chapter 11

Question 1

two extreme market structures:

Answer 1

• Perfect competition: many firms selling identical products

* Monopoly: one firm in a market

Question 2

market structures in between (monopoly and perfect competition) two extreems:

Answer 2

• Oligopoly: only a few sellers offer identical products

* Monopolistic competition: many firms sell similar but not identical products.

Question 3

Monopolistic competition describes a market with the following attributes:

Answer 3

• Many competing producers
• Product differentiation
• Free entry and exit in the long run:

Question 4

Product differentiation:

Answer 4

• Each firm produces a product that is at least slightly different from those of other firms. Different products are imperfect substitutes.
• Rather than being a price taker, each firm faces a downward-sloping demand curve.

Question 5

Free entry and exit in the long run:

Answer 5

The number of firms in the industry adjusts until economic profits are zero

Question 6

(in short run) A firm in a monopolistic competitive market behaves like a monopolist.

Answer 6

• Because the product of the firm is different from those offered by other firms, the firm faces a downward-sloping demand curve.
• To maximize profits, a firm chooses the quantity such that MR = MC.
• The firm uses the demand curve to determine the price

Question 7

Two characteristics describe the long-run equilibrium in a monopolistically
competitive market:

Answer 7

1. As in a monopoly market, price exceeds marginal costs.

2. As in a competitive market, price equals average total costs.

Question 8

Differences between monopolistic competition and perfect competition

Answer 8

1. Excess capacity

2. Mark-up over marginal cost

Question 9

The number of firms in a monopolistically competitive market may not be optimal due to external effects from the entry of new firms:

Answer 9

1. The product-variety externality:
   • Entry of a new firm conveys a positive externality on consumers because consumers get surplus from the introduction of a new product.
2. The business-stealing externality:
   • Entry of a new firm imposes a negative externality on existing firms because existing firms lose consumers and profits.

Question 10

The critique of advertising:

Answer 10

• Firms advertise to manipulate people’s tastes.
• Advertising impedes competition. It creates the perception that products
are more differentiated than they really are. This leads to a less elastic demand curve allowing higher mark-ups.

Question 11

The defence of advertising:

Answer 11

• Advertising provides information to buyers and allows buyers to exploit price differences.
• Advertising promotes competition and reduces market power.
• Advertising allows new firms to enter more easily by giving entrants a means to attract customers from existing firms.

Question 12

Branding:

Answer 12

the means by which a business creates an identity for itself and highlights the way in which it differs from its rivals.

Question 13

The critique of branding:

Answer 13

• Brand names cause consumers to perceive differences that do not really exist.
• Consumers’ willingness to pay more for brand names is irrational, fostered by advertising.

Question 14

The defence of branding:

Answer 14

• Brand names provide information about quality to consumers.
• Companies with brand names have an incentive to maintain quality and to protect the reputation of their brand names