Kandula 1

Sai Gayathri Kandula

BBA LLB 2020 C
Economics – I
21 October 2021

Section A
Question 1
Setting: We are ‘The Goats’, a breakfast oatmeal porridge company serving since 1950 in the
UK. Our target segment is women belonging to the age group of 20-45. Our range includes
fruity, spicy, vanilla and chocolate flavored oats. So, we operate in the breakfast cereal
industry. Our immediate competitors are firms who operate in the oat market such as
Kellogg’s, Quaker, Morning Foods Ltd., etc. We also compete with firms in the breakfast
cereal industry which don’t offer oats like Nestle, Alpen and many other firms. Our market
share in the whole of breakfast cereal industry is less than 1% and in the Oatmeal industry it
is 13%. Our products are similar to our competitors’ products but there is a difference in the
flavors and quantities offered. There are close substitutes in this market, as one can easily
switch to other types of breakfast cereal. Therefore, there is a high positive cross elasticity of
demand. High selling cost due to extensive advertising. Price competition exists; however,
more emphasis is placed on non-price competition. Our main aim is to maximize the profits
and retain market share.

Fig.1- The Goats Fruity Oatmeal Box

Manager Report
Price and Output Determination:
 Kandula 2

Fig.2- Short Run Equilibrium

The profit maximizing price and output occurs in the short run when MC = MR. The MR cuts
MC at point E, which is the market equilibrium. The firms will be setting their price at point
P, which corresponds to point A. The quantity is set at Q. The super normal profits earned by
the firm is represented by the shaded area. Any price lower than point A and between B will
reduce the profits earned and any point below B would result in losses.
Steps to Determine Price and Output:
Firstly, the firm should indulge in a demand, cost, and revenue analysis. The firm should
determine AR, MR, MC, and ATC. Upon determining them, a graphical representation would
give us the profit maximizing price and output. Even though our firm contains 13% market
share and is the third largest firm in the oatmeal market, we are the price takers, and we must
adhere to the market equilibrium price and quantity. This is mainly because of the high
positive crossover elasticity. Our products have close substitutes in the whole breakfast cereal
industry, so any increase in the price might drive out the consumers. Our target segment
being women in the age group of 20-45 have multiple options in the oatmeal market itself.
Our biggest rivals – Kellogg’s and Quaker are in a better position as they have a much larger
market share in the overall breakfast cereal industry including the one, we are operating in.
So, it is very essential to not enter into a price war with these firms as it is more likely to
harm us. However, non-price competition can be very useful, even if they increase the selling
and development costs for us. Our firm should thus determine the price of the product by
examining the price charged by the rivals and by determining the demand. The demand can
be determined by using trial and error method and calculating the quantity demanded at each
price. This requires extensive field work. Upon, operating at a price no lower than the ATC
 Kandula 3

curve, we will be able to experience economic profits and operating at equilibrium would
maximize them.
Economic Profits and its Factors:
It is highly likely for us to experience super normal profits in the short run. However, such
profits cease to exist in the long run. In the long run there will be a no profit, no loss
situation. This can be better understood using a long run graph.

Fig.3- Long Run Equilibrium

The long run average cost curve intersects with the average revenue curve at the equilibrium
price. This means that AR is equal to AC in the long run. In such a situation, point A acts as
the break-even point, indicating that there will no profits or losses in the long run. So, our
firm will not be able to make super normal profits in the long run. The factors influencing this
is free entry. Since, we are operating in monopolistic conditions which allows easy entry into
the market, new firms will easily be able to make entry into the breakfast cereal market due to
the attractive economic profits. The new firms will now make the demand more elastic as
there are higher substitutes. This will reduce the demand for our product. As new entrants
keep coming, the demand reduces until it equals the average cost (point A), where there will
be no profits. There will also be no losses in the long run as the firms can freely exit the
market. Firms might leave the market due to the losses and this will increase the demand for
the remaining ones, until the break-even point.
 Kandula 4

Section B
Question 3
Market Type:
The market in which the unshelled corn business is operating in is the perfect competition.
“Perfect competition entails rational conduct on the part of buyers and sellers, full
knowledge, absence of frictions, perfect mobility and perfect divisibility of factors of
production, and completely static conditions” (qtd. in Robinson 104).
Features of Perfect Competition:
The following are the characteristics of perfect competition:
1. Homogenous Products: “Homogenous products are considered to be homogenous when
they are perfect substitutes and buyers perceive no actual or real differences between the
products offered by different firms” (OCED). Firms operating in perfect competition offer
homogeneous goods, i.e., the products offer no means of differentiation from its competitors.
This makes the demand for the good perfectly inelastic. A slight increase in the price of the
good would render an outcome that results in losing all the sales. The lack of differentiation
in the products prompts the consumers to switch to the competitor’s products in case the price
increases. Unshelled corn being an agricultural product is homogenous. The product remains
uniform and the buyers often don’t look out for any specificities when buying unshelled corn.

