Microeconomics

a) The following graphical representation shows the Marginal Cost (MC) curve, Average Cost (AV) curve, Average Fixed Cost (AFC) curve, and Average Variable Cost (AVC).

The relationship between the supply curve and the marginal cost curve is illustrated by the figure 1 above. The firm will be forced to stop its operation if its revenue in the short run cannot pay for all the variable costs. This happens when the firm cannot operate at or above point B where MC curve is equal to minimum AVC (Gravelle & Rees, 2004).

b)  Marginal cost curve intersects the average cost curve at its minimum point, because in the long run all variable and fixed cost must be paid, in order the firm to stay in the business. Thus, it must operate at the break-even level. This is represented by point D, where MC is equal to minimum ATC. If the firm produces at E, it will make excess profits. In the short run, supply curve will be represented by the MC curve above AVC (Baumal & Blinder, 2007). In the long run, it will be represented by the part of MC curve above ATC.

(ii) The minimum point of the AVC curve occurs at a lower level of output than the minimum point is the AC curve, because fixed costs occur at all the production levels, accordingly raising the levels higher in AV curve than AVC curve.

1) The two examples of price discrimination that is practised by firms in Australia include perfect (first degree) and second degree price discriminations. Under the perfect price discrimination, Australian firms sort out consumers in the market according to their willingness and ability to purchase goods and services. This implies that the consumers are charged prices that they are willing and capable to pay. Upon a successful application of the perfect price discrimination model, Australian firms remove the consumer surplus below the demand curve by turning it into producer surplus. On the other hand, the second degree price discrimination is used by firms in Australia in selling a product package that appears to be in a surplus capacity. The product package is usually sold at a relatively lower cost than the price that was advertised before (Baumal & Blinder, 2007).

2) The profit maximizing price and output under third degree price discrimination occurs when a firm is capable of dividing its customers into two or more markets. Each separate market is characterized by some unique demand. This implies that some of these markets will be price inelastic, while others are going to be price sensitive/elastic. In order to maximize profit and output, a firm can find it more appropriate to charge a relatively higher price 'P₁' and to sell at output 'Q₁' in market one. To this end, the firm charges a relatively lower price 'P₂' and sells output 'Q₂' in market two. Therefore, it is evident that profit is more than in a single price 'P* '   (P₂ < P* < P₁) for the outputs sold.

Assuming that the total costs are the same in both cases, profit maximising price and output hold under the third degree price discrimination when the following formula is attained.

P₁Q₁ + P₂Q₂ > P*Q* (Q* = Q1 + Q2

The statement is true since in a monopolist market, the decision making process is left to one firm that controls the prices. This implies that a monopolist will charge as high as the market is able to bear. However, a monopolist may not charge a higher price that the consumers in the market can no longer bear. Moreover, in a monopolist market, the decision of the firm is not determined by the forces of demand and supply (Richards, 2007). A monopolist will make decisions to make profit at a point where Marginal Revenue (MR) = Marginal Cost (MC) in the short run.

a) The demand curve under the kinked demand curve hypothesis would a kinked Demand Curve Model that represents an elastic oligopolistic situation. If an oligolistic raises prices, other firms do not. However, a corresponding decrease in prices is followed by other firms, thus no gains are made.

b) The marginal revenue figures corresponding to the kinked demand curve can be calculated as shown below.   

(c) The profit-maximising output can be calculated as shown below.

Marginal revenue (R_M) = (C_M)

M - Q₂ - 2Q₁ = C_M

2Q₁ = (M-C_M) - Q₂

Where: M = $185

CM = $165

Q₁ = (M-C_M)/2 - Q₂/2 = 10 – 0.5 Q₂…equation 1

Q₂ = 2(M-C_M) - 2Q₂ = 20 – 2 Q₂…equation 2

Substituting equation 1 and 2

2 Q₂     = 20

Q₂   = 10

Q₁ = 5

 1) A micro-economic reform issue that is relevant to the Australian economy can be discussed under advantage of having a market structure that does not conform to perfect competition. The advantage includes the following: preventing negative externalities, sufficient profits for investments, promoting fair competition, uniform economic development, resource allocation and economies of scale (Georke, 2009).

2) Pan (2010) studied that these reform measures were successful, because the Australian government intervenes in the economy in order to prevent negative externalities such as pollution that reduces social welfare levels in a perfectly competitive market. The government also intervenes in a non-perfectively competitive market to ensure fair competition among firms. This is done through regulation and fair distribution of resources.