Ch 17 Complete

Chapter 17. Monopolistic Competition.

1. Suppose the firm in the diagram operates in a monopolistically competitive market. In the long run we would expect

a. firms to enter the market, and the demand curve facing the firm to shift to the left.Correct. There are economic profits earned and new entrants will come in to this market.

b. firms to enter the market, and the demand curve facing the firm to shift to the right.Incorrect. When firms enter, the individual firm demand curves shift leftward.

c. firms to exit the market, and the demand curve facing the firm to shift to the left.Incorrect. There are economic profits earned and new entrants will come in to this market.

d. firms to exit the market and the demand curve facing the firm to shift to the right.Incorrect. There are economic profits earned and new entrants will come in to this market.

2. Recently economists have argued that brand names may

a. convey useful information to consumers about the likely quality of various products.Correct.

Branding is a way to provide valuable information about product quality.

b. remove sellers' incentives to supply the level of quality consumers expect of their brands.Incorrect. If brands are well known, then there is an incentive to maintain high quality.

c. give sellers the incentive to engage in false or misleading advertising.Incorrect. False advertising would lead to declines in demand for the product.

d. provide little information to consumers.Incorrect. Branding is a way to provide valuable information about product quality.

3. Based on the diagram, which of the statements is correct?

a. The firm maximizes profit by producing at the minimum point of its average total cost curve.Incorrect. Firms always maximize profits where MC = MR.

b. The firm is incurring an economic loss.Incorrect. In this diagram, price is equal to average total costs where MC = MR.

c. The firm is making zero economic profits.Correct. In this diagram, price is equal to average total costs where MC = MR.

d. This firm is giving 15,000 haircuts at a price of $7.Incorrect. The price of haircuts in this diagram is $9 and output is slightly higher than 12,000.

4. Critics of advertising argue that advertising

a. increases the elasticity of demand for the firm's product.Incorrect. Product differentiation decreases elasticity of demand.

b. impedes competition.Correct. Critics contend that it creates meaningless differentiation that gives market power to firms.

c. decreases demand for the firm's product.Incorrect. If advertising is successful, demand would increase.

d. decreases supply of the firm's product.Incorrect. Advertising works on the demand side of the market.

5. The firm in the diagram maximizes profits by

a. charging a price of $7 per unit and producing approximately 12,000 haircuts per year.Incorrect. At $9 and 12,000 units, the firm is maximizing profits because at this point MC = MR.

b. charging a price of $8 per unit and producing approximately 15,000 haircuts per year.Incorrect. At $9 and 12,000 units, the firm is maximizing profits because at this point MC = MR.

c. charging a price of $9 per unit and producing approximately 12,000 haircuts per year.Correct. At $9 and 12,000 units, the firm is maximizing profits because at this point MC = MR.

d. charging a price of $8 per unit and producing approximately 12,000 haircuts per year.

Incorrect. At $9 and 12,000 units, the firm is maximizing profits because at this point MC = MR.

6. In long-run equilibrium, the monopolistically competitive firm

a. produces at its minimum long-run average cost.Incorrect. In the long run a monopolistically competitive firm produces to the left of its minimum ATC.

b. experiences excess capacity.Correct. In the long run a monopolistically competitive firm produces to the left of its minimum ATC.

c. can earn economic profits if it is efficient.Incorrect. In long run equilibrium, the free entry of firms will compete away economic profits and the firm produces where price equals ATC.

d. earns a price that exceeds the average total cost of production.

Incorrect. In long run equilibrium, the free entry of firms will compete away economic profits and the firm produces where price equals ATC.

7. Monopolistic competition differs from perfect competition in the sense that

a. there are many firms in a monopolistically competitive industry.Incorrect. In both market structures there are many firms.

b. monopolistically competitive firms have a downward sloping demand curve.Correct. Because there is some product differentiation, each firm has some market power.

c.

barriers to entry limit the number of firms in a monopolistically competitive industry.Incorrect. In both market structures, there is relatively easy entry.

d. the products in a monopolistically competitive industry are homogeneous.Incorrect. Monopolistically competitive firms sell differentiated products.

.

