Chapter 11: Imperfect competition and Strategic Behaviour

Question 1

What doesn’t a perfectly competitive model explain?

Answer 1

How many industries have a large number of relatively small firms

Question 2

What is a characteristic among most modern industries dominated by large firms?

Answer 2

They contain several firms and are not competitive markets

Question 3

What is meant when an industry is said to be highly concentrated?

Answer 3

When the industry has a small number of relatively large firms

Question 4

What is a concentration ratio?

Answer 4

The fraction of total market sales controlled by a specified number of the industry’s largest firms

Question 5

What is a monopolistic competition?

Answer 5

A large number of small firms in an industry, each with little market power

Question 6

What is an oligopoly?

Answer 6

A small number of large firms in an industry, each with considerable market power

Question 7

What is the key difference between monopolistic competition and oligopolies?

Answer 7

Strategic behaviour

Question 8

What does the term ‘competitive’ imply when referring to the market?

Answer 8

Not a monopoly

Question 9

What does an imperfect competition emphasize?

Answer 9

Firms are not price takers

Question 10

What are characteristics that are typical of imperfectly competitive firms?

Answer 10

Firms choose their products

Firms choose their prices

Question 11

What do most firms in imperfectly competitive markets sell?

Answer 11

Differentiated products

Question 12

What is a differentiated product?

Answer 12

A group of products similar enough to be called the same product (beer) but dissimilar enough that all of them do not have to be sold at the same price (Stella vs Bud light)

Question 13

What is a price setter?

Answer 13

A firm that faces a downwards-sloping demand curve for its product (chooses which price to set)

Question 14

What behavior is present in imperfectly competitive firms that is not present in monopoly/perfect competition?

Answer 14

Firms spend large sums of money on advertising

Firms engage a variety of non-price competition (offering competing standards of quality and product guarantees)

Question 15

What are 4 assumptions of monopolistic competition?

Answer 15

Each firm produces its own version of the industry’s differentiated product
All firms have access to the same technology
The industry contains so many firms that each one ignores competitiors when making price and output decisions
Firms are free to enter and exit the industry

Question 16

Why is a firm’s demand curve highly elastic despite having a negatively sloped demand curve in a monopolistic competition?

Answer 16

Because competing firms produce many close substitutes

Question 17

What is a consequence of all firms having access to the same technology?

Answer 17

They all have the same cost curves

Question 18

What happens when a firm makes profits during monopolistic competition in the short run?

Answer 18

There is an incentive for new firms to enter the industry
The existing market demand must be shared among a larger number of firms
Profits per firm are reduced, and eventually eliminated
(in the LR equilibrium, each firm has excess capacity)

This is called the “excess-capacity” theorem of monopolistic competition

Question 19

How does Monopolistic competition differ from perfect competition in terms of LR equilibrium?

Answer 19

The LR equilibrium in monopolistic competition does not minimize ATC
(Excess capacity)
If a firm increases its output, cost per unit decreases but revenue decreases more, so selling more would reduce revenue more than it reduces cost
This excess capacity may not be wasteful if consumers value product variety

Society faces a tradeoff between product variety and lower cost per unit

Question 20

What is an oligopoly?

Answer 20

An industry that contains two or more firms, at least one of which producing a significant portion of the industry’s total output (very little competition)

Question 21

What is central to the actions of oligopolies?

Answer 21

Strategic behavior

Firms consider how their rivals are likely to respond to their own actions

Question 22

What are 2 ways oligopolistic firms can maximize their profits?

Answer 22

Cooperate (collude) to maximize joint profits

Compete and maximize individual profits

Question 23

How can decision making be studied in oligopolistic situations?

Answer 23

Game theory

Question 24

What is a Nash equilibrium?

Answer 24

The equilibrium that results when each player is currently doing the best it can, given the current behavior of other players

(for each firm, the best action is always to compete, no matter what the other firm is doing)

Question 25

What are two types of cooperative behavior for oligopolists?

Answer 25

Explicit: when firms formally agree
Tacit: cooperation without explicit agreement

Question 26

How can firms compete for market share? What is a consequence of these?

Answer 26

Advertising
Variations in quality
Discounts to increase sales
Innovation (creative destruction)

Consumers usually gain from this

Question 27

Why does Nike have so many types of products? (different shoes, clothes, etc?)

Answer 27

Brand proliferation - a large number of differentiated products leaves a small market share available to a new firm (entry barrier)

Question 28

How can advertising be used as an entry barrier?

Answer 28

Heavy spending on advertising requires a new firm to spend as much on advertising to compete, causing a substantial disadvantage

Question 29

When wouldn’t a firm enter a market? How can existing firms use this to keep entrant firms from starting up?

Answer 29

If it expects continued losses after entry

Existing firms can keep prices low until the entrant goes bankrupt (sacrifice profits for competition)

“predatory pricing”

Question 30

In the long run, what do profits that survive competitive behavior attract?

Answer 30

Entry of new firms

Question 31

In the long run, profits persist only insofar as _______

Answer 31

Entry is restricted