Chapter 11 Monopolistic ion and Oligopoly

CHAPTER 12Monopolistic Competition and Oligopoly

MULTIPLE CHOICE

Section 12.1

easy 1. For which of the following market structures is it assumed that there are barriers to entry?

a. perfect competitionb. monopolistic competitionc. monopolyd. all of the abovee. (b) and (c) only

easy 2. Use the following two statements about monopolistic competition to answer this question.

I. In the long run, the price of the good will equal the minimum of the average cost.

II. In the short run, firms may earn a profit.

a. I and II are true.b. I is true, and II is false.c. I is false, and II is true.d. I and II are false.

easy 3. A market with few entry barriers and with many firms that sell differentiated products is

a. purely competitive. b. a monopoly.c. monopolistically competitive.d. oligopolistic.

easy 4. The most important factor in determining the long-run profit potential in monopolistic competition is

a. free entry and exit.b. the elasticity of the market demand curve.c. the elasticity of the firm's demand curve.d. the reaction of rival firms to a change in price.

easy 5. Which of the following is NOT regarded as a source of inefficiency in monopolistic competition?

a. the fact that price exceeds marginal cost.b. excess capacity.c. product diversity.d. the fact that long-run average cost is not minimized.e. all of the above.

easy 6. Monopolistically competitive firms have monopoly power because they

a. face downward sloping demand curves.b. are great in number.c. have freedom of entry.d. are free to advertise.

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CHAPTER 12 TEST BANKMONOPOLISTIC COMPETITION AND OLIGOPOLY SIXTH EDITION

easy 7. A monopolistically competitive firm in short run equilibrium:

a. will make negative profit (lose money).b. will make zero profit (break-even).c. will make positive profit.d. any of the above are possible.

easy 8. A monopolistically competitive firm in long run equilibrium:

a. will make negative profit.b. will make zero profit.c. will make positive profit.d. any of the above are possible.

easy 9. What happens to an incumbent firm's demand curve in monopolistic competition as new firms enter?

a. It shifts right.b. It shifts left.c. It becomes horizontal.d. New entrants will not affect an incumbent firm's demand curve.

easy 10. Which of the following is true of the output level produced by a firm in long run equilibrium in a monopolistically competitive industry?

a. It produces at minimum average cost.b. It does not produce at minimum average cost, and average cost is increasing.c. It does not produce at minimum average cost, and average cost is decreasing.d. Either (b) or (c) could be true.

easy 11. Which of the following is true in long run equilibrium for a firm in a monopolistic competitive industry?

a. The demand curve is tangent to marginal cost curve.b. The demand curve is tangent to average cost curve.c. The marginal cost curve is tangent to average cost curve.d. The demand curve is tangent to marginal revenue curve.

easy 12. Which of the following is true for both perfect and monopolistic competition?

a. Firms produce a differentiated product.b. Firms face a downward sloping demand curve.c. Firms produce a homogeneous product.d. There is freedom of entry and exit in the long run.

easy 13. Which of the following is true for both perfectly competitive and monopolistically competitive firms in the long run?

a. P=MC.b. MC=ATC.c. P>MR.d. Profit equals zero.

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TEST BANK CHAPTER 12SIXTH EDITION MONOPOLISTIC COMPETITION AND OLIGOPOLY

moderate 14. Which of the following is true in long run equilibrium for a firm in monopolistic competition?

a. MC=ATC.b. MC>ATC.c. MC<ATC.d. Any of the above may be true.

moderate 15. Excess capacity in monopolistically competitive industries results because in equilibrium

a. each firm's output rate is too great to minimize average cost.b. each firm's output rate is too small to minimize average cost.c. firms make positive economic profit.d. price equals marginal cost.

Section 12.2

easy 16. The market structure in which strategic considerations are most important is

a. monopolistic competition.b. oligopoly.c. pure competition.d. pure monopoly.

easy 17. In the Cournot duopoly model, each firm assumes that

a. rivals will match price cuts but will not match price increases.b. rivals will match all reasonable price changes.c. the price of its rival is fixed.d. the output level of its rival is fixed.

easy 18. A situation in which each firm is doing the best it can, given what its rivals are doing is called a

a. Nash equilibrium.b. Cooperative equilibrium.c. Stackelberg equilibrium.d. zero sum game.

easy 19. Which of the following can be thought of as a barrier to entry?

a. scale economies.b. patents.c. strategic actions by incumbent firms.d. all of these.

easy 20. In the _____, each firm treats the output of its competitor as fixed and then decides how much to produce.

a. Cournot modelb. model of monopolistic competitionc. Stackelberg modeld. kinked-demand modele. none of the above

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easy 21. A _____ shows how much a firm will produce as a function of how much it thinks its competitors will produce.

a. contract curveb. demand curvec. reaction curved. Nash equilibrium curvee. none of the above

easy 22. Which of the following markets is most likely to be oligopolistic?

a. the market for cornb. the market for aluminumc. the market for colasd. the market for ground coffees

easy 23. The market structure in which there is interdependence among firms is

a. monopolistic competition.b. oligopoly.c. perfect competition.d. monopoly.

moderate 24. In comparing the Cournot equilibrium with the competitive equilibrium,

a. both profit and output level are higher in Cournot.b. both profit and output level are higher in the competitive equilibrium.c. profit is higher, and output level is lower in the competitive equilibrium.d. profit is higher, and output level is lower in Cournot.