8. Monopolistic competition is characterized by

a. homogeneous output throughout the industry.Incorrect. Products are differentiated in monopolistic competition.

b. a small number of sellers in the industry.Incorrect. There are large numbers of firms and entry is relatively easy.

c. the ability of firms to influence the price of output.Correct. This is due to their ability to differentiate their products.

d. high barriers to entry.Incorrect. There are large numbers of firms and entry is relatively easy.

9. Which of the following is correct?

a. In the short run, a monopolistically competitive firm can earn an economic profit.Correct. If price is above ATC, then the firm will earn an economic profit.

b. In the long run, a monopolistically competitive firm can earn an economic profit.Incorrect. Easy entry of new firms will compete away economic profits.

c.

In the short run, a monopolistically competitive firm will shut down if price is greater than average variable cost.Incorrect. Firms operate if price is above AVC.

d. A monopolistically competitive firm produces at the point where marginal revenue equals average total cost.

Incorrect. All firms produce where MC = MR.

10. Monopolistic competition results in inefficiency because

a. they can earn an economic profit in the long run.Incorrect. There are no long run economic profits due to ease of entry.

b. price is not equal to minimum average total cost in the long run.Correct. The firm does not operate where MC cuts the minimum point on the ATC as is the case in perfect competition.

c. firms exit the industry in response to losses.Incorrect. This is not a cause of inefficiency but a determinant of the level of profits.

d. price is less than marginal cost.Incorrect. Due to a downward sloping demand curve, price is above MC.

11. If a monopolistically competitive firm is earning profits over the long run,

a. the demand curve it faces will increase.Incorrect. The existence of profits will cause new firms to enter and reduce the demand for existing firms’ output.

b. the demand curve it faces will decrease.

Correct. The existence of profits will cause new firms to enter and reduce the demand for existing firms’ output.

c. its supply curve will increase.Incorrect. The entry of new firms affects the demand curves facing each firm.

d. its supply curve will decrease.Incorrect. The entry of new firms affects the demand curves facing each firm.

12. Assume that firms in a monopolistically competitive industry are incurring short-run losses. In the long run

a. all firms in the industry will move their resources to a different industry.Incorrect. Losses will cause some firms to exit and the demand curves for the remaining firms will shift rightward.

b. demand for the industry's product will increase.Incorrect. Industry demand will remain the same but the demand for individual firms will increase.

c. firms will leave the industry, and those that remain will experience an increase in demand for their products.Correct. Losses will cause some firms to exit and the demand curves for the remaining firms will shift rightward.

d. cost curves will shift lower because producers will demand price concessions from their suppliers.Incorrect. Exit of firms caused by losses will affect the demand side of the market.

13. Which of the following conditions must hold for a monopolistically competitive firm to be in long-run equilibrium?

a. P = MC and P = ATC

Incorrect. In monopolistic competition, due to the downward sloping demand curve, price does not equal marginal revenue.

b. P = MR and MR = MCIncorrect. In monopolistic competition, due to the downward sloping demand curve, price does not equal marginal revenue.

c. MR = MC and P = ATCCorrect. In monopolistic competition, as in all structures, output produced is where MC = MR and profits are maximized. Because of easy entry, there are no economic profits and P = ATC.

d. MR = MC and P > ATCIncorrect. . Because of easy entry, there are no economic profits and P = ATC.

14. A monopolistically competitive firm in short-run equilibrium

a. always earns an economic profit.Incorrect. No market structure has guaranteed economic profits.

b. does not shut down if total revenue is less than total variable cost.Incorrect. All firms follow this shut down rule.

c. always produces the output where MC=AC.Incorrect. A monopolistically competitive firm always produces to the left of minimum ATC.

d. produces where P>MC.Correct. This is due to the downward sloping demand curve and the inequality of price and marginal revenue at all output levels.

15. Unlike perfect competition, the monopolistically competitive firm

a. produces at its minimum long-run average cost.Incorrect. A monopolistically competitive firm never produces at minimum ATC.

b. may earn economic profit in the long run.Incorrect. Ease of entry will compete away long run economic profits.

c. may advertise the advantages of its product.Correct. One of the key differences from perfect competition is the existence of product differentiation.

d. produces output up to the point where price equals marginal cost.Incorrect. Because of the downward sloping demand curve, price does not equal marginal revenue, so price will never equal marginal cost.

