AP_Krugman_Textbook

Tackle the Test: Free-Response Questions

1. a. Define price discrimination.
   b. Why do firms price discriminate?
   c. In which market structures can firms price discriminate?
   Explain why.
   d. Give an example of price discrimination.

Answer (5 points)

1 point:Price discrimination is the practice of charging different prices to
different customers for the same product.

1 point:Firms price discriminate to increase their profits.

1 point:In order to price discriminate, firms must be in the monopoly, oligopoly,
or monopolistic competition market structure.

1 point:Because rather than being price-takers, firms in these market
structures have some degree of market power, which gives them the ability to
charge more than one price.

1 point:An example is different prices for movie tickets charged for people of
different ages.

2. Draw a correctly labeled graph showing a monopoly practicing
   perfect price discrimination. On your graph, identify the
   monopoly’s profit. What does consumer surplus equal in this
   case? Explain.

Summary

1.A producer chooses output according to the price-

taking firm’s optimal output rule:produce the

quantity at which price equals marginal cost. However,

a firm that produces the optimal quantity may not be

profitable.

2.A firm is profitable if total revenue exceeds total cost or,

equivalently, if the market price exceeds its break-even

price—minimum average total cost. If market price ex-

ceeds the break-even price, the firm is profitable. If mar-

ket price is less than minimum average total cost, the

firm is unprofitable. If market price is equal to mini-

mum average total cost, the firm breaks even. When

profitable, the firm’s per-unit profit is P−ATC;when

unprofitable, its per-unit loss is ATC−P.

3.Fixed cost is irrelevant to the firm’s optimal short-run

production decision. The short-run production deci-

sion depends on the firm’s shut-down price—its mini-

mum average variable cost—and the market price. When

the market price is equal to or exceeds the shut-down

price, the firm produces the output quantity at which

marginal cost equals the market price. When the market

price falls below the shut-down price, the firm ceases

production in the short run. This generates the firm’s

short-run individual supply curve.

4.Fixed cost matters over time. If the market price is

below minimum average total cost for an extended pe-

riod of time, firms will exit the industry in the long run.

If market price is above minimum average total cost, ex-

isting firms are profitable and new firms will enter the

industry in the long run.

5.Theindustry supply curvedepends on the time period

(short run or long run). When the number of firms is

fixed, the short-run industry supply curveapplies.

Theshort-run market equilibriumoccurs where the

short-run industry supply curve and the demand curve

intersect.

Section 11 Review

630 section 11 Market Structures: Perfect Competition and Monopoly