best product.
 Prominence: Common in sectors with high entry costs like utilities (e.g.,
electricity, water supply).
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 3. Oligopoly:

 Characteristics:
o Few Sellers: A small number of firms dominate the market.
o Interdependence: Firms are aware of each other’s actions and
decisions.
o Barriers to Entry: Moderate to high barriers to entry.
o Product Differentiation: Products may be homogeneous or
differentiated.
 Advantages:
o Stable Prices: Firms may avoid price wars, leading to price stability.
o Economies of Scale: Larger firms benefit from reduced costs.
 Disadvantages:
o Collusion Risk: Firms may collude to set prices, harming consumers.
o Limited Choices: Consumers may have fewer options.
 Prominence: Seen in industries like banking, telecommunications, and the
beer industry.

4. Monopolistic Competition:

 Characteristics:
o Many Sellers: A large number of firms compete in the market.
o Differentiated Products: Firms sell similar but not identical
products.
o Low Barriers to Entry: Firms can enter and exit the market
relatively easily.
o Some Price Control: Firms have some control over pricing due to
product differentiation.
 Advantages:
o Product Variety: Consumers have access to a wide range of
products.
o Innovation: Firms innovate to distinguish their products.
 Disadvantages:
o Inefficiency: Firms do not produce at the lowest possible cost.
o Excessive Advertising: High costs associated with marketing and
brand differentiation.
 Prominence: Common in industries like retail, restaurants, and consumer
goods.

ii. Discuss the game theoretic foundations for understanding the behavior of firms. Link
the idea of game theory for the development of institutions. Give few examples of
game theory with the help of payoff matrix.

Game Theory is a mathematical framework for analyzing strategic interactions among

firms where the outcome for each participant depends on the choices made by others.

Key Concepts:

 Nash Equilibrium: A situation where no player can improve their payoff by

changing their strategy while the other players' strategies remain unchanged.
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  Dominant Strategy: A strategy that yields a higher payoff regardless of what the
other players do.
 Payoff Matrix: A table that shows the payoffs for each player based on the strategies
chosen by all players.

Examples:

1. Prisoner's Dilemma:
o Two firms (Firm A and Firm B) must decide whether to compete
aggressively or cooperate.
o Payoff Matrix:
o
Firm B: Cooperate Firm B: Compete
Firm A: Cooperate (3, 3) (1, 4)
Firm A: Compete (4, 1) (2, 2)

Nash Equilibrium: Both firms compete, resulting in lower payoffs

o
(2, 2).
2. Cournot Competition:
o Firms choose output quantities simultaneously. The equilibrium is
where each firm's output decision maximizes its profit, given the
output of the other firm.

Link to Institutions:

 Regulatory Bodies: Institutions may use game theory to anticipate the behavior of
firms in response to regulations, leading to more effective policy-making.
 Cartels: Understanding the incentives for collusion can help institutions prevent
anti-competitive behavior.

iii. Rational producers always expected to make rational decisions. In which stages of
production, the manager intends to maximize production? Discuss clearly with the
comparison of other stages.

Production can be divided into three stages based on the relationship between input and output:

1. Stage I: Increasing Returns to Scale

o Characteristics: Marginal product (MP) increases with additional input.
o Rational Decision: A manager should continue to increase production in this
stage since each additional unit of input results in a larger increase in output.
2. Stage II: Diminishing Returns to Scale
o Characteristics: MP starts to decline but remains positive. Total product
(TP) is increasing at a decreasing rate.
o Rational Decision: This is the optimal stage for production, where the
manager should aim to operate. The firm maximizes its output relative to the
cost of input.
3. Stage III: Negative Returns to Scale
o Characteristics: MP becomes negative, meaning that adding more input
actually reduces output.

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 o Rational Decision: The manager should avoid this stage since additional
input decreases overall production.

Comparison:

 In Stage I, production is efficient, but the firm is not utilizing its full potential.
 In Stage III, the firm is overusing inputs, leading to inefficiencies.
 Stage II is where the firm should aim to produce, balancing input costs and
output maximization.

These stages are critical in decision-making, guiding managers on how to allocate resources
effectively for optimal production.

Part II. Workout.

1. Of the following production functions, which exhibit increasing, constant, or decreasing

returns to scale?

(a) F(K, L) = K2 L
(b) F(K, L) = 10K + 5L
(c) F(K, L) = (KL)0.5
Answer: -

To determine whether each of the given production functions exhibits increasing, constant, or
decreasing returns to scale, we need to analyze how the output changes when we scale the inputs
K (capital) and L (labor) by a common factor t>1.