Scenario 1:

Suppose mountain spring water can be produced at no cost and that the demand and marginal revenue curves for mountain spring water are given as follows:

Q = 6000 - 5P MR = 1200 - 0.4Q

moderate 25. Refer to Scenario 1. What is the profit maximizing price of a monopolist?

a. $400b. $600c. $800d. $900e. none of the above

moderate 26. Refer to Scenario 1. What will be the price in the long run if the industry is a Cournot duopoly?

a. $400b. $600c. $800d. $900e. Competition will drive the price to zero.

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difficult 27. The Cournot equilibrium can be found by treating _____ as a pair of simultaneous equations and by finding the combination of Q1 and Q2 that satisfy both equations.

a. the reaction curves for firms 1 and 2b. the market supply curve and the market demand curvec. the contract curve and the market demand curved. the contract curve and the market supply curvee. the firm's supply curve and the firm's demand curve

Section 12.3

easy 28. The oligopoly model that is most appropriate when one large firm usually takes the lead in setting price is the ______________ model.

a. Cournot b. Stackelbergc. game theoryd. prisoner's dilemma

easy 29. What is one difference between the Cournot and Stackelberg models?

a. In Cournot, both firms make output decisions simultaneously, and in Stackelberg, one firm sets its output level first.

b. In Stackelberg, both firms make output decisions simultaneously, and in Cournot, one firm sets its output level first.

c. In Cournot, a firm has the opportunity to react to its rival.d. Profits are zero in Cournot and positive in Stackelberg.

easy 30. Which of the following is true in the Stackelberg model?

a. The first firm produces less than its rival.b. The first firm produces more than its rival.c. Both firms produce the same quantity.d. Both firms have a reaction curve.

moderate 31. In the Stackelberg model, there is an advantage

a. to waiting until your competitor has committed herself to a particular output level before deciding on your output level.

b. to being the first competitor to commit to an output level.c. to the firm with a dominant strategy.d. to producing an output level which is identical to a monopolist’s output level.

Section 12.4

easy 32. Which oligopoly model(s) have the same results as the competitive model?

a. Cournot.b. Bertrand.c. Stackelberg.d. Both Cournot and Stackelberg.

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easy 33. In which oligopoly model(s) do firms earn zero profit?

a. Cournot.b. Bertrand.c. Stackelberg.d. Oligopoly firms always earn positive economic profits.

moderate 34. In the _____, one firm sets its output first, and then a second firm, after observing the first firm's output, makes its output decision.

a. Cournot modelb. model of monopolistic competitionc. Bertrand modeld. kinked-demand modele. none of the above

easy 35. In the _____, two duopolists compete by simultaneously selecting price.

a. Cournot modelb. Nash modelc. Bertrand modeld. kinked-demand modele. none of the above

easy 36. In the Bertrand model with homogeneous products,

a. the firm that sets the lower price will capture all of the market.b. the Nash equilibrium is the competitive outcome.c. both firms set price equal to marginal cost.d. all of the above.e. the outcome is inconclusive.

moderate 37. Relative to the Nash equilibrium in the Cournot model, the Nash equilibrium in the Bertrand model with homogeneous products

a. results in the same output but a higher price.b. results in the same output but a lower price.c. results in a larger output at a lower price.d. results in a smaller output at a higher price.e. any of the above may result.

moderate 38. Which statement most nearly describes a Nash equilibrium applied to price competition?

a. Two firms get together and set the price that maximizes joint profits.b. Each firm automatically moves to the purely competitive equilibrium because it knows the

other firm will eventually move to that price anyway.c. Given the prices chosen by its competitors, no firm has an incentive to change their

prices from the equilibrium level.d. One dominant firm sets the price, and the other firms take that price as if it were given by

the market.

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Section 12.5

moderate 39. Two firms operating in the same market must choose between a collude price and a cheat price. Firm A's profit is listed before the comma, B's outcome after the comma.

Firm BCheat Price Collude Price

Firm A Cheat Price 18, 18 30, 6 Collude Price 6, 30 24, 24

If each firm tries to choose a price that is best for it, regardless of the other firm's price, which of these statements is correct?

a. Firm A should charge the collude price, Firm B should charge a cheat price.b. Firm A should charge a cheat price, Firm B should charge a collude price.c. Both firms should charge a collude price.d. Both firms should charge a cheat price.

Section 12.6

easy 40. The oligopoly model that predicts that oligopoly prices will tend to be very rigid is the ______________ model.

a. Cournotb. Stackelbergc. dominant firmd. kinked demand

easy 41. In the kinked demand curve model, if one firm reduces its price

a. other firms will also reduce their price.b. other firms will compete on a non-price basis.c. other firms will raise their price.d. both (a) and (b) are correct. e. both (b) and (c) are correct.

easy 42. Suppose that three oligopolistic firms are currently charging $12 for their product. The three firms are about the same size. Firm A decides to raise its price to $18, and announces to the press that it is doing so because higher prices are needed to restore economic vitality to the industry. Firms B and C go along with Firm A and raise their prices as well. This is an example of

a. price leadership.b. collusion.c. the dominant firm model.d. the Stackelberg model.e. none of the above.

