Economics (McConnell), AP Edition, 20th Edition Chapter (9).docx

Chapter 13: Monopolistic Competition and Oligopoly Multiple-Choice Questions 1. Each of the following statements is a characteristic of monopolistic competition EXCEPT (A) A large number of firms produce in the industry. (B) The products produced by the industry are homogeneous (identical). (C) Firms can easily enter and exit the industry. (D) The firms in the industry act independently. (E) Firms rely on advertising the qualities of their product. (B) In monopolistic competition, products are differentiated. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Monopolistic Competition Book Section: Monopolistic Competition 2. Why is the monopolistically competitive firm's marginal revenue curve below its demand curve? (A) The competition forces the firm to lower its prices. (B) To sell more products, the firm must lower the price of all of its products. (C) The firm's costs are lower than its revenues at each unit of output. (D) The firm has no rivals, so price is significantly higher than marginal cost. (E) As output increases, the firm's average total cost of production decreases. (B) Because it must lower the price of all of its products, the marginal revenue earned from selling the next product will be lower than the price. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Monopolistic Competition Book Section: The Firm’s Demand Curve 3. A monopolistically competitive firm is operating at profit-maximizing output in the long run. If the government were to place a lump-sum tax on production, how would the tax impact output, price, and profitability in the short run? Output Price Profit/Loss (A) Increase Increase Incur a profit (B) Decrease Increase Incur a loss (C) No change Increase No change (D) Decrease No change Incur a loss (E) No change No change Incur a loss (E) A lump-sum tax does not affect marginal cost, so output does not change. Therefore, the price will not change. However, the lump-sum tax will shift the average total cost curve upward and the firm will now incur a loss in the short run. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Short-Run and Long-Run Equilibrium Book Section: Price and Output in Monopolistic Competition 4. When the monopolistically competitive industry adjusts to economic profit in the long run, the demand curve for the individual firm (A) shifts inward (B) becomes vertical (C) becomes horizontal (D) shifts outward (E) does not change (A) When new firms enter the monopolistically competitive industry, each firm produces a smaller portion of the industry output, so the demand curve for that firm shifts inward to the left. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Short-Run and Long-Run Equilibrium Book Section: The Long Run: Only a Normal Profit 5. The inefficiency generated by the monopolistically competitive firm results in (A) lower prices (B) higher output (C) excess capacity (D) long-run economic profit (E) higher wages (C) Because the firm reduces output to maximize profit, the firm produces less than its allocatively efficient output; excess capacity is available for the firm to produce more output, but it chooses not to do so. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Excess Capacity and Inefficiency Book Section: Excess Capacity 6. One characteristic that makes oligopolies unique among the market structures is (A) long-run economic profit (B) productive and allocative efficiency (C) their role as price-takers (D) product differentiation (E) mutual interdependence among the firms (E) Mutual interdependence in oligopolies requires each firm to consider its rivals' reactions to pricing and output decisions. Monopolies have no rivals. Perfectly and monopolistically competitive firms are such a small part of the industry that their decisions do not affect other firms. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Interdependence, Collusion, and Cartels Book Section: Control over Price, but Mutual Interdependence 7. When oligopolistic firms successfully maintain a long-term collusive agreement (A) the product price will rise with this subsidy to firms (B) the product price is higher than the marginal cost (C) the output is higher than it would have been under perfect competition (D) the price is lower than it would have been if there were no agreement (E) the long-run economic profit falls to zero (B) Oligopolists produce at an output where the price is higher than the marginal cost of producing the output. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Microeconomics: Interdependence, Collusion, and Cartels Book Section: Collusion 8. It is difficult for cartels to maintain collusive agreements because (A) such agreements are illegal in all countries (B) firms recognize an obligation to their customers to keep prices low (C) competitors can easily enter the industry (D) each firm has an incentive to cheat to increase its own profit (E) the products are so similar that customers cannot distinguish the differences between them (D) Collusive agreements are often unstable because each firm has an incentive to break the agreement in order to increase its own profit. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Interdependence, Collusion, and Cartels Book Section: Incentive to Cheat Use the payoff matrix below to answer questions 9-11. Robert's Review Daily Editions Producing Strategy Daily Edition Morning Evening Morning $500, $500 $600, $400 Evening $400, $600 $300, $300 Tom's Times Daily Editions Producing Strategy Assume that Robert’s Review and Tom’s Times are the only newspapers producers in a city. The first number in each cell is the profit for Tom’s Times, while the second number in each cell is the profit for Robert’s Review. 9. If the two firms do not collude and each uses its best strategy to maximize profit (A) the dominant strategy for Tom's Times is to produce a morning paper (B) the dominant strategy for Robert's Review is to produce an evening paper (C) each of the firms will earn $300 per day profit in the short run (D) both firms would increase their profits by bringing a third newspaper into the industry (E) if Tom's Times produces an evening paper, Robert's Review would reap more profit by producing an evening paper rather than a morning paper (A) The dominant strategy of Tom's Times is to produce a morning paper because it will earn a higher profit from producing a morning paper, regardless of whether Robert's Review produces a morning paper or an evening paper. Difficulty: Hard Style: Application AP Economics Curricular Requirement Microeconomics: Dominant Strategy Book Section: Oligopoly Behavior: A Game-Theory Overview 10. If these two firms make a collusive agreement using their best strategies, then I. each of the firms will earn $500 profit per day II. both of the firms are following their dominant strategies III. Tom's Times will produce a morning paper IV. Robert's Review will produce an evening paper (A) I only (B) I and III only (C) II and IV only (D) I, II, and III only (E) I, II, III, and IV (D) Both firms have a dominant strategy of producing a morning paper, because each earns a greater profit doing so than producing an evening paper, regardless of the other firm's decision. Difficulty: Hard Style: Application AP Economics Curricular Requirement Microeconomics: Game Theory and Strategic Behavior Book Section: Oligopoly Behavior: A Game Theory Overview 11. Assuming that there are no changes in economic conditions, will the production relationship between these two rivals remain stable in the long run? (A) Yes, because these firms have achieved Nash equilibrium (B) Yes, because the firms have made a collusive agreement to maximize profit (C) No, because each firm could make a greater profit by choosing a different strategy (D) No, because if one firm produces a morning paper, the other will make a greater profit by producing an evening paper (E) No, because consumers in a community will not support two morning papers (A) Both firms have selected the production strategy that maximizes profit for its firm. It has no incentive to change strategy, so the relationship will remain stable. Difficulty: Medium Style: Application AP Economics Curricular Requirement Microeconomics: Nash Equilibrium Book Section: A One-Time Game: Strategies and Equilibrium Use the graphs below to answer questions 12-14. 12. Which of the graphs above indicates the long-run equilibrium position(s) for this monopolistically competitive firm? (A) Diagram A, because this firm is operating where MR=MC and earns a positive economic profit (B) Diagram B, because this firm is operating where MR=MC and is therefore maximizing profit (C) Diagram C, because this firm is operating where MR=MC and making a normal profit (D) Diagrams A and B, because in both of these cases, the firm is operating where MR=MC (E) Diagrams A, B, and C, because in all of these cases, the firm is operating where MR=MC (C) The long-run equilibrium position for a monopolistically competitive firm occurs at the point where the average total cost curve (ATC) and the average revenue curve (AR=D) meet (a point of tangency). This is vertically above where MR=MC which establishes the maximum profit output. At this level of output, this firm will earn a normal profit (AR=ATC). With only a normal profit, neither this firm nor other firms will have the incentive to expand, contract, enter, or exit the industry. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Short-Run and Long-Run Equilibrium Book Section: Price and Output in Monopolistic Competition 13. In Diagram B, the optimal price and output for this monopolistically competitive firm in the short run would be (A) (P1, Q2) because at this output, MR=MC and price is greater than marginal revenue (B) (P2, Q2) because at this output, MR=MC and price is greater than marginal revenue (C) (P3, Q2) because at this output, MR=MC and price is equal to marginal revenue (D) (P1, Q2) because at this output, MR=MC and the firm can cover all of its costs (E) (P3, Q2) because at this output, MR=MC and the firm can cover all of its marginal costs (B) Where MR=MC gives the firm the optimal output (Q2). To determine the price at this level of output, this firm must then determine from the demand curve what the market price will be (P2). This firm is, however, incurring a loss in the short run. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Profit Maximization Book Section: Price and Output in Monopolistic Competition 14. The total revenue and total cost earned by this profit-maximizing firm in Diagram B are Total Revenue Total Cost (A) P3 x Q2 P1 x Q2 (B) P1 x Q2 P1 x Q2 (C) P2 x Q2 P3 x Q2 (D) P3 x Q2 P3 x Q2 (E) P2 x Q2 P1 x Q2 (E) This firm is operating in the short run with a loss. Its optimal output is determined by where MR=MC (Q2). At that output, the demand curve indicates the market price will be P2. Total revenue is therefore P2 x Q2. At Q2 output, the total cost is P1 x Q2. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Profit Maximization Book Section: Price and Output in Monopolistic Competition Use the graph below to answer questions 15-16. 15. Which of the following statements are true about this monopolistic competitor? I. In the long run, unlike other imperfectly competitive industries, this firm will achieve productive efficiency because only normal profits are earned. II. In the long run, unlike other imperfectly competitive industries, this firm will achieve allocative efficiency because it produces the output where MC=MR. III. This firm will not achieve productive efficiency because at profit-maximizing output, average total cost exceeds the minimum average total cost. IV. This firm will not achieve allocative efficiency because at profit-maximizing output, price exceeds marginal cost. (A) I only (B) II only (C) III only (D) I and II only (E) III and IV only (E) To achieve productive efficiency, at profit-maximizing output, average total cost must be at its minimum. To achieve allocative efficiency at profit-maximizing output, price must equal marginal cost. This firm will achieve not productive efficiency, because average total cost at profit-maximizing output is greater than the minimum average total cost. It will not achieve allocative efficiency because profit-maximizing price is greater than marginal cost at that output. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Excess Capacity and Inefficiency Book Section: Neither Productive nor Allocative Efficiency 16. The area of allocative inefficiency and deadweight loss is equal in size to (A) P1, a, b, c, d, P4 (B) P1, a, b, P2 (C) P2, b, c, P3 (D) a, b, d (E) a, c, d (E) With the profit-maximizing output of Q1 and a profit-maximizing price of P1, the monopolistic competitor is under-allocating resources. The optimal allocation occurs at point c where demand equals marginal cost. In this case, all of the benefits lost from output Q1 to Q2 where marginal benefit exceeds marginal cost constitute allocative inefficiency. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Excess Capacity and Inefficiency Book Section: Neither Productive nor Allocative Efficiency 17. Which of the following are characteristics of oligopoly? I. Economies of scale tend to establish significant barriers to entry. II. Firms are few in number and mutually interdependent in pricing and marketing strategies. III. Firms will find that collusion will enhance their profits. IV. Firms that collude can benefit from cheating. (A) I only (B) II only (C) III only (D) I, II, and III only (E) I, II, III, and IV (E) These define key characteristics of oligopolies. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Oligopoly Book Section: Oligopoly 18. Unlike firms in pure competition, firms that compete in monopolistic competition in the long run I. will be few in number II. can earn greater than normal profits III. will have average total costs greater than the minimum average total cost IV. benefit from significant barriers to entry (A) I only (B) II only (C) III only (D) II and III only (E) I, II, III, and IV (C) In the long run, unlike firms in pure competition, monopolistically competitive firms will have profit-maximizing output where average total cost is greater than the average total cost at its minimum. I, II, and IV are not characteristics of either competitive or monopolistically competitive firms in the long run. