Test Questions with Answers
Chapter 14. Competition Theory II.
Imperfect Competition
Chapter 14 ― Question 1
For a monopolistic firm marginal revenue is
- equal to price
- below price
- above price
- unrelated to price
*B. Remember that for imperfect competitors the marginal revenue curve is below the demand curve, which indicates price and average revenues. This is because an imperfect competitor has a downward sloping demand curve.
Chapter 14 ― Question 2
Explain the prisoners' dilemma by using an example of a duopoly.
* The prisoners' dilemma assumes that there is either no collusion or that an agreement can be violated.
Each of the firms must anticipate its competitor's responses to its own decisions. If it lowers price, its competitors is likely to follow suit. As a result, profits for both firms decline. If it raises price and its competitor does not follow suit, it will lose market share. The prisoners' dilemma helps to explain why single-handed price increases or cuts can backfire.
Chapter 14 ― Question 3
Name some barriers to entry.
* Economies of scale, high sunk costs, high set-up costs, cartels, high differentiation costs.
Chapter 14 ― Question 4
What conditions must be fulfilled to enable price discrimination?
* A firm must be able to divide its customers into different groups with different preferences and different abilities to pay. The customers should not be able to sell the discriminating firm's product to each other.
Chapter 14 ― Question 5
Explain which advantages cartels offer to their members.
* They allow their members to fix output and price. Cartels are an enormously high entry barrier; so competition from new firms is unlikely to occur.
Chapter 14 ― Question 6
Explain why there is an inherent incentive for cartel members to violate the cartel's agreements.
* Cartel members can easily change their individual output or price. They can do so secretly or openly. There is no possibility of penalising firms that violate the cartel's agreement as cartels are illegal. In essence, cartels protect against newcomers, but not against internal cheaters.
Chapter 14 ― Question 7
A monopoly maximises profit by charging $10 per unit. The marginal cost of its product is therefore
- $10
- above $10
- below $10
*C. A monopoly maximises profits by expanding output until MC equals MR. It then charges the price which is indicated for this output on the demand curve.
Chapter 14 ― Question 8
Why does a monopolistic firm make no profits in the long run?
*As entry is easy, profits are competed away by new firms. Before that happens, profits consisted of price minus ATC. In equilibrium, P equals ATC.
Chapter 14 ― Question 9
Draw a diagram to illustrate the price formation of a monopolist.
Chapter 14 ― Question 10
What is the best strategy in the prisoners' dilemma? Explain your answer.
* If there is the possibility of collusion, the best strategy is neither of the suspects confesses.
In the absence of collusion, confessing is best for both if there is a mutual suspicion that the other one will confess.
Chapter 14 ― Question 11
Which of the statements below is correct about monopolists and price-taking perfect competitors
- only the monopolist sets MR = MC
- only the price-taking perfect competitors sets MR = MC
- both do so
- neither of them does so
*C. All firms maximise profits by expanding output until MC equals MR.
Chapter 14 ― Question 12
Explain why a monopoly is not efficient.
* It does not obey the marginal-cost-pricing rule; its price is above MC. It does not, indeed cannot, expand output. Any expansion would mean that marginal costs exceed marginal revenue.
Chapter 14 ― Question 13
If an industry is a single-price monopoly - i.e. a non-price-discriminating monopoly - consumer surplus is
- higher than consumer surplus with price discrimination
- lower than consumer surplus with price discrimination
- equals consumer surplus with price discrimination.
*A. When a monopoly price-discriminates, consumer surplus is zero.
Chapter 14 ― Question 14
Which of the Acts below forbids unfair methods of competition?
- Sherman
- Clayton
- Federal Trade Commission
- Hart et al.
*C
Chapter 14 ― Question 15
Name two instances of unfair competition.
* Deceptive advertising and predatory pricing.
Chapter 14 ― Question 16
There are 10 firms in an industry. 5 have a market share of 15 percent each, the other five 5 a market share of 5 each.
1) What is the concentration ratio in the industry?
2) And what is its Herfindahl index?
*1) The five-firm concentration ratio is 75 (5 x 15).
*2) The Herfindahl index is 1250 (225 x 5) + (25 x 5).
Remember that the concentration ratio is the sum of the market shares of the leading firms. The Herfindahl Index is the sum of the squares of all firms' market shares.
Chapter 14 ― Question 17
A monopolist with perfect price discrimination is not inefficient. Explain why not.
* For the explanation, economists suddenly assume that the monopolist's marginal cost curve is a horizontal line, that is, they assume that costs are constant. The monopolist expands output until MC intersects the demand curve. All consumers above this intersection, that is, all consumers who are willing and able to pay a price above marginal cost, provide the monopolist with profits. The loss of total surplus that makes single-price monopolists inefficient is gone. However, consumer surplus is also gone. All surplus is reaped by the monopolist.
Chapter 14 ― Question 18
Give some examples of price discrimination.
* Textbooks are the most interesting example for students. Identical American textbooks are sold in the USA and the rest of the world. In the USA they are much more expensive than abroad. There is an international edition, which is sold in the rest of the world at a lower price. Re-exporting the international edition to the USA is not allowed.
Happy-hour discounts are another example. Discounts on cinema tickets or entrance fees for students and elderly people are also quite frequent. The most sophisticated price discriminators are airlines. Customers are categorised according to their ability to pay and elasticity of their demand. Businesspeople are charged the highest fares, travellers who are willing to stand by the lowest.
Chapter 14 ― Question 19
On what conditions does contestability of an industry depend?
* On low entry barriers.
Chapter 14 ― Question 20
If a monopolist can sell 200 units a day at $10 each or 201 units a day at $9.90 each, what is the marginal revenue of the 201st unit?
* Minus $10,10. The firm's revenues were $2,000, after the price cut they are $1989.90.
Chapter 14 ― Question 21
Marginal revenue is below price whenever the demand curve slopes downwards. True or false? Explain your answer.
* True. To sell additional units, firms must lower prices for all units. The revenue from the last unit is price received minus price cuts for all units.
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