Define the term increasing returns to scale.

Using the data in Table 1 to support your answer, identify how changes in inputs may result in constant returns to scale and in decreasing returns to scale.

Determine:

• marginal revenue when output is equal to 4 units.

Determine:

• average revenue when output is equal to 6 units.

Determine:

• economic profit if output is equal to 2 units and average cost is equal to $130 per unit.

Calculate the marginal revenue resulting from a fall in price from $8 to $6.

Calculate the price elasticity of demand when price falls from $10 to $8.

Explain why a profit-maximizing monopolist would never choose to operate on the inelastic portion of its demand curve.

State two characteristics of monopolistic competition.

Calculate Firm B’s short-run profit/loss at the profit-maximizing level of output.

Using the diagram, explain how long-run equilibrium will be reached.

With reference to the diagram, outline whether allocative efficiency will be achieved in the long run in a monopolistically competitive market.

Level
0 The work does not meet a standard described by the descriptors below. [0]

1 Vague definition. [1]

For the idea that if input/inputs are increased, there is a large increase in output / an increase in productivity
OR that average costs fall as output increases.

2 Accurate definition. [2]

For stating that an increase in all inputs leads to a proportionately greater increase in output
OR that an increase in all inputs by x% leads to a greater than x% increase in output.

Constant returns are seen when output increases from 3000 to 4000 units (33% increase in inputs and output).

Decreasing returns are seen if output increases from 4000 units – increase in inputs – 25% and then 20%, while output increases by 20% and then 14.6%.

OR by taking ratios of inputs and output (ie that 5/4 = 100/80 = 30/24 = 4800/4000 = 1.25)

For identifying and illustrating one of these OR for identifying but not illustrating both. [1]

For identifying and illustrating both. [2]

Any valid combination of inputs used should be accepted. A candidate who focuses on one factor of production only may be awarded a maximum of [1].

$0 or 0

$50

$40

Candidates who provide an answer of $20 per unit may not be awarded a mark here but should NOT be penalized in part (h) for the same error (giving the answer as “per unit”).

$\frac{\mathrm{\Delta }TR}{\mathrm{\Delta }Q}=\frac{24}{12}$ [1]

Any valid working is sufficient for [1] so either 24 or 12 would be sufficient.

= $2 [1]

An answer of $2 or 2 without workings is sufficient for [1].

PED = $\frac{\mathrm{\%}\mathrm{\Delta }Q}{\mathrm{\%}\mathrm{\Delta }P}=\frac{100}{-20}$

Any valid working is sufficient for [1].

= –5 or 5 [1]

OR an answer of 3 (or –3) if the midpoint method is used.

An answer of 5 (or –5) without any valid working is sufficient for [1] only.

Correct use of negative sign for ΔP may be present but is not necessary.

When demand is price inelastic, a decrease in output / increase in price will:

• increase total revenue [1]
• decrease output and therefore total costs [1]
• increase profit. [1]

Therefore, the profit-maximizing monopolist would never choose to produce on the inelastic portion of its demand curve, as profit could always be increased by raising price. [1]

Responses which state that if demand is inelastic an increase in output will cause revenue to fall [1] and therefore profits will fall [1] may be awarded a maximum of [2].

OR an accurate explanation such as the one below may be fully rewarded:

MR = MC is a condition for profit maximization.
MC must be a positive number, so MR must be positive at the profit-maximizing
level of output.
If MR is positive, then demand must be elastic.

• low or zero barriers to entry
• many firms
• product differentiation/some price-setting power
• the firms are small, relative to the size of the industry.

Award [1] for each valid characteristic up to a maximum of [2].

350 X (16 – 20) [1]

Any valid working is sufficient for [1].

= –$1400 (or a loss of $1400) [1]

An answer of $1400 or 1400 without workings is sufficient for [1].

$4 with working should be awarded [1] for valid working.

If the candidate provided a “per unit” answer in part (c)(iii) and again here, do not penalize again.

Level

0 The work does not reach a standard described by the descriptors below. [0]

1 The response is limited. [1-2]

For an explanation that losses incurred will force some firms to leave the industry.

2 The response is accurate. [3-4]

For an explanation that losses (of $1400) incurred will force some firms to leave the industry. As a result, the demand curve faced by remaining firms will shift to the right (reducing losses). The process will continue until remaining firms make normal profits.

If there is no reference to the diagram (losses or $1400), a maximum of [3] may be awarded.

Level

0 The work does not reach a standard described by the descriptors below. [0]

1 Vague outline. [1]

For stating that allocative efficiency requires that P = MC (or MB = MC).

2 Accurate outline. [2]

For outlining that as P > MR, then P cannot equal MC when MR = MC.

A candidate who draws and refers to long run equilibrium on the diagram provided, explaining that it is inconsistent with the position of allocative efficiency, may be fully rewarded. Please note that stating the condition is sufficient for [1], even if the candidate goes on to provide the incorrect conclusion.