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easy 43. A market structure in which there is one large firm that has a major share of the market and many smaller firms supplying the remainder of the market is called:

a. the Stackelberg Model.b. the kinked demand curve model.c. the dominant firm model.d. the Cournot model.e. the Bertrand model.

easy 44. In the dominant firm model, the smaller fringe firms behave like:

a. competitive firms.b. Cournot firms.c. Stackelberg firms.d. Bertrand firms.e. monopolists.

easy 45. Under the kinked demand curve model, an increase in marginal cost will lead to

a. an increase in output level and a decrease in price.b. a decrease in output level and an increase in price.c. a decrease in output level and no change in price.d. neither a change in output level nor a change in price.

easy 46. Which of the following is true about the demand curve facing the dominant firm?

a. It equals market demand minus fringe firms' supply curve.b. It is identical to market demand.c. It equals market demand minus demand facing the fringe firms.d. It is horizontal.

moderate 47. The kinked demand curve model is based on the assumption that each firm

a. considers its rival's output to be fixed.b. considers its rival's price to be fixed.c. believes rivals will match all price changes.d. believes rivals will never match price changes.e. none of the above.

moderate 48. In the dominant firm model, the fringe firms

a. are price takers.b. maximize profit by equating average revenue and average cost.c. determine their price and output before the dominant firm determines its price and output.d. all of the above.e. none of the above.

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Scenario 2:

You are studying a market for which the kinked demand curve model applies. The kinked demand curve is as follows:

Q = 1200 - 5P for 0 <= Q < 150

Q = 360 - P for 150 <= Q

The marginal cost is given as:

MC = Q

difficult 49. Refer to Scenario 2. What is the profit maximizing level of output?

a. 171.43b. 120c. 150d. all of the abovee. none of the above

difficult 50. Refer to Scenario 2. What is the profit maximizing price?


difficult 51. Refer to Scenario 2. Suppose that the marginal cost increases such that:

MC = Q + 10

What is the profit maximizing level of output?


difficult 52. Refer to Scenario 2. Suppose that the marginal cost increases such that:

MC = Q + 10

What is the profit maximizing price?


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difficult 53. Refer to Scenario 2. Suppose that the marginal cost falls such that:

MC = Q - 10

What is the profit maximizing level of output?


difficult 54. Refer to Scenario 2. Suppose that the marginal cost falls such that:

MC = Q - 10

What is the profit maximizing price?

a. 205.72b. 240c. 210 d. all of the abovee. none of the above

Section 12.7

easy 55. Which of the following is NOT conducive to the successful operation of a cartel?

a. Market demand for the good is relatively inelastic.b. The cartel supplies all of the world's output of the good.c. Cartel members have substantial cost advantages over non-member producers.d. The supply of non-cartel members is very price elastic.

easy 56. This market situation is much like a pure monopoly except that its member firms tend to cheat on agreed upon price and output strategies. What is it?

a. Duopoly.b. cartel.c. market sharing monopoly.d. natural monopoly.

easy 57. Use the following statements to answer this question:

I. Cartels are illegal in the United States.

II. Once price and production levels are agreed upon, each member of a cartel has an incentive to "cheat" on the agreement.

a. Both I and II are true.b. I is true, and II is false.c. I is false, and II is true.d. Both I and II are false.

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moderate 58. If all producers in a market are not cartel members, then the demand curve facing the cartel is

a. the market demand curve.b. horizontal.c. identical to the demand curve in the dominant firm model.d. identical to the monopolist's demand curve.

The following integrated series of questions relates to several sections in the text.

Scenario 3:

Suppose a stream is discovered whose water has remarkable healing powers. You decide to bottle the liquid and sell it. The market demand curve is linear and is given as follows:

P = 30 - Q

The marginal cost to produce this new drink is $3.\

Section 12.2

difficult 59. Refer to Scenario 3. What price would this new drink sell for if it sold in a competitive market?

a. 0b. $3c. $13.50d. $16.50e. $27

difficult 60. Refer to Scenario 3. What is the monopoly price of this new drink?

a. 0b. $3c. $13.50d. $16.50e. $27

Section 12.3

difficult 61. Refer to Scenario 3. What will be the price of this new drink in the long run if the industry is a Cournot duopoly?

a. $3b. $9c. $12d. $13.50e. none of the abovef. Both Cournot and Stackelberg.

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difficult 62. Refer to Scenario 3. What will be the price of this new drink in the long run if the industry is a Stackelberg duopoly?

a. $3b. $9c. $12d. $13.50e. none of the above

Section 12.4

difficult 63. Refer to Scenario 3. What will be the price of this new drink in the long run if the industry is a Bertrand duopoly?


Section 12.5

difficult 64. Refer to Scenario 3. What will be the price of this new drink in the long run if the firms in the industry collude with one another to maximize joint profit?


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SHORT-ANSWER PROBLEMS

Section 12.1

moderate 65. A firm operating in a monopolistically competitive market faces demand and marginal revenue curves as given below:

P = 10 - 0.1Q MR = 10 - 0.2Q

The firm's total and marginal cost curves are:

TC = - 10Q + 0.0333Q3 + 130 MC = -10 + 0.0999Q2,

where P is in dollars per unit, output rate Q is in units per time period, and total cost C is in dollars.

a. Determine the price and output rate that will allow the firm to maximize profit or minimize losses.

b. Compute a Lerner index.

Solution:

a.

Calculate MR and equate it to MC.

MC = MR

- 10 + 0.10Q2 = 10 - 0.2Q

0.1Q2 + 0.2Q - 20 = 0

The quadratic formula yields:

Q1 = 13.17 Q2 = -15.15.