Fig.1- Perfectly Elastic Demand for Unshelled Corn

2. Many Competitors: there are numerous sellers and buyers in perfect competition.
Unshelled corn being an agricultural good is produced and sold by several farmers and
sellers. The homogeneity and the lack barriers to entry and exit in perfect competition makes
it a highly competitive market. However, there will be no price competition. An increase in
 Kandula 5

the price of unshelled corn by us, might result in losing all our sales. A decrease in price is
not possible as we are already operating at the equilibrium price and any price below the
equilibrium would result in losses. Hence, we will be price takers as we accept the prevailing
market equilibrium price, because we do not supply a significant amount of the produce in
the market, due to the presence of numerous competitors.
3. No Barriers to Entry and Exit: Firms are free to enter and exit a market under perfect
competition. They enter when they find the market attractive and leave when it turns
unattractive to them. The lack of barriers is mainly because of the lack of impact of the
existing firms and them acting as price takers. The unshelled corn market is free to enter, as
its requires low investment making it more attractive for the new or the prospective entrants.
It is also free to exit as there is low investment, firms can stop operating when they find the
market to be unattractive.
4. Perfect Information: This feature of perfect competition assumes that all the buyers and
sellers have full knowledge of the market prices and products. For example, the unshelled
corn sellers can have full knowledge of the market when they are fully aware of the
prevailing prices and the availability of resources for production. However, it is difficult to
say that all the sellers are fully aware of the prices and resource availability.
Losses in Short Run:

Fig.2- Losses in Short Run

 Kandula 6

Firms reach their equilibrium in the short run when the quantity demanded is equal to the
quantity supplied. The demand curve in short run is equal to the Average and Marginal
Revenue curve. The average revenue and marginal revenue in perfect competition is equal to
the price of the product (AR= P x Q/Q = P and MR= ∆TR/ ∆Q = P). The supply curve in
perfect competition in short run is represented by the Marginal cost curve above the
shutdown point. So, the equilibrium or the profit maximisation occurs when MR is equal to
the MC. This also determines the equilibrium price (P E) and output. The firms can make
losses in short run when the market price falls below the average total cost (P M). The firms at
this level are at least able to cover their variable costs. Despite making losses, some of the
firms will continue to operate in the short run in perfect competition. Firstly because they
have committed to the payment of the fixed costs. Therefore, even if there is no production,
the firm will continue making losses equal to the amount of fixed costs. Secondly, the
market’s self-adjustment mechanism in the long run also plays a role. The losses will
disappear in the long run as the loss making firms tend to exit the market. This leads to a
decrease in supply causing the price to increase. Thus, the market will now reach a new
equilibrium where the firms can operate without losses.
Shutdown:

Fig.3- Shutdown Price & Break-even Price

Even though some firms continue operating in losses in short run, they can be forced to shut
down when the market price falls below the average variable cost curve. This is because the
firms are no longer able to cover the variable costs. When MC = P is equal to ATC ( A), there
will no economic profits or no losses and any price higher than ATC will result in economic
 Kandula 7

profits. Point A serves as the break-even point. When MC = P is below ATC and above AVC
(between point A and B in figure 3), the firms will not shut down and continue operating. But
when MC = P falls below AVC (any point below point B), “individual firms are making
losses in addition to the fixed cost for every unit they are producing because the price does
not even cover the variable cost” (Ubabukoh, slide 29). Therefore, to minimize the losses to
the extent of fixed cost the firms will choose to close at any price below the shutdown price
(Point B).

Question 4
Rent control is a price ceiling practice imposed by the government to provide affordable
housing and to further the notions of equality. The government intervenes by controlling the
amount of rent that an owner of a building can possibly charge on their tenants

Rent Control, Market Equilibrium, and Efficiency:

Market equilibrium is attained at a level where the demand curve meets the supply curve. The
equilibrium price is also achieved at this point, and it is the most efficient outcome for both
the buyers and the sellers. Rent controls on housing disrupts the market efficiency as the
market price is lower than the equilibrium price. This leads to the creation of deadweight loss
in the long run. No deadweight loss is observed in the short run as the supply is perfectly
inelastic. In the short run, demand and supply are price inelastic. The supply remains
perfectly inelastic as the conversion or building a new building cannot be done in the short
run. Demand cannot vary much in the short run despite the decreased rent, as the
responsiveness of people to this, is slow. It is also important to note that there will be an
excess of quantity demanded in the short run. So, the availability of housing under rent
control is slightly lower than the quantity demanded. The shortage of supply produces an
inefficiency in the market. For example, in terms of pareto efficiency, in situation A where
there is no rent control (market equilibrium) both the buyers and sellers are in a better
position than in situation B where there is a rent control. In situation A, sellers acquire rentals
worth PE and in situation B, the same sellers acquire rentals worth P M which is lower than PE.
So, situation A is pareto efficient. The same theory applies to the buyers. The buyers are
better off in situation A when everybody’s needs are met rather than in situation B where
there is a shortage of supply.
 Kandula 8

Fig.1- Rent Control in Short Run

The rent control in long run similarly produces such a market inefficiency, however, there
will be a greater inefficiency in the long run when compared to short run. This is primarily
due to the following reasons:
1. Supply is more price elastic: In the long run the owners have the ability to put their
housing out of the market by either converting it or by demolishing it if the rental price
lowers. On the other hand, an increase in the rental price might encourage them to build and
offer more housing. So, the supply of housing is more price elastic in the long run. With the
imposition of rent control, the supply of rental units decreases. Because the incentive to
remain in the market is low for the property owners as there can be better returns if they put
their buildings for other uses. This decrease in the returns might ignite a drive towards
converting the controlled residential rental units into ones that are not controlled or ones that
are non-residential (Rosen 4). New entrants will also be discouraged due to this, hindering the
construction of new rental units. Furthermore, it reduces the quality of the housing and
contributes to its deterioration. With the decreased revenues and lack of incentive, the
property owners will spend less on repairing and maintaining the building, leading to a faster
deterioration of the property. This will further cut down the supply.
2. Demand is more price elastic: In the long run the demand for rent controlled housing
units becomes more price elastic than in short run, as people’s responsiveness increases.
Thus, there will be an excess shortage of rental units, as with the lowered rent the quantity
demanded has increased much more than in the short run.
Market Efficiency and Rent Control:
 Kandula 9

Fig.2- Rent Control in Long Run

Imposing a rent control will create deadweight loss in the long run. This is because the
quantity supplied (QM) is lower than the equilibrium quantity supplied (Q E). This essentially
means the market can operate at a better situation where it offers more rental units but due to
the rent controls imposed by the government, there is a loss of efficiency to this extent.
Moreover, the shortage of rental units is more in long run when compared to the short run.
The quantity demanded increases significantly in the long run leading to an excess shortage.
At market equilibrium (situation A) i.e., without the rent control, the producer surplus is
(represented by the grey highlighted area in figure 3.) more than when rent control is imposed
(situation B) (represented by the dark shaded area in figure 2). The producer’s condition is
better in situation A, and it worsens in situation B because the producers lose some of the PS
to deadweight loss and some to the consumers. The consumers are relatively in a better
position in situation B when compared to the property owners. However, whether they are
gaining or losing depends on the area of the producer surplus they have gained. If the area
they gained is lower than what they lost to deadweight loss, there will be a loss in CS. (CS in
situation A is represented by the black highlighted area in figure 3 and in situation B it is
represented by the light shaded area in figure 2). There is also a reduction in the total surplus
 Kandula 10

in situation B as the summation of CS + PS is lower than the summation of CS + PS in

situation A due to the deadweight loss. So, in situation B, the consumers and the owners
become worse off, making situation A pareto efficient to situation B. Even if the consumers
become better off in situation B, the owner’s position will always worsen. Therefore, making
situation B inefficient.

Fig.3- Consumer & Producer Surplus (Situation A)

Rent Control Gentrification and Discrimination:
Despite the goal of rent control to increase integration of various segments of the society, it
rather produces a contrary result by feeding gentrification and discrimination. Rent controlled
units are usually secured by the highly affluent segments who are well educated and have
“sufficient lifestyle flexibility and career opportunities to allow for long-term residency”
(Rosen 5). The affluent segments by means of connections and speedy information
availability, can occupy the rent-controlled units before the targeted segments. This ceiling
increases the rental price of non-controlled units due to the increase in demand. The low-
income segment, who were unable to occupy the rent-controlled units will now have to live
under the burden of the increased rental prices of the non-controlled units. Moreover, “rent
control forces housing providers to look to income and credit history in choosing among
competing consumers, factors which sharply bias the selection process against low” income,
racial, and young consumer segments (NMHC). The allocation is based on the preference of
the owners, making this policy extremely discriminatory and socially inefficient (Glaeser 1).
Conclusion:
Given the loss in market efficiency and the increased prospects of discrimination and
gentrification, NYC should not maintain rent control. The rent control mechanism leads to
 Kandula 11

inefficient allocation of rental units as the affluent segments are more likely to occupy these
units.
 Kandula 12

Works Cited

Glaeser, Edward L. "Does rent control reduce segregation?." Available at SSRN

348084 (2002).
National Multifamily Housing Council. "The High Cost of Rent Control"
Organisation For Economic Co-Operation And Development. “Glossary Of Industrial
Organisation Economics And Competition Law” 2002.
Robinson, Joan. "What is perfect competition?." The Quarterly Journal of Economics 49.1
(1934): 104.
Rosen, Kenneth T. "The Case for Preserving Costa-Hawkins: Who Really Benefits from Rent
Control?." (2018).
Rosen, Kenneth T. "The Case for Preserving Costa-Hawkins: Three Ways Rent Control
Reduces the Supply of Rental Housing." (2018).
Ubabukoh, Chisom. “Market Structures I.” 2021.
 Kandula 13

References

1. Study Material for Microeconomics - KLE LAW ACADEMY BELAGAVI

2. Microeconomics in Context (Fourth Edition) – Neva Goodwin, Jonathon M. Harris, Julie

A. Nelson, Pratistha Joshi Rajkarnikar, Brian Roach, Mariano Torras.

3. Advanced Economic Theory – H Lahuja

4. Market Structures I – Prof. Chisom Ubabukoh

5. Markets and Efficiency – Prof. Anamika Srivastava