Chapter 10-11

Question 1

characteristics of monopolistic competition

Answer 1

1. many firms
2. easy entry and exit
3. firms compete by selling similar but differentiated products (stress product differentiation)

Question 2

forms of product differentiation

Answer 2

1. product attributes
2. service
3. location
4. brand names and packaging

Question 3

price and output decisions in monopolistic competition

Answer 3

firm ignores possible reactions of its many competitors because there are too many to take into account

Question 4

monopolistic competition demand curve

Answer 4

downward sloping, but elasticity depends on how similar products are to rivals’ (flatter than the industry demand curve)

Question 5

monopolistic competition short run equilibrium

Answer 5

output where MR = MC

Question 6

monopolistic competition in the long run

Answer 6

positive economic profits –> firms enter market –> demand curve for each existing firm shifts left + demand curve for each existing firm flattens (less differentiation)
–> marginal cost must shift in –> entry continues until each firm earns zero profits, each firm is maximizing profits but pi=0, and each firm is selling at a p,q combination along its demand curve

Question 7

trade-off between product variety and social costs of higher price/lower output

Answer 7

1. pi=0, but not an efficient outcome since P>MC
2. firms operate below cost-minimizing levels of operation - could increase production and lower ATC
3. consumer gets more choice and product variety

Question 8

Hotelling Boardwalk example

Answer 8

in monopolistic competition, product variety diminishes over time - both shift closer –> inefficient allocation (ex: radio stations, political parties)

Question 9

competitive fringe

Answer 9

large number of other firms in industry that do not dominate

Question 10

examples of oligopolies

Answer 10

banks, railways, oil

Question 11

characteristics of oligopoly

Answer 11

1. market dominated by few firms
2. entry barriers exist
3. firms are mutually interdependent

Question 12

mutual interdependence

Answer 12

each firm must consider the possible reaction of its rivals to its price, advertising, and product development decisions

Question 13

the basic dilemma of an oligopoly

Answer 13

1. the firms in an oligopolistic industry will typically make more profits as a group if they cooperate with each other
2. however, any firm making more profits for itself competes with the others while they are cooperating

Question 14

types of cooperative behaviour

Answer 14

1. explicit cooperation

2. tacit cooperation

Question 15

explicit cooperation

Answer 15

firms ensure they will maintain their joint profit maximizing output by an explicit agreement - cartel (tends to be unstable because there is always incentive for an individual firm to cheat) - prohibited in Canada

Question 16

tacit cooperation

Answer 16

firms recognize influence without explicit agreement to achieve the cooperative equilibrium, but each firm is interested in its own profits and can increase profits by behaving like rivals

Question 17

the prisoner’s dilemma

Answer 17

example of game theory where equilibrium is the worst possible outcome - noncooperative equilibrium (Nash equilibrium)

Question 18

Nash equilibrium

Answer 18

each player’s best strategy is to maintain its present behaviour given the present behaviour of the other player - best decision for each firm is worst overall (applies to output quantity, advertisement)

Question 19

factors that increase incentives to cooperate

Answer 19

1. smaller numbers of sellers than larger (due to motivation and ability)
2. producers of similar products than differentiated (more direct rivalry)
3. growing market rather than contracting
4. nonprice rivalry is absent or limited
5. when barriers to entry of new firms are greater

Question 20

competition act and oligopolies

Answer 20

competition act applies to oligopolies too - price fixing is illegal

Question 21

four firm concentration ratio

Answer 21

the percentage of the value of sales accounted for by the four largest firms
low concentration = high competitiveness
high concentration = low competitiveness

Question 22

problems with concentration ratios

Answer 22

1. definition of the geographic region (industry may not be concentrated at national level but a firm could have a monopoly on a specific region)
2. definition of the industry (several firms operate in several industries, but classified only in one)