Use Q1 since negative quantities are not meaningful.

At Q1 = 13.17

P = 10 - 0.1(13.17) = 8.68

b.

Computation of monopoly power. The Lerner index is computed below:

LP MC

P

At Q = 13.17, P = 8.68, and MC = 7.34

L = (8.68 – 7.34)/8.68 = 0.154

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Section 12.2

difficult 66. Suppose that the market demand for mountain spring water is given as follows:

P = 1200 - Q

Mountain spring water can be produced at no cost.

a. What is the profit maximizing level of output and price of a monopolist? b. What level of output would be produced by each firm in a Cournot duopoly in the long

run? What will the price be? c. What will be the level of output and price in the long run if this industry were perfectly

competitive?

Solution:

a.

The monopoly level of output is found where marginal revenue equals marginal cost. The marginal revenue curve has the same price intercept as the demand curve and twice the slope. Thus:

MR = 1,200 - 2Q

Setting MR equal to MC (which is zero in this problem) yields:

1,200 - 2Q = 0

Q = 600

P = 1,200 - 600 = 600

b.

The Cournot equilibrium is found by using the reaction curves of the two firms to solve for levels of output. The reaction curve for firm 1 is found as follows:

R1 = PQ1 = (1,200 - Q)Q1

= 1,200Q1 - (Q1 + Q2)Q1

= 1,200Q1 - Q12 - Q2Q1

The firm's marginal revenue MR1 is just the incremental revenue R1 resulting from an incremental change in output Q1:

MR1 = R1/Q1 = 1,200 - 2Q1 - Q2

Setting MR1 equal to zero (the firm's marginal cost) and solving for Q1 yields the reaction curve for Q1:

Firm 1's Reaction Curve: Q1 = 600 - (1/2)Q2

Going through the same calculations for firm 2 yields:


Solving the reaction curves simultaneously for Q1 and Q2 yields: Q1 = Q2 = 400. Thus the total output is 800 and the price will be $400.

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c.

In the industry were perfectly competitive, price will be equated to marginal cost.

P = 1,200 - Q = 0 or Q= 1,200 and P = 0

difficult 67. Bartels and Jaymes are two individuals who one day discover a stream that flows wine cooler instead of water. Bartels and Jaymes decide to bottle the wine cooler and sell it. The marginal cost of bottling wine cooler and the fixed cost to bottle wine cooler are both zero. The market demand for bottled wine cooler is given as:

P = 90 - 0.25Q

where Q is the total quantity of bottled wine cooler produced and P is the market price of bottled wine cooler.

a. What is the economically efficient price of bottled wine cooler?b. What is the economically efficient quantity of bottled wine cooler produced?c. If Bartels and Jaymes were to collude with one another and produce the profit-maximizing

monopoly quantity of bottled wine cooler, how much bottled wine cooler will they produce?

d. Given the output level in (c), what price will Bartels and Jaymes charge for bottled wine cooler?

e. At the output level in (c), what is the welfare loss?f. Suppose that Bartels and Jaymes act as Cournot duopolists, what are the reaction functions

for Bartels and for Jaymes?g. In the long run, what level of output will Bartels produce if Bartels and Jaymes act as

Cournot duopolists?h. In the long run, what will be the price of wine coolers be if Bartels and Jaymes act as

Cournot duopolists?i. Suppose that after Bartels and Jaymes have arrived at their long run equilibrium as Cournot

duopolists, another individual, Paul Mason, discovers the streams. Paul Mason, who will sell no wine cooler before its time, decides to bottle wine coolers. There are now three Cournot firms producing at once. In the long run, what level of output will Bartels produce?

Solution:

a.

The economically efficient level of price is found where price equals marginal cost. The marginal cost is zero. Therefore, the efficient price is zero.

b.

At a price of zero, Q = 360.

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c.

The profit maximizing level of output is found where

MR = MC. The MR curve has the same price intercept as the demand curve and is twice as steep. Thus, a monopolist will produce half as much as the competitive level (this is only true because marginal cost is constant). The competitive level of output is 360. Therefore, the monopoly level of output is 180.

Mathematically, the marginal revenue curve is:

MR = 90 - 0.5Q

Equating MR to MC yields:

90 - 0.5Q = 0

Q = 180

d.

When Q = 180 we have P = 90 - 0.25(180) = 45.

e.

The welfare loss is the value of the output that would have been produced under the conditions of economic efficiency, but is not produced due to the monopoly. This is the area of the triangle from Q = 180 to Q = 360, under the demand curve. The base of the triangle is 180, the height of the triangle is 45, and therefore the welfare loss is (1/2)(180)(45) = 4,050.

f.

The Cournot equilibrium is found by using the reaction curves of the two firms to solve for levels of output. The reaction curve for firm 1 (Bartels) is found as follows:

R1 = PQ1 = (90 - 0.25Q)Q1

= 90Q1 - 0.25(Q1 + Q2)Q1

= 90Q1 - 0.25Q12- 0.25Q2Q1

The firm's marginal revenue MR1 is just the incremental revenue dR1 resulting from an incremental change in output dQ1:

MR1 = dR1/dQ1 = 90 - 0.5Q1 - 0.25Q2





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g.

Solving the reaction curves simultaneously for Q1 and Q2 yields: Q1 = Q2 = 120.

h.

The total output is 240 (120 by each firm). Therefore:

P = 90 - 0.25(240) = 30.

i.

