BEC 4 - Market Structure

Question 1

What are the four market structures normally considered in economic analysis?

Answer 1

Perfect competition;
Perfect monopoly;
Monopolistic competition;
Oligopoly.

Question 2

What charachteristics are found in industires or markets of perfect competition?

Answer 2

1. Large number of independent buyers and sellers, each of which is too small to separately affect the price of a commodity.
2. All firms sell homogenous products or services.
3. Firms can enter or leave the market easily.
4. Resources are completely mobile
5. Buyers and sellers have perfect information.
6. Gvmt doesn’t set prices.

Question 3

T/F: In a perfect competiton market: short run and long run profts are maximized when MR = MC.

Answer 3

False.
In the short run this would be true, however in the long run, more firms enter the market, supply increases and the market price will fall until all firms just break even.

Question 4

What is the shape of the demand curve for a firm in perfect competition?

Answer 4

The demand curve faced by a single firm in a perfectly competitive market is a straight horizontal line originating at the price set by the market (of all firms).

Question 5

What is the shape of the demand curve for a firm in perfect monopoly?

Answer 5

Downward sloping (and, since the firm is the only firm in the industry, it is also the industry demand curve).

Question 6

In the long-run, how may a monopoly firm increase its profits?

Answer 6

A monopoly firm may increase its profits in two ways: 1.Reduce cost by changing the size if its operations;
2.Increase demand through advertising, promotion, etc.

Question 7

List the characteristics of a perfect monopoly.

Answer 7

1. A single seller
2. A commodity for which there are no close substitutes;
3. Restricted entry into the market.

Question 8

List examples of reasons why monopolies exist.

Answer 8

1. Control of raw materials or processes;
2. Government granted franchise (i.e., exclusive right);
3. Increasing return to scale (i.e., natural monopolies).

Question 9

Describe the point of short-run profit maximization for a firm in perfect monopoly.

Answer 9

Short-run profit is maximized where marginal revenue is equal to rising marginal cost. The price charged at that quantity will depend on the level of the demand curve.

Question 10

T/F: In a Monopolistic competiton market: short run and long run profts are maximized when MR = MC.

Answer 10

False.
In the short run this would be true, however in the long run, more firms enter the market, supply increases and the market price will fall until all firms just break even.

Question 11

List the characteristics of monopolistic competition.

Answer 11

1. A large number of sellers;
2. Firms sell a differentiated product or service (similar but not identical), for which there are close substitutes;
3. Firms can enter or leave the market easily.

Question 12

What is the shape of the demand curve for a firm in monopolistic competition?

Answer 12

Downward-sloping and highly elastic (because there are close substitutes for the good or service offered).

Question 13

Distinguish between overt collusion and tacit collusion.

Answer 13

1. Overt Collusion = Firms conspire to set output, price or profit; illegal in the U.S.;
2. Tacit Collusion = Firms follow price charged by the price leader in the market; not illegal in the U.S.

Question 14

List the characteristics of an oligopoly.

Answer 14

1. A few sellers
2. Firms sell either a homogeneous product (standardized oligopoly) or a differentiated product (differentiated oligopoly);
3. Restricted entry into the market.

Question 15

In what ways do firms in an oligopoly market compete?

Answer 15

Firms in an oligopoly market compete based on quality, service, distinctiveness, etc., but not on price, which might incite a “price war.”

Question 16

How are long-run profits determined for a firm in an oligopoly industry?

Answer 16

A firm in an oligopoly industry will make profits in the long-run if average total cost is less than market price, and can continue to do so because entry into the market is restricted.

Question 17

What is the shape of the demand curve for a firm in an Oligopoly?

Answer 17

The kinked demand curve results from the fact that there are few firms each of which knows and responds to the actions of other firms. If you assume from that characteristic that rival firms will lower prices if you lower your price, but not raise prices if you raise your price, the demand curve will kink at the established current price. That reflects that prices will be more elastic above the kink (if a firm raises its price it loses a disproportionate number of customers) and more inelastic below the kink (if a firm lowers its price, others will too, so you don’t gain a disproportionate number of customers).

Question 18

In which form of market structure is competition based on price least likely to occur?

Answer 18

Oligopoly, because each firm in the industry is aware of the actions of other firms in the industry.

Question 19

Describe the justification for natural monopolies.

Answer 19

A monopoly exists where there is a single provider of a commodity for which there are no close substitutes and where entry into the market is difficult. Natural monopolies exist where there is increasing return to scale of operations and is justified by a single entity being able to satisfy demand at a lower cost than two or more firms. Public utilities have been cited traditionally as examples of natural monopolies.