1. F (K, L) =K2L

 Test for Returns to Scale:

o If we scale both inputs K and L by a factor of t, the new output is:

F(tK,tL) = (tK)2⋅(tL) = t2K2⋅tL=t3⋅K2L

The output increases by a factor of t3.

o Conclusion:
 Since t3>t for t>1, the production function exhibits increasing returns to
scale.

2. F (K, L) = 10K+5L

 Test for Returns to Scale:

o If we scale both inputs K and L by a factor of t, the new output is:

F(tK,tL)=10(tK)+5(tL)=10tK+5tL=t(10K+5L)

The output increases by a factor of t.

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 o Conclusion:
 Since the output scales exactly by the factor ttt, the production function
exhibits constant returns to scale.

3. F (K, L) =(KL)0.5

 Test for Returns to Scale:

o If we scale both inputs K and L by a factor of t, the new output is:

F(tK,tL)=(tK⋅tL)0.5=(t2KL)0.5=t⋅(KL)0.5

The output increases by a factor of t.

o Conclusion:
 Since the output scales exactly by the factor ttt, the production function
exhibits constant returns to scale.

Summary:

 F (K, L) =K2L exhibits increasing returns to scale.

 F (K, L) =10K+5L exhibits constant returns to scale.
 F (K, L) =(KL)0.5 exhibits constant returns to scale.

2. The price of a product in a perfect competitive firm is 16 birr and the total cost functions
are given as TC= 4Q2-8Q+15, respectively. Find

(a) The optimum quantity and the optimum price level.

(b) The profit/loss on these levels.

(c) At what price should the perfect competitive firm shut down?

Answer: -

Given:

 The price of the product (P) is 16 birr (since the firm operates in a perfectly competitive
market, the price is given and constant).
 The total cost (TC) function is given as:

TC=4Q2−8Q+15

(a) The Optimum Quantity and the Optimum Price Level

In a perfectly competitive market, a firm maximizes profit by producing the quantity where
marginal cost (MC) equals the market price (P).

1. Calculate the Marginal Cost (MC):

MC=d(TC)/dQ=d(4Q2−8Q+15)/dQ=8Q−8

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Set MC=P to find the optimum quantity (Q∗):
8Q−8=16

Solving for Q:

8Q=24
Q∗=24/8=3

 Optimum Quantity (Q∗): 3 units

Since this is a perfectly competitive market, the price P remains constant at 16 birr.

 Optimum Price Level: P∗=16 birr

(b) The Profit/Loss on These Levels

1. Calculate Total Revenue (TR):

TR=P×Q=16×3=48 birr

2. Calculate Total Cost (TC) at the optimum quantity:

TC=4(3)2−8(3) +15=4(9) −24+15=36−24+15=27 birr

Calculate Profit (or Loss):
Profit=TR−TC=48−27=21 birr

 Profit at the optimum level: 21 birr

(c) At What Price Should the Perfectly Competitive Firm Shut Down?

A perfectly competitive firm should shut down if the price falls below the minimum of
the Average Variable Cost (AVC).

1. Calculate the Variable Cost (VC):

o From the total cost function TC=4Q2−8Q+15, the variable cost (VC) is the
part of the total cost that depends on Q. Therefore: VC=4Q2−8Q

2. Calculate the Average Variable Cost (AVC):

AVC=VC/Q=4Q2−8Q/Q=4Q−8

3. Find the minimum AVC by setting the derivative equal to zero:

Take the derivative of AVC with respect to Q and set it to zero:

d(AVC)/dQ=4

Since 4 is a constant, it implies that AVC is increasing as Q increases. Therefore, the

minimum AVC is achieved at Q=0, where AVC will be:

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 AVC=4(0) − 8= −8 (Not applicable as AVC cannot be negative)

4. Price should equal AVC at the shutdown point:

Therefore, the firm should consider the price at which AVC=0 because at any price
lower than that, the firm would incur losses greater than its fixed costs:

For Q>0

P=AVC=4Q−8

Set AVC=0 for shutdown price

0=4Q−8
Q=2

At Q=2

P=4(2) −8=0

Thus, the firm should shut down when the price falls below 8 birr, because at any price below
this, it won't be able to cover its variable costs.

Summary:

 Optimum Quantity: Q∗ = 3 units

 Optimum Price: P∗ = 16 birr
 Profit at Optimum Level: 21 birr
 Shutdown Price: 8 birr

3. Suppose a monopolist has TC = 200 + 15Q + 5Q2, and the demand curve it faces is P= 190 - 2Q.

(a) The optimum quantity and the optimum price level.

(b) The profit/loss on these levels.