The Cournot equilibrium for three firms is found by solving the reaction curves of the three firms simultaneously for levels of output. The reaction curve for firm 1 (Bartels) is found as follows:

R1 = PQ1 = (90 - 0.25Q)Q1

= 90Q1 - 0.25(Q1 + Q2 + Q3)Q1

= 90Q1 - 0.25Q12 - 0.25Q2Q1 - 0.25Q3Q1

The firm's marginal revenue MR1 is just the incremental revenue dR1 resulting from an incremental change in output dQ1:

MR1 = dR1/dQ1 = 90 - 0.5Q1 - 0.25Q2 - 0.25Q3


Firm 1's Reaction Curve: Q1 = 180 - 0.5Q2 - 0.5Q3





Solving the reaction curves simultaneously for Q1, Q2 and Q3 yields: Q1 = Q2 = Q3 = 90.

difficult 68. Two large diversified consumer products firms are about to enter the market for a new pain reliever. The two firms are very similar in terms of their costs, strategic approach, and market outlook. Moreover, the firms have very similar individual demand curves so that each firm expects to sell one-half of the total market output at any given price. The market demand curve for the pain reliever is given as:

Q = 2600 - 400P.

Both firms have constant long-run average costs of $2.00 per bottle. Patent protection insures that the two firms will operate as a duopoly for the foreseeable future. Price and quantities are per bottle. If the firms act as Cournot duopolists, solve for the firm and market outputs and equilibrium prices.

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Solution:

Begin by solving for P.

Q = 2600 - 400P

Q - 2600 = -400P

P = 6.5 - 0.0025Q

Denote the two firms A and B and solve for reaction functions.

TRA = PA · QA

TRA = (6.5 - 0.0025Q)QA

TRA = 6.5QA - 0.0025[(QA + QB)QA]

TRA = 6.5QA - 0.0025QA2 - 0.0025QAQB

MRA = 6.5 - 0.005QA - 0.0025QB

Set MRA = MC

6.5 - 0.005QA - 0.0025QB = 2

- 0.005QA = 4.5 + 0.0025QB

QA = 900 - 0.5QB

One can verify that:

QB = 900 - 0.5QA

Substitute expression for QB into QA

QA = 900 - 0.5(900 - 0.5QA)

QA = 900 - 450 + 0.25QA

QA - 0.25QA = 450

QA(1 - 0.25) = 450

QA 450

0 75600

.

Substitute expression for QA into QB

QB = 900 - 0.5(900 - 0.5QB)

QB = 900 - 450 + 0.25QB

QB - 0.25QB = 450

QB(1 - 0.25) = 450

Q450

0.75600B

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QT = QA + QB

QT = 600 + 600 = 1200

P = 6.5 - 0.0025(1200)

P = $3.5 per bottle

Section 12.3

difficult 69. Lambert-Rogers Company is a manufacturer of petrochemical products. The firm's research efforts have resulted in the development of a new auto fuel injector cleaner that is considerably more effective than other products on the market. Another firm, G.H. Squires Company, independently developed a very similar product that is as effective as the Lambert-Rogers formula. To avoid a lengthy court battle over conflicting patent claims, the two firms have decided to cross-license each other's patents and proceed with production. It is unlikely that other petrochemical companies will be able to duplicate the product, making the market a duopoly for the foreseeable future. Lambert-Rogers estimates the demand curve given below for the new cleaner. Marginal cost is estimated to be a constant $2 per bottle.

Q = 300,000 - 25,000P.

where P = dollars per bottle and Q = monthly sales in bottles.

a. Lambert-Rogers and G.H. Squires have very similar operating strategies. Consequently, the management of Lambert-Rogers believes that the Cournot model is appropriate for analyzing the market, provided that both firms enter at the same time. Calculate Lambert-Rogers' profit-maximizing output and price according to this model.

b. Lambert-Rogers' productive capacity and technical expertise could allow them to enter the market several months before Squires. Choose an appropriate model and analyze the impact of Lambert Rogers being first into the market. Should Lambert-Rogers hurry to enter first?

Solution:

Denote Lambert-Rogers price and quantity as PL, QL and Squires as PS, QS.

Demand function is given as:

Q = 300,000 - 25,000P

Solve for P:

Q - 300,000 = -25,000P

P = 12 - 0.00004Q

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Outcome under Cournot model:

a.

TRL = PL · QL

TRL = (12 - 0.00004Q)QL

Q = QL + QS

TRL = [12 - 0.00004(QL + QS)]QL

TRL = 12QL - 0.00004QL2 - 0.00004QLQS

MRL = 12 - 0.00008QL - 0.00004QS

Set MRL = MC

12 - 0.00008QL - 0.00004QS = 2

-0.00008QL - 0.00004QS = -10

QL = 125,000 - 0.5QS

So, QS = 125,000 - 0.5QL

Substitute for QS:

QL = 62,500 + 0.25QL

QL = 62 500

0 75

,

. = 83,333

Q = QL + QS

Q = 83,333 + 83,333 = 166,666

P = 12 - .00004(166,666)

P = 12 - 6.67 = $5.33

P = $5.33 per bottle

166,666 bottles sold per month

b.

The Stackelberg model is appropriate when one firm enters first.

Lambert-Rogers determines its output, which Squires then takes as given.

Lambert's total revenue function is given as:

TRL = 12QL - 0.00004QL2 - 0.00004QLQS

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Squires reaction function QS = 125,000 - 0.5QL can be substituted into TRL, since Squires will take Lambert's output as given.

TRL = 12QL - 0.00004QL2 - 0.00004QL(125,000 - .5QL)

TRL = 12QL - 0.00004QL2 - 5QL + 0.00002QL

2

TRL = 7QL - 0.00002QL2

MRL = 7 - 0.00004QL

Set MRL = MC

7 - 0.00004QL = 2

-0.00004QL = -5

QL = 125,000

To find QS substitute QL into S reaction function

QS = 125,000 - 0.5QL

QS = 125,000 - 0.5(125,000)

QS = 62,500

Q = QL + QS

Q = 125,000 + 62,500

Q = 187,500

P = 12 - 0.0004(187,500)

P = 12 - 7.5 = $4.50

Lambert-Rogers gets a much larger share of the market by entering first. It should advance its schedule in order to enter first.

L8.68

8 68 7 34

015. .

.

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Section 12.5

moderate 70. The two leading U.S. manufacturers of high performance radial tires must set their advertising strategies for the coming year. Each firm has two strategies available: maintain current advertising or increase advertising by 15%. The strategies available to the two firms, G and B, are presented in the payoff matrix below.

Firm BIncrease Adv. Maintain Adv.

Firm G Increase Adv. 27, 27 50, 12Maintain Adv. 12, 50 45, 45

The entries in the individual cells are profits measured in millions of dollars. Firm G's outcome is listed before the comma, and Firm B's outcome is listed after the comma.

a. Which oligopoly model is best suited for analyzing this decision? Why? (Remember it is illegal to collude in the United States.)

b. Carefully explain the strategy that should be used by each firm. Support your choice by including numbers.

Solution:

a.

The prisoner's dilemma model is most appropriate for analyzing this situation. We can conclude that the prisoner's dilemma is most appropriate because each firm must set its advertising strategy without knowledge of the rival's strategy.

b.

Increasing the advertising level is the dominant strategy, since the firm is better off increasing regardless of the rival's action. For example, if Firm B increases, Firm G earns 27 if it increases and12 if it does not increase. G is better off increasing. If Firm B doesn't increase, Firm G earns 45 by not increasing and 50 by increasing. Again, Firm G is better off to increase. It is obvious that no matter what B does, G is better off to increase. Firm B faces the same situation.

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Section 12.6

difficult 71. The market for an industrial chemical has a single dominant firm and a competitive fringe comprised of many firms that behave as price takers. The dominant firm has recently begun behaving as a price leader, setting price while the competitive fringe follows. The market demand curve and competitive fringe supply curve are given below. Marginal cost for the dominant firm is $0.75 per gallon.

QM = 140,000 - 32,000P

QF = 60,000 + 8,000P,

where QM = market quantity demanded, and QF = the supply of the competitive fringe. Quantities are measured in gallons per week, and price is measured as a price per gallon.

a. Determine the price and output that would prevail in the market under the conditions described above. Identify output for the dominant firm as well as the competitive fringe.

b. Assume that demand curve shifts rightward by 40,000 units. Show that the dominant firm is indeed a price leader. What output (leader and follower) and market price will prevail after the change in demand?

Solution:

a.

QM = 140,000 - 32,000P

QF = 60,000 + 8,000P

Denote dominant firm demand curve as QD.

QD = QM - QF

QD = 140,000 - 32,000P - (60,000 + 8,000P)

QD = 80,000 - 40,000P

Solve for P

QD - 80,000 = -40,000P

P = 2 - 0.000025QD

MRD = 2 - 0.00005QD

Marginal cost for the dominant firm is $0.75. Equate MRD to MCD

2 - 0.00005QD = 0.75

-0.00005QD = -1.25

QD = 25,000

P = 2 - 0.000025(25,000)

P = 2 - 0.625 = 1.375 per gallon

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Fringe takes dominant firm price as given

QF = 60,000 + 8,000(1.375)

QF = 71,000

QT = 25,000 + 71,000 = 96,000

b.

A 40,000 increase in demand curve to:

QM = 180,000 - 32,000P

QF = 60,000 + 8,000P

QD = 180,000 - 72,000P - (60,000 + 8000P)

QD = 120,000 - 40,000P

Solve for P

QD - 120,000 = -40,000P

PD = 3 - 0.000025QD

MRD = 3 - 0.00005QD

setting MRD = MCD

3 - 0.00005QD = 0.75

-0.00005QD = -2.25

QD = 45,000

PD = 3 - 0.000025(45,000)

PD = 3 - 1.125 = $1.875

Fringe again follows

QF = 60,000 + 8,000(1.875)

QF = 75,000

QT = 45,000 + 75,000 = 120,000

We can see that when demand changed, the dominant firm raised price. The competitive fringe took the new price as given and adjusted output accordingly.

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difficult 72. In the town of Battle Springs, the market for fast food is dominated by Mr. Berger. The other companies tend to follow Mr. Berger's lead in setting price and style of burger. The total demand for cheeseburgers in Battle Springs is:

P = $1.50 - $0.00015Q.

The marginal cost of producing and serving burgers at Mr. Berger is:

MCL = 0.25 + 0.0000417Q.

The competitive supply curve of burgers by all the other (competitor) firms is:

Pf = 0.50 + 0.000285Qf.

Compute the price that will be set in the market when Mr. Berger behaves as a dominant firm and maximizes profit for itself. Also, compute the production rate by Mr. Berger and the competitor firms.

Solution:

The price will be determined along Mr. Berger's demand curve, where MCL = MRL. First, we find DL, which is the difference in quantity that will be forthcoming from the followers (QS) and the dominant firm QL at various prices below the intersection of Sf and D. This difference at various prices represents the locus of points tracing of DL.

Total demand:

P = 1.50 - 0.00015Q, which can be expressed as

Q = 10,000 - 6,666.67P

Competitor supply:

P = Sf = 0.50 + 0.000285Qf, which can be expressed as

Qf = -1,754.40 + 3,508.77P. (Sf = P)

Take the difference and the result is the dominant firm's demand curve:

QL = 10,000 - 6,666.67P + 1,754.40 - 3,508.77P

QL = 11,754.40 - 10,175.44P or

P = 1.155 - 0.0000983Q

Now find MR for the dominant firm, Mr. Berger.

RL = P · QL = 1.155QL - 0.0000983QL2

MRL = 1.155 - 0.000197QL

Equate MRL to MCL to find Mr. Berger's production rate.

1.155 - 0.000197QL = 0.25 + 0.0000417QL

0.905 = 0.0002387QL

QL = 3,791

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At this production rate, the dominant firm would set the price at

PL = 1.155 - 0.0000983(3,791)

PL = 0.78 per unit.

Under these conditions, the competitor firms will produce along their collective supply curve at P = 0.78.

Qf = -1,754.40 + 3,508.79(0.78) = 982.46

Section 12.7

difficult 73. Consider two identical firms (no. 1 and no. 2) that face a linear market demand curve. Each firm has a marginal cost of zero and the two firms together face demand:

P = 50 - 0.5Q, where Q = Q1 + Q2.

a. Find the Cournot equilibrium Q and P for each firm. b. Find the equilibrium Q and P for each firm assuming that the firms collude and share the

profit equally.c. Contrast the efficiencies of the markets in (a) and (b) above.

Solution:

a.

Determine the reaction curve for no. 1. Equate MR1 to MC1.

R1 = P1Q1 = (50 - 0.5Q)Q1 = 50Q1 - 0.5QQ1

= 50Q1 - 0.5(Q1 + Q2)Q1 = 50Q1 - 0.5Q12 - 0.5Q1Q2

MR1 = 50 - 1Q1 - 0.5Q2.

Since MC1 = 0, then

50 - 1Q1 - 0.5Q2 = 0

Q1 = 50 - 0.5Q2

The reaction curve for firm no. 2 is calculated in the same way as that for firm no. 1.

Q2 = 50 - 0.5Q1

At the intersection of two reaction curves, we find the equilibrium Q1 and Q2. By substitution:

Q2 = 50 - 0.5(50 - 0.5Q2)

Q2 = 50 - 25 + 0.25Q2

0.75Q2 = 25

Q2 = 33.33

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Now solve for Q1:

Q1 = 50 - 0.5Q2 = 50 - 0.5(33.33) = 33.33

The total quantity produced Q = Q1 + Q2 = 66.67

The market equilibrium price is:

P = 50 - 5Q = 50 - 0.5(66.67) = $16.67/unit.

Each firm is maximizing its own profit, given its competitor's production rate.

b.

The total revenue for the two firms is:

R = PQ - (50 - 0.5Q)Q = 50Q - 0.5Q2, and thus

MR = 50 - Q

Set MR equal to MC = 0 to find Q that maximizes profit.

50 - Q = 0

Q = 50

If profit is shared equally, then Q1 = Q2 = 25.

The collusive price is P = 50 - 0.5(50) = 25.

c.

When competing, each firm produces 33.33 at a price of 16.67; and when colluding, each produces 25 at a price of 25. The market is more efficient when the firms compete, because in this situation selling price is more nearly equal to marginal cost.

easy 74. The market structure of the local pizza industry is best characterized by monopolistic competition. One Guy's Pizza is one of the producers in the local market. The demand for One Guy's Pizza is:

The resulting marginal revenue curve is

One Guy's cost function is:

Determine One Guy's profit maximizing level of output and the price charged to customers. Is this a long-run equilibrium?

Solution: To determine One Guy's optimal output, we set One Guy's marginal revenue equal to marginal cost. This is The market price for One Guy's Pizza at this level of output is $18. This is not a long-run equilibrium because One Guy's is earning a positive profit. The positive profit will attract entrants into the local pizza industry.

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easy 75. The market structure of the local boat industry is best characterized by monopolistic competition. Homer's Boat Manufacturing is one of the producers in the local market. The demand for Homer's Boats is:


Homer's cost function is:

Determine Homer's profit maximizing level of output and the price charged to customers. Is this a long-run equilibrium?

Solution: To determine Homer's optimal output, we set Homer's marginal revenue equal to marginal cost.

Thus, 5,000 2 6 625.Q Q Q The market price for Homer at this level of output is $4,375. This is not a long-run equilibrium because Homer is earning a positive profit. The positive profit will attract entrants into the local boat industry.

easy 76. The market structure of home video gaming systems is best characterized by monopolistic competition. Quasar Entertainment is one of the producers in this market. The inverse demand for Quasar systems is:

P = 500 – 9.75Qd


Quasar's cost function is:

Determine Quasar's profit maximizing level of output and the price charged to customers. Is this a long-run equilibrium?

