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Chapter 10 Practice Quiz

Monopolistic Competitionand Oligopoly

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1. An industry with many small sellers, a differentiated product, and easy entry would best be described as which of the following?a. Oligopoly.b. Monopolistic competition.c. Perfect competition.d. Monopoly.

B. An oligopoly has only a few sellers. A monopoly only has one, and perfect competition has homogeneous products.

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2. Which of the following industries is the best example of monopolistic competition? a. Wheat.b. Restaurant.c. Automobile.d. Water service.

B. Wheat would be in a perfectly competitive market. Automobiles would be an oligopoly. And the water service is an example of a regulated monopoly.

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3. Which of the following is not a characteristic of monopolistic competition? a. A large number of small firms.b. A differentiated product.c. Easy market entry.d. A homogeneous product.

D. A characteristic of monopolistic competition is differentiated products.

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4. A monopolistically competitive firm willa. maximize profits by producing where MR = MC.b. not earn an economic profit in the long run.c. shut down if price is less than average variable

cost.d. do all of the above.

D. Both a monopolistically competitive firm and a perfectly competitive firm share these characteristics.

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5. The theory of monopolistic competition predicts that in long-run equilibrium a monopolistically competitive firm will

a. produce the output level at which price equals long-run marginal cost.

b. operate at minimum long-run average cost.c. overutilize its insufficient capacity.d. produce the output level at which price equals

long-run average cost.

D. In long-run equilirum, output occurs where the price equals long-run average cost.

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6. A monopolistically competitive firm is inefficient because the firm a. earns positive economic profit in the long run.b. is producing at an output where marginal cost

equals price.c. is not maximizing its profit.d. produces an output where average total cost is

not minimum.

D. Output occurs where average cost is not at a minimum.

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7. A monopolistically competitive firm in the long run earns the same economic profit as a a. perfectly competitive firm.b. monopolist.c. cartel.d. none of the above.

A. In the long-run, a normal profit is made because of the ease of entry and exit. Once economic profits are made, more firms will enter the industry driving the price down. When losses are made, firms leave the industry, driving the price up, restoring profits.

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8. One possible effect of advertising on a firm’s long-run average cost curve is to a. raise the curve.b. lower the curve.c. shift the curve rightward.d. shift the curve leftward.

A. The ATC curve is raised because of the added expense of the advertising.

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9. Monopolistic competition is an inefficient market structure because a. firms earn zero profit in the long-run.b. marginal cost is less than price in the long-run.c. a wider variety of products is available compared

to perfect competition.d. all of the above.

B. In the long-run, marginal cost is less than price because of the downward sloping demand curve and a marginal revenue curve that is more steeply sloped beneath the demand curve.

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10. The “Big Three” U.S. automobile industry is described as a. a monopoly.b. perfect competition.c. monopolistic competition.d. an oligopoly.

D. An oligopoly is a market form with only a few sellers.

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11. The cigarette industry in the United States is described as a. a monopoly.b. perfect competition.c. monopolistic competition.d. an oligopoly.

D. The cigarette industry has only a few sellers.

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12. A characteristic of an oligopoly is a. mutual interdependence in pricing

decisions.b. easy market entry.c. both (a) and (b).d. neither (a) nor (b).

A. The distinguishing feature of an oligopoly is mutual interdependence. No one firm will make a decision without first considering the reaction of its competitors to its policy change.

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13. The kinked demand curve theory attempts to explain why an oligopolistic firm

a. has relatively large advertising expenditures.b. fails to invest in research and development (R

and D).c. infrequently changes its price.d. engages in excessive brand proliferation.

C. Everything else being equal, if firm A raises its price, other firms will not raise theirs, and A will experience a big decline in sales. If A lowers its price, other firms will follow suit and A will not gain many sales.

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14. According to the kinked demand curve theory, when one firm raises its price, other firms will a. also raise their prices.b. refuse to follow.c. increase their advertising expenditures.d. exit the industry.

B. They will refuse to follow firm A because they can gain more by charging a lower price, their sales will increase because fewer people will buy from firm A.

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15. Which of the following is evidence that OPEC is a cartel? a. Agreement on price and output quotas by oil

ministries.b. Ability to raise prices regardless of demand.c. Mutual interdependence in pricing and output

decisions.d. Ability to completely control entry.

A. A cartel is characterized by collusion, the coming together and agreeing to certain policies, for example, the level of prices.

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Exhibit 10: A Two-Firm Payoff Matrix

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16. Assume costs are identical for the two firms in Exhibit 10. If both firms were allowed to form a cartel and agree on their prices, equilibrium would be established by a. Zeba Oil charging $100 and Tucker Oil charging $100. b. Zeba Oil charging $100 and Tucker Oil charging $50. c. Zeba Oil charging $50 and Tucker Oil charging $50. d. Zeba Oil charging $50 and Tucker Oil charging $100.

A. The collective interest is best served in cell A where each firm charges the same high fare and makes the maximum profit.

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17. Suppose costs are identical for the two firms in Exhibit 10. If both firms assume the other will compete and charge a lower price, equilibrium will be established by a. Zeba Oil charging $100 and Tucker Oil charging $100. b. Zeba Oil charging $100 and Tucker Oil charging $50. c. Zebo Oil charging $50 and Tucker Oil charging $100. d. Zeba Oil charging $50 and Tucker Oil charging $50.

D. Cell D is the result of each firm countering with a low fare and both fear changing the price and causing the other to counter.

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18. Suppose costs are identical for the two firms in Exhibit 10. Each firm assumes without formal agreement that if it sets the high price, its rival will not charge a lower price. Under these tit-for-tat conditions, equilibrium will be established by a. Zeba Oil charging $100 and Tucker Oil charging $100. b. Zeba Oil charging $100 and Tucker Oil charging $50. c. Zeba Oil charging $50 and Tucker Oil charging $50. d. Zeba Oil charging $50 and Tucker Oil charging $100.

A. The low fare outcome in cell D is avoided under a tit for tat belief that a rival will do what the other rival did last time.

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19. Which of the following is a game theory strategy for oligopolists to avoid a low-price outcome? a. Tit for tat b. Win-win c. Last-in-first-out d. Second best

A. Under the tit for tat approach, a player will do whatever the other player did last time.

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20. Which of the following is a game theory strategy for oligopolists to avoid a low-price outcome? a. Tit-for-tat b. Price leadership c. Cartel d. All of the above

D. The payoff matrix demonstrates why a competitive oligopoly would use one of these strategies to avoid a low-price outcome.