(c) At what price should the monopolist shut down

 Total Cost (TC) Function:

TC=200+15Q+5Q2

 Demand Curve (Price as a function of Quantity, P):

P=190−2Q

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(a) The Optimum Quantity and the Optimum Price Level

For a monopolist, profit is maximized when Marginal Revenue (MR) equals Marginal
Cost (MC).

Step 1: Determine the Revenue Function (TR)

Total Revenue (TR) is given by:

TR=P×Q=(190−2Q) × Q = 190Q−2Q2

Step 2: Determine the Marginal Revenue (MR)

Marginal Revenue (MR) is the derivative of Total Revenue with respect to Q:

MR = d(TR)/dQ =190−4Q

Step 3: Determine the Marginal Cost (MC)

Marginal Cost (MC) is the derivative of Total Cost with respect to Q

MC=d(TC)/dQ = d/dQ(200+15Q+5Q2) = 15+10Q

Step 4: Set MR = MC to find the Optimum Quantity (Q∗)

190−4Q=15+10Q

Solving for Q:

190−15=10Q+4Q

175=14Q

Q∗=175/14=12.5

So, the optimum quantity is Q∗=12.5units.

Step 5: Determine the Optimum Price (P∗)

Substitute Q* back into the demand curve to find the optimum price:

P* = 190−2(12.5) =190−25=165 birr So, the optimum price is P* = 165 birr.

(b) The Profit/Loss on These Levels

Step 1: Calculate Total Revenue (TR) at Q∗=12.5Q^* = 12.5Q∗=12.5

TR= P*× Q* = 165 × 12.5 =2062.5 birr

Step 2: Calculate Total Cost (TC) at Q* = 12.5

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 TC=200+15(12.5) +5(12.5)2
TC=200+187.5+781.25=1168.75 birr

Step 3: Calculate Profit

Profit=TR−TC=2062.5−1168.75=893.75 birr
So, the profit at the optimum level is 893.75 birr.

(c) At What Price Should the Monopolist Shut Down?

A monopolist should shut down if the price falls below the minimum of Average Variable Cost
(AVC).

Step 1: Determine the Variable Cost (VC)

The Variable Cost (VC) is the part of the Total Cost (TC) that depends on Q:

VC=15Q+5Q2

Step 2: Determine the Average Variable Cost (AVC)

AVC=VC/Q=15Q+5Q2/Q=15+5Q

Step 3: Find the Minimum AVC

The minimum AVC occurs when d(AVC)/dQ=5

Since the derivative is constant, AVC increases as Q increases. Therefore, the

minimum AVC is at Q=0, but let's evaluate it for practical purposes:

 At Q=0, AVC is undefined (since AVC=VC/Q).

 Thus, the shutdown price occurs when AVC=P.

For the firm to avoid a shutdown, the price P must cover AVC:

P=AVC=15+5Q

Set AVC equal to the minimum price the firm can sustain If the price falls below15 birr,
the firm should shut down.

Summary:

 Optimum Quantity: Q∗=12.5Q^* = 12.5Q∗=12.5 units

 Optimum Price: P*=165birr
 Profit at Optimum Level: 893.75 birr
 Shutdown Price: 15 birr

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 4. The total cost (TC) and demand equations for a monopolist is

𝑇𝐶 = 100 + 5𝑄2
𝑃 = 200 − 5𝑄
(a) What is the profit-maximizing quantity?
(b) What is the profit-maximizing price?

Given:

 Total Cost (TC) Function: TC=100+5Q2

 Demand Equation (Price as a function of Quantity, P): P=200−5Q

(a) What is the Profit-Maximizing Quantity?

For a monopolist, profit is maximized where Marginal Revenue (MR) equals

Marginal Cost (MC).

Step 1: Determine the Revenue Function (TR)

Total Revenue (TR) is given by:

TR=P×Q=(200−5Q)×Q=200Q−5Q2

Step 2: Determine the Marginal Revenue (MR)

Marginal Revenue (MR) is the derivative of Total Revenue with respect to Q:

MR=d(TR)/dQ=200−10Q

Step 3: Determine the Marginal Cost (MC)

Marginal Cost (MC) is the derivative of Total Cost with respect to Q:

MC=d(TC)/dQ=d(100+5Q2)/dQ=10Q

Step 4: Set MR=MC to find the Profit-Maximizing Quantity (Q*)

200−10Q=10Q

Solving for Q:

200=20Q=200/20=10

So, the profit-maximizing quantity is Q∗=10 units.

(b) What is the Profit-Maximizing Price?

To find the profit-maximizing price, substitute the quantity Q=10 back into the demand
equation:

P=200−5(10) = 200−50=150 birr

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So, the profit-maximizing price is P =150 birr.

Summary:

 Profit-Maximizing Quantity: Q =10 units

 Profit-Maximizing Price: P =150 birr

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