Solution: To determine Quasar's optimal output, we set Quasar's marginal revenue equal to marginal cost. This is The market price for Quasar at this level of output is $256.25. This is a long-run equilibrium because Quasar is earning zero profit. Thus, no firms have an incentive to exit or enter the industry.

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easy 77. The market structure of Red Raider Gear is best characterized by monopolistic competition. Red Raider Gear is one of the producers in this market. The demand for Red Raider Gear is:

The resulting marginal revenue curve is The

Red Raider Gear cost function is C(Q) = (1/8)Q2 + 555.56. Therefore we have MC (Q) = 0.25Q. Determine the profit maximizing level of output and the price charged to customers for Red Raider Gear. Is this a long-run equilibrium?

Solution: To determine Red Raider's optimal output, we set Red Raider's marginal revenue equal to marginal cost. Then we have 50 – 2Q = 0.25Q, and therefore Q = 22.22. The market price for Red Raider Gear at this level of output is $27.78. This is a long-run equilibrium because Red Raider Gear is earning zero profit. Thus, no firms have an incentive to exit or enter the industry.

moderate 78. Hale's One Stop Gas and Auto Service competes with Murray's Gas and Service Mart. The local

demand is given by: 2.50 0.01 .P Q Hale's marginal cost function is: 0.35 .H H HMC q q

Murray's marginal cost function is: 0.30 .M M MMC q q Given the demand relationship above,

Hale's marginal revenue function is: , 2.50 0.02 0.01 .H H M H MMR q q q q Determine Hale's

reaction function. Murray's marginal revenue function is:

, 2.50 0.02 0.01 .M M H M HMR q q q q Determine Murray's reaction function. What is the

Cournot solution?

Solution: To determine Hale's reaction function, we set Hale's marginal revenue equal to marginal cost and solve for Hale's output as a function of Murray's output.

Murray's reaction function is determined

in the same manner. To determine the

Cournot solution, we may insert Hale's reaction function in for Hale's output level in Murray's

reaction function. This gives us: We may plug

this level of output for Murray into Hale's reaction function to learn Hale's optimal output. This is

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moderate 79. The Grand River Brick Corporation uses Business-to-Business internet technology to set output before Bernard's Bricks. This gives the Grand River Brick Corporation "first-move" ability. The market demand for bricks is: Bernard Brick's

marginal revenue curve is: The marginal cost of producing

an additional unit of bricks is constant at $2.00 for each firm. Determine Bernard's reaction function. Given that the Grand River Brick Corporation has this information and moves first,

Grand River's marginal revenue curve is: Calculate Grand River Brick

Corporations optimal output level. Does the "first-move" ability of the Grand River Brick Corporation allow them to capture a larger market share (note that the marginal revenue curves would be symmetric if Grand River did not have first-move ability)?

Solution: Bernard's reaction function is solved for by equating marginal revenue to marginal cost and solving for Bernard's output as a function of Grand River output.

Given symmetry if Grand River did not have first

move ability, Grand River's reaction function would be: This implies each firm

would produce 266.66 units of bricks if there is no first-move ability. With first move ability, Grand River maximizes profits by setting marginal revenue equal to marginal cost. With first

move ability, this is: Thus, we see that Grand

River captures a larger market share given first move ability.

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difficult 80. Quasar Corporation is set to release its latest video game system which utilizes the newest game technology. In fact, the release date is sooner than that of its only rival Orion. This gives Quasar Corporation "first-move" ability. The demand for video game systems is:

150 0.1 1,500 10 . d dQ P P Q Orion's marginal revenue curve is:

, 1,500 20 10 O O Q O QMR q q q q. The marginal cost functions are:

Determine Orion's reaction function. Given that Quasar Corporation has this information and

moves first, Quasar's marginal revenue function is: Calculate Quasar Corporation's optimal output level. Does the "first-move" ability of Quasar Corporation allow it to capture a larger market share?

Solution: Orion's reaction function is found by equating marginal revenue to marginal cost and solving for Orion's output as a function of Quasar output.

Given symmetry if Quasar did not have first

move ability, Quasar's reaction function would be: This implies each firm

would produce 49.18 units if there is no first-move ability. With first move ability, Quasar maximizes profits by setting marginal revenue equal to marginal cost. With first move ability,

this is: Thus, we see that Quasar

captures a larger market share given first move ability.

moderate 81. Hale's One Stop and Auto Service competes with Murray's Gas Mart. The local demand is: Both firms sell exactly the same quality of gasoline. Thus,

if the firms charge a different price, the lower price firm will capture the entire market share. If the firms charge the same price, they will split the market share. The marginal cost functions are both constant at $1.25. If the firms compete by setting price, what is the market output level? What is the market price level?

Solution: If the firms compete by setting price, the equilibrium price will be $1.25 per unit. The market output level will be 12.5 units. If both firms attempt to price above $1.25, the firm with the lower price will enjoy the entire market share and earn an economic profit while the higher pricing firm sells no units of output. The higher price firm will have an incentive to undercut the price of the other firm. This behavior will continue until both firms charge $1.25. If the firms offer a price below $1.25, they will lose money and exit the industry or raise prices. Thus, equilibrium occurs where both firms charge $1.25 per unit.

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moderate 82. On the planet Economus, the demand for Kryptonite is:

There are four producers of Kryptonite on the

planet who have formed a Kryptonite Cartel. