Market Structure

Question 1

What are the four common market structures used in economic analysis in a free-market economy?

Answer 1

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

Question 2

Which one of the following is central to determining the nature of market structure in a free-market economy?

Answer 2

Extent of competition in market. Perfect competition and perfect monopoly occupy opposite ends of the spectrum.

Question 3

What are the five characteristics of perfect competition?

Answer 3

1. Large number of independent buyers and sellers. They’re too small to affect the price of commodity.
2. All firms sell a homogenous product/service
3. Resources are completely mobile
4. Buyers and sellers have perfect information
5. Government does not set prices

Question 4

In the short run, a firm in perfect competition will cease to produce when which of the following conditions exists?

Answer 4

Price is less than average variable cost. Firm will continue is price is less than average total cost.

Question 5

For perfect competition, what is the shape of the demand curve?

Answer 5

Horizontal. Marginal revenue equals demand. Every firm is a price taker. They do not set the prices.

Question 6

In perfectly competitive market, how do traders impact market prices?

Answer 6

No trader has any impact on market prices. Price stays the same due to demand curve being horizontal.

Question 7

In the short run for perfect competition, when price is greater than average total cost, at what point has the best level of output for a firm?

Answer 7

MR (Marginal Revenue) = MC (Marginal Cost)

Question 8

During perfect competition, what will happen to a firm when MR is equal to or less than ATC? Also, what will happen when MR is less than AVC?

Answer 8

1. MR=ATC: Firm will break even

2. MR

Question 9

In perfect monopoly, why is the MR curve below the demand curve and diverges as the quantity increases?

Answer 9

The basic reason for the relationship is that, facing a downward-sloping demand curve, the firm must continuously lower its selling price in order to sell more units; therefore, marginal revenue must be below demand.

Question 10

In the long run, how will a firm maximize revenue in perfect monopoly? In other words, at which point should the firm be at?

Answer 10

MR=MC; just like perfect competition.

Question 11

In the long run for perfect monopoly, when a firm is producing at a quantity to maximize revenue, will the firm use resources efficiently or inefficiently and will its price be higher or lower than in a competitive environment?

Answer 11

Use of resources: Inefficient

Monopoly price: Higher than perfect competition

Question 12

What is the characteristic of a natural monopoly?

Answer 12

A firm has increasing returns to scale.

Question 13

What characterizes a perfect monopoly?

Answer 13

1. Single seller
2. Commodity for which there are no close substitutes
3. Restricted entry into the market

Question 14

What characterizes a monopoly (regular)?

Answer 14

1. Control of raw material inputs or processes
2. Government action (gov. granted franchise)
3. Increasing returns to scale (natural monopolies)

Question 15

In perfect monopoly, what is the shape of the demand curve?

Answer 15

Negatively sloped

Question 16

In the short run, a firm in monopolistic competition will maximize profit by producing at which of the following levels?

Answer 16

Marginal Revenue (MR) = Marginal Cost (MC)

Question 17

What are some characteristics of monopolistic competition?

Answer 17

1. Large # of sellers
2. Firms sell products or services that are slightly differentiated
3. Close substitutes for product or service
4. Ease of entry into or exit from the market

Question 18

In monopolistic competition, the demand curve is what shape?

Answer 18

Negatively sloped

Question 19

In monopolistic competition, can firms make a profit in the short run or long run?

Answer 19

Short run: Yes. Market price must be > ATC
Long run: No. New firms will enter the market and/or consumers will switch to substitute products. This will result in a lower demand curve for each firm, such that each firm just breaks even (i.e., earn only normal profits in the long-run).

Question 20

Why would a monopolistically competitive industry produce a greater variety of products and at a higher cost per unit than perfect competition?

Answer 20

#1: Greater variety of products is due to the fact that under perfect competition, homogenous goods and services are being sold even w/ high # of buyers and sellers. 
#2: Higher cost per unit is due to the fact that in perfect competition, P=MR, since firms are price takers. In long run, more firms will enter market increasing supply which will drive down market price. In monopolistic competition, P is greater than MC=MR. Price is higher under monopolistic competition than under perfect competition. Therefore a higher cost per unit is required.

Question 21

What is a cartel?

Answer 21

A group of firms that conspire to make price and output decisions for a product or service; it is overt collusion and illegal in the U.S.

Question 22

What are some characteristics of an oligopoly?

Answer 22

1. There are few sellers (kinked demand curve)
2. Firms can sell homogenous or differentiated products
3. Restricted entry into market
4. Firms compete on non-price factors
5. Downward sloping demand curve

Question 23

For oligopoly, explain if # of sellers is high or low and if entry into market is easy or difficult.

Answer 23

# of sellers: Low
Entry into market: Difficult

Question 24

What are the differences between overt collusion, tacit collusion, and price war?

Answer 24

Overt collusion: Firms (cartel) conspire to set output, price, or profit. (Illegal in U.S.)
Tacit collusion: Firms tend to follow price changes initiated by price leader in the market. (Not illegal in U.S.)
Price War: When one firm lowers its price to increase its share in the market (demand), other firms will reduce their prices as well.

Question 25

Oligopolistic firms are more likely to collude when?

Answer 25

1. Firms’ cost structures are similar
2. Fewer firms in the industry
3. Firms’ products are standardized

Question 26

Oligopolistic firms are less likely to collude when?

Answer 26

General economic conditions are recessionary

Question 27

Define collusive pricing, dual pricing, predatory pricing, and transfer pricing (oligopoly).

Answer 27

1. Collusive pricing - occurs when the few firms in an oligopolistic market (or industry) conspire to set the price at which a good or service will be provided. Such collusion typically is carried out to establish a price higher than would exist under normal competition.
2. Dual pricing - Occurs when a good or service is offered at different prices in different markets or market segments.
3. Predatory pricing - Setting of prices low in an attempt to eliminate the competition.
4. Transfer pricing - Setting of the amount (price) at which goods or services are transferred between affiliated entities.

Question 28

Which market structure are firms most likely to avoid price competition for fear of creating a price war?

Answer 28

Oligopoly. This is because there is so few sellers. Actions of each firm affect all the other firms in the industry.

Question 29

Which of the following market structures is least likely to be found in any industry in the U.S.?

Answer 29

Perfect competition. This is because PC assumes that all products are perfectly homogenous which they are not in the U.S.

Question 30

Regarding the four market structures, are any firms guaranteed a profit in the short run?

Answer 30

None for all four! This is because whether or not a firm makes a profit in any market structure depends on the firm’s ability to produce a good or service at a cost that is less than the price at which it can sell the product in the market.
A firm in any of the market structures can make a profit, break even, or suffer a loss, depending on the relationship between average cost to produce and sales price.

Question 31

Price discrimination is accomplished most effectively in markets with which of the following characteristics?

Answer 31

Fairly distinct segments of customers. price discrimination is a pricing strategy that charges customers in different market segments different prices for the same or largely the same product or service.

Question 32

In which of the following market structures is there the greatest incentive and is it most feasible for firms to engage in collusion in the setting of the quantity and price of industry output?

Answer 32

Oligopoly.