Market Structure

Question 1

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

Answer 1

1. Perfect competition;
2. Perfect monopoly;
3. Monopolistic competition;
4. Oligopoly.

Question 2

How are long-run profits determined for a firm in perfect competition?

Answer 2

There are no long-run profits possible in a perfectly competitive market. If profits are made in the short-run, more firms will enter the market and increase supply, thus decreasing market price until all firms just break even.

Question 3

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

Answer 3

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 4

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

Answer 4

Short-run profit is maximized where marginal revenue is equal to rising marginal cost; total revenue will exceed total costs by the greatest amount at that point.

Question 5

What is a “price taker” firm?

Answer 5

The assumption that a firm in a perfectly competitive market must accept (“take”) the price set by the market and can sell any quantity of its commodity at that price. Thus, the demand curve faced by a single firm in perfect competition is a straight horizontal line at the market price.

Question 6

List the characteristics of perfect competition

Answer 6

1. A 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 homogeneous 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. Government does not set prices.

Question 7

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

Answer 7

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 8

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

Answer 8

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

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

List examples of reasons why monopolies exist.

Answer 10

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 11

List the characteristics of a perfect monopoly.

Answer 11

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

Question 12

List the characteristics of monopolistic competition.

Answer 12

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 13

How are long-run profits determined for a firm in monopolistic competition?

Answer 13

There are no long-run profits possible in a monopolistic competition. If profits are made in the short-run, more firms will enter the market and lower the demand for each firm until each just breaks even.

Question 14

Under monopolistic competition, what determines whether or not a firm makes a profit?

Answer 14

The relationship between the price (P) that can be charged and the firm’s average total cost (ATC). If ATC < P, the firm will make a profit. Otherwise, it will either break even (ATC = P) or have a loss (ATC > P).

Question 15

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

Answer 15

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

Question 16

Describe the point of short-run profit maximization for a firm in monopolistic competition.

Answer 16

Short-run profit is maximized where marginal revenue is equal to rising marginal cost (provided price > average total cost).

Question 17

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

Answer 17

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 18

In what ways do firms in an oligopoly market compete?

Answer 18

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

Question 19

Distinguish between overt collusion and tacit collusion

Answer 19

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 20

Describe the point of short-run profit maximization for a firm in an oligopoly industry.

Answer 20

Short-run profit is maximized where marginal revenue is equal to rising marginal cost (provided price > average total cost).

Question 21

List the characteristics of an oligopoly.

Answer 21

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 22

Describe the nature of the market structure in the U.S. economy.

Answer 22

The U.S. economy is a mix of market structures with different commodities/industries operating in different market structures.

Question 23

Describe the justification for natural monopolies.

Answer 23

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.

Question 24

Describe the least likely market structure in the U.S. economy.

Answer 24

Perfect Competition. A market or industry with all of the criteria of perfect competition is virtually nonexistent in the U.S. economy. Monopoly, monopolistic competition and oligopoly markets are common.

Question 25

Describe a market structure that includes only a few providers.

Answer 25

Oligopoly market. In an oligopoly market, there are few providers of goods or services. In a monopoly there is only one provider; in perfect competition or monopolistic competition there are many providers.

Question 26

In which form of market structure is a “price war” most likely possible?

Answer 26

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