16. In what sense is monopolistic competition similar to monopoly?

a. barriers to entryIncorrect. There are no barriers to entry in monopolistic competition.

b. number of producers in the industryIncorrect. Monopolistic competition has many more firms.

c. differentiated products among the industry's producersIncorrect. In monopoly, there are no other producers of the product.

d. product demand curves that are downward slopingCorrect. Because of product differentiation, monopolistic competitors have some market power and some ability to raise prices.

17. Which of the following best illustrates a firm operating in a monopolistically competitive industry?

a. an automobile producerIncorrect. This industry would have high barriers to entry and only a few firms.

b. a wheat farmerIncorrect. This firm does not sell a differentiated product.

c. an electric utilityIncorrect. This would more likely be a natural monopoly.

d. a firm selling pizzasCorrect. This firm could sell a differentiated product but the market would have low barriers to entry.

18. At the present level of production, a monopolistically competitive firm observes that P=$100, MR=$50, MC=$50, and AVC=$75. Based on these figures,

a. the firm is maximizing profit.Correct. This firm is producing where MC = MR and price is above AVC so it should operate.

b. the firm should shut down.Incorrect. This firm is producing where MC = MR and price is above AVC so it should operate.

c. the firm should continue to produce but should reduce its rate of output.Incorrect. This firm is producing at the profit maximizing level because MC = MR.

d. the firm should expand production.

Incorrect. This firm is producing at the profit maximizing level because MC = MR.

19. If a monopolistically competitive firm earns an economic profit in the short run, the economic profit in the long run is

a. even larger because the firm can find an even less-expensive method of production in the long run.Incorrect. The ease of entry characteristic assures the economic profits will be eliminated in the long run.

b. the same because the firm has no incentive to change what it is doing.Incorrect. The ease of entry characteristic assures the economic profits will be eliminated in the long run.

c. reduced because of increased prices of inputs.Incorrect. The ease of entry characteristic assures the economic profits will be eliminated in the long run.

d. eliminated as new firms enter the industry.

Correct. The ease of entry characteristic assures the economic profits will be eliminated in the long run.

20. Suppose a monopolistically competitive industry evolved into a perfectly competitive industry. Which of the following statements is correct?

a. The industry would produce more output and charge a lower price after the change.Correct. A perfectly competitive firm produces farther to the right on its ATC curve and at the minimum point on the ATC.

b.

Elasticity of demand for the firm's product would remain the same after this change occurred.Incorrect. The firm's demand curve would be horizontal instead of downward sloping.

c. This industry would produce the same level of output at lower prices in the long run than before the change.

Incorrect. The industry's output would increase as firms moved to produce at minimum ATC. d. The industry's excess capacity would not be eliminated.Incorrect. By producing at minimum ATC, as in perfect competition, excess capacity is eliminated.

21. Product differentiation

a. refers to product price differences between sellers.Incorrect. This refers to differences in product characteristics or quality.

b. refers to one firm's products being at least slightly different from other firms' products.Correct. Buyer perceive that each firm produces a product that is different from its competitors.

c. is a negative characteristic of monopolistic competition.Incorrect. Product differences may be valued by consumers.

d. decreases the elasticity of demand for the industry demand curve.Incorrect. It increases the elastic of demand for each firm's product.

22. Because price is greater than marginal cost under monopolistic competition, each firm

a. has an incentive to advertise in order to attract new customers.

Correct. Product differentiation gives a firm some market power and the ability to raise prices for its product.

b. has little incentive to advertise in order to attract more customers.Incorrect. Product differentiation gives a firm some market power and the ability to raise prices for its product.

c. operates at the efficient level of output.Incorrect. Monopolistically competitive firm do not operate at the minimum point on their ATC curves.

d. attempts to create a product-variety externality in order to attract more customers.Incorrect. Product variety is not an externality but a benefit to the firm and its customers.

23. Recently, economists have argued that brand names may

a. enable producers to act as price setters.Incorrect. This would not benefit buyers.

b. enable producers to earn economic profits.Incorrect. This would not benefit buyers.

c. make entry into a market more difficult.Incorrect. This would not benefit buyers but increase firm's profits.

d. provide consumers with information about product quality.Correct. This is a potential benefit of monopolistic competition advertising.

24. Monopolistic competition may have a negative impact on society's welfare for all of the following reasons EXCEPT:

a. the price of the product exceeds marginal cost.Incorrect. This a type of inefficiency associated with monopolistic competition.

b. the number of firms may not be the "ideal" one.Correct. The notion of an "ideal" number is a normative concept.

c. the existence of a business-stealing externality.Incorrect. This a type of inefficiency associated with monopolistic competition.

d. the existence of a production-variety externality.Incorrect. This a type of inefficiency associated with monopolistic competition.

25. Excess capacity arises under conditions of monopolistic competition because

a. there is underutilization of resources and not enough firms.Incorrect. Excess capacity is judged relative to the minimum point on the ATC.

b. the output produced does not minimize average total cost.Correct. Due to the downward sloping demand curve, monopolistically competitive firms produce to the left of the minimum point on the ATC.

c. a monopolistically competitive firm produces more output than would be produced by a perfectly competitive firm.Incorrect. A monopolistically competitive firm produces less than a perfectly competitive firm.

d. there are too many goods chasing too few resources.Incorrect. A monopolistically competitive firm produces less than a perfectly competitive firm.

26. Which statement regarding the effects of advertising is correct?

a. Advertising inevitably pushes up per-unit costs.Incorrect. Advertising affects the demand side not the supply side of the market.

b. Advertising causes the elasticity of demand to decrease.Correct. Advertising creates difference among products and gives firms the ability to raise prices for their own products.

c. Advertising causes the elasticity of demand to increase.Incorrect. Advertising creates difference among products and gives firms the ability to raise prices for their own products.

d. Advertising does not increase demand for a product.

Incorrect. Advertising creates difference among products and gives firms the ability to raise prices for their own products.

27. According to the figure, in the short run, what is the firm's average total cost of production if it is maximizing profits?

a. $4 Incorrect. At the profit maximizing level of output where MC = MR, 300, the firm's ATC is $6.

b. $6 Correct. At the profit maximizing level of output where MC = MR, 300, the firm's ATC is $6.

c. $7 Incorrect. At the profit maximizing level of output where MC = MR, 300, the firm's ATC is $6.

d. $8.50 Incorrect. At the profit maximizing level of output where MC = MR, 300, the firm's ATC is $6.

28. Which of the following is NOT characteristic of monopolistic competition?

a. many sellers

Incorrect. This is one of the characteristics of monopolistic competition. b. few sellers

Correct. This is a characteristic of oligopoly. c. product differentiationIncorrect. This is one of the characteristics of monopolistic competition.

d. free entry

Incorrect. This is one of the characteristics of monopolistic competition. .

29. Which of the following is NOT a characteristic of a monopolistically competitive industry?

a. many buyers and sellersIncorrect. This is a characteristic of monopolistic competition.

b. free entry

Incorrect. This is a characteristic of monopolistic competition.

c. product standardizationCorrect. This is a characteristic of perfect competition.

d. downward-sloping demand curve facing each firm in the industry

Incorrect. This is a characteristic of monopolistic competition.

30. When new firms enter a monopolistically competitive market,

a. there are externalities due to increased pollution.Incorrect. The externality is due to perceived differences of product characteristics or quality.

b. there are externalities due to increased advertising.Incorrect. Each firm in a monopolistically competitive industry produces a differentiated product from its competitors.

c. there is a product-variety externality.Correct. Each firm in a monopolistically competitive industry produces a differentiated product from its competitors.

31. Monopolistically competitive firms earn economic profits

a. in the short run but not the long run.Correct. Firms can earn short run profits but the ease of entry will cause long run profits to disappear due to firms entering the industry until economic profits go to zero.

b. in both the short run and the long run.Incorrect. Firms can earn short run profits but the ease of entry will cause long run profits to disappear due to firms entering the industry until economic profits go to zero.

c. only if competition sharply reduces the number of firms in the industry.Incorrect. Ease of entry will bring new firms into the industry to eliminate long run profits.

d. only when marginal revenue is greater than marginal cost.Incorrect. Firms maximize profits by producing where MC = MR.

32. Which of the following industries would NOT be classified as monopolistically competitive?

a. retail groceriesIncorrect. There is relatively easy entry in this industry.

b. automobile productionCorrect. Very high capital costs create significant barriers to entry.

c. restaurantsIncorrect. There is relatively easy entry in this industry.

d. department storesIncorrect. There is relatively easy entry in this industry.

33. Which of the following will most likely occur if monopolistically competitive firms are earning economic profits?

a. New firms will enter the industry and will eventually eliminate the economic profit.Correct. As long as economic profits exist, new firms will enter and eventually compete away economic profits in the long run.

b. Existing firms will collude to maintain the present level of prices and output.Incorrect. There are insufficient barriers to entry to prevent new firms from coming into the industry.

c. Diseconomies of scale will eventually reduce profit to zero.Incorrect. It is ease of entry and new firms that eliminate economic profits.

d. New firms will enter the market until it becomes purely competitive.Incorrect. New firms eliminate economic profits but do not change the character of the industry.

34. The market characteristic that insures that economic profit is reduced to zero in long-run equilibrium in a monopolistically competitive market is

a. homogeneous products.Incorrect. Homogeneous products could exist in oligopoly.

b. differentiated products.Incorrect. Differentiated products could exist in an oligopolistic industry.

c. a small number of sellers.

Incorrect. This would be the sign of barriers to entry and little competition.

d. entry and exit.Correct. If economic profits exist and there are no barriers to entry, firms will enter until all economic profits are competed away.

35. A firm in a monopolistically competitive market is "monopolistic" in the sense that it

a. produces a product for which there are no good substitutes.Incorrect. There are no perfect substitutes but there may be close substitutes.

b. need not worry about a competitor producing a product that is identical to its own.Correct. A differentiated product gives each producer a little "monopoly" of their own in terms of pricing power.

c. is protected from competition from new entrants.Incorrect. There are no significant barriers to entry.

d. has the entire market to itself.Incorrect. There are no significant barriers to entry.

36. What is the price and level of output that will prevail in the short run if the firm depicted in the diagram is maximizing profits?

a. 300 steaks at $8.50Correct. At 300 steaks, MC = MR and the price given by the demand curve at this output level is $8.50.

b. 350 steaks at $5.75Incorrect. At 300 steaks, MC = MR and the price given by the demand curve at this output level is $8.50.

c. 400 steaks at $7.00Incorrect. At 300 steaks, MC = MR and the price given by the demand curve at this output level is $8.50.

d. 300 steaks at $6.00Incorrect. At 300 steaks, MC = MR and the price given by the demand curve at this output level is $8.50.

37. Unlike the ______________________ model, price is greater than marginal revenue for monopolistically competitive firms for all output beyond the first unit.

a. perfectly competitiveCorrect. Because price is constant in perfect competition, marginal revenue and price are always the same.

b. monopolyIncorrect. Price is different from marginal revenue in a monopoly.

c. differentiated oligopoly

Incorrect. In all oligopolies, the demand curve is downward sloping and price differs from marginal revenue.

d. homogeneous oligopoly

Incorrect. In all oligopolies, the demand curve is downward sloping and price differs from marginal revenue.

38. In the diagram, this monopolistically competitive firm is

a. earning an economic profit in the short run.Correct. The output level where MC = MR occurs where price is greater than average total costs so profits are being earned.

b. earning an economic profit in the long run.Incorrect. Ease of entry will eliminate all long run economic profits.

c. earning an economic profit--it is impossible to tell whether the time period is the short run or the long run.Incorrect. This must be short run because there are no long run profits in monopolistic competition.

d. breaking even in the short run.Incorrect. At the MC = MR point, P > ATC so we know that profits are being earned.

39. Suppose the firm in the diagram is currently in a short-run position maximizing profits. We know that

a. this firm is also in long-run equilibrium.Incorrect. There are no economic profits in the long run.

b. the demand curve will shift left in the long run.Correct. The existence of short run profits will cause new firms to enter and reduce demand for each individual firm.

c. the average total cost curve will shift down in the long run.Incorrect. It is the demand curve that is affected by new entrants.

d. the demand curve will shift right in the long run.Incorrect. The existence of short run profits will cause new firms to enter and reduce demand for each individual firm.

40. Because a monopolistically competitive firm must decrease price in order to sell additional output, marginal revenue is

a. increasing at a decreasing rate as output increases.Incorrect. Marginal revenue falls faster than the price falls.

b. greater than price.Incorrect. Marginal revenue falls faster than the price falls.

c. less than price.

Correct. As the price is cut to everyone, some revenue is lost from each previous buyer. d. equal to price.Incorrect. Marginal revenue falls faster than the price falls.