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Firm Behavior and Market Structure Book Section: Monopolistic Competition 19. Which of the following is NOT characteristic of firms in both monopolistically competitive and oligopolistic industries? (A) Firms create deadweight loss. (B) Industries are characterized by high concentration ratios. (C) Firms set prices greater than marginal costs. (D) Firms have average total costs greater than their minimum at profit-maximizing output. (E) Firms have control over the price they charge. (B) Oligopolies have high concentration ratios because only a few firms dominate the industry. Monopolistic competitive industries have low concentration ratios because the industry output is distributed among many firms. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Firm Behavior and Market Structure Book Section: Monopolistically Competitive Industries 20. Price changes are least frequent in (A) oligopoly (B) monopolistic competition (C) perfect competition (D) perfect competition and monopolistic competition (E) perfect competition and oligopoly (A) Oligopoly pricing tends to be the least flexible, especially when compared to perfect competition and monopolistic competition. If price changes do happen in an oligopoly, the firms tend to change prices in unison. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Firm Behavior and Market Structure Book Section: Price Leadership Model 21. Interdependence and price rigidity tend to be characteristics of (A) pure competition, because firms cannot change price (B) monopolistic competition, because there is minimal competition and price pressure (C) oligopoly, because firms make price and output decisions based on the decisions of rivals (D) monopoly, because monopolies will always charge the highest possible price (E) oligopoly and monopoly, because they always seek the highest per-unit profit (C) Due to mutual interdependence, oligopoly pricing tends to be more inflexible than perfect or monopolistic competition. In perfect competition, the market sets the price; the action of any single firm will not impact price. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Microeconomics: Firm Behavior and Market Structure Book Section: Price Leadership Model 22. Firms rely heavily on advertising to highlight product differentiation in which of the following market structures? I. Perfect competition II. Monopolistic competition III. Oligopoly IV. Monopoly (A) I only (B) III only (C) I and II only (D) II and III only (E) II and IV only (D) Firms engaged in monopolistic competition and oligopoly must use advertising to lure consumers to buy their products, rather than the products of their rivals. In perfect competition, the products are identical so advertising is unnecessary. Monopolists have no perfect substitutes, so advertising is less important. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Product Differentiation and the Role of Advertising Book Section: Advertising 23. Nash equilibrium occurs when (A) an oligopolistic firm achieves productive efficiency (B) an oligopolistic firm achieves allocative efficiency (C) both firms in an oligopoly achieve a stable production strategy (D) an oligopolistic firm achieves long-run equilibrium (E) all of the firms in an oligopoly collude, but then cheat on the agreement (C) At Nash equilibrium, each of the rivals chooses a production strategy that is optimal, given their rival’s production strategy. Because neither firm wants to deviate from that option, the relationship remains stable. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Microeconomics: Nash Equilibrium Book Section: A One-Time Game: Strategies and Equilibrium 24. In the long run, firms earn zero economic profit in which of the following industries? I. Perfect competition II. Monopolistic competition III. Oligopoly IV. Monopoly (A) I only (B) II only (C) I and II only (D) III and IV only (E) II and IV only (C) Because of competitive pressure and few or no barriers to entry, perfectly competitive and monopolistically competitive firms earn no long-run economic profit. They do earn normal profit to compensate owners for implicit costs of production, but no economic profit, because the existence of economic profit would draw competitors into the industry until economic profit again fell to zero. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Firm Behavior and Market Structure Book Section: The Long Run: Only a Normal Profit 25. If an improvement in technology reduces the cost of production for firms in a monopolistically competitive industry, how will the industry adjust to long-run equilibrium? Entry/Exit of Firms Firm’s Demand Economic Profit (A) Exit Increases Zero (B) Exit Increases Positive (C) Exit Decreases Negative (D) Enter Increases Positive (E) Enter Decreases Zero (E) When the cost of production falls, firms enjoy a short-run economic profit. But that profit entices other firms to enter the industry, decreasing the demand for existing firms, until economic profit returns to zero. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Short-Run and Long-Run Equilibrium Book Section: The Long Run: Only a Normal Profit Free-Response Questions 1. Assume Jenna's Toy Emporium is a retail toy store operating in a monopolistically competitive industry. (a) Assume Jenna's Toy Emporium is earning a short-run economic profit. Using a correctly labeled graph, show each of the following. (i) The profit-maximizing output and price (ii) The area of profit (b) Now draw a new graph for Jenna's Toy Emporium maximizing profit in long-run equilibrium, and answer each of the following. (i) Will the firm experience long-run economic profit? Explain. (ii) Given your answer in (b) (i), how does the demand curve for the firm change in the long run? Explain. (c) Will the firm achieve productive efficiency in the long run? Explain. 2. The payoff matrix below shows the profits per year that can be earned by the only two firms in an industry selling memberships to online political discussion forums. They must determine whether the forum will be strictly moderated or whether members will be free to say anything. Robbie and Dak cannot change that decision during the year due to contracts with the members. The first number in each cell shows Dak's profit; the second number is Robbie's profit. Robbie’s Moderating Strategy Moderators No Moderators Moderators $100, $200 $90, $300 No Moderators $80, $100 $60, $250 Dak’s Moderating Strategy (a) What kind of market structure is illustrated in this scenario? Explain. (b) Identify the dominant strategy for Dak. Explain. (c) If Dak chooses to run a forum with moderators, is a forum with or without moderators the best strategy for Robbie? Explain. (d) If both firms use their dominant strategies and do not collude, what is Robbie's annual profit? (e) If firms recognize they can increase their profits by collusive arrangements, why are firms in the United States reluctant to collude? Free-Response Explanations 1. 11 points (4 + 5+ 2) (a) 4 points: 1 point is earned for a correctly labeled graph with a downward-sloping demand curve and marginal revenue lower than demand. 1 point is earned for showing output where MC = MR. 1 point is earned for showing price on the demand curve above where MC = MR. 1 point is earned for illustrating the area of profit. (b) 5 points: 1 point is earned for a correctly labeled graph of long-run equilibrium, with the ATC curve above demand, tangential to the demand curve at the price. 1 point is earned for stating that the firm will not earn long-run economic profit. 1 point is earned for explaining that profit draws firms into the industry. 1 point is earned for stating that the firm's demand curve will shift to the left. 1 point is earned for explaining that as firms enter the industry, each existing firm produces a smaller portion of the industry's total output. (c) 2 points: 1 point is earned for stating that the firm will not achieve productive efficiency. 1 point is earned for explaining that because the firm restricts output in order to maximize profit, it produces where average total cost is higher than its minimum. Difficulty: Medium Style: Application AP Economics Curricular Requirement Microeconomics: Short-Run and Long-Run Equilibrium Book Section: Monopolistic Competition 2. 8 points (2 + 2 + 2 + 1 + 1) (a) 2 points: 1 point is earned for stating that this market structure is an oligopoly. 1 point is earned for explaining that the firms are mutually interdependent. (b) 2 points: 1 point is earned for stating that Dak's dominant strategy is to have a moderated board. 1 point is earned for explaining that Dak's profit is higher when he chooses moderators compared to when he has no moderators, regardless of which option Robbie chooses. (c) 2 points: 1 point is earned for stating that Robbie's best strategy is to have no moderators. 1 point is earned for explaining that when Dak chooses moderators, if Robbie chooses no moderators he will earn $300 profit, but if he chooses moderators, he will only earn $200 profit. (d) 1 point: 1 point is earned for stating that Robbie's annual profit is $300. (e) 1 point: 1 point is earned for explaining that collusion is illegal under United States law. Difficulty: Medium Style: Application AP Economics Curricular Requirement Microeconomics: Game Theory and Strategic Behavior Book Section: Oligopoly Behavior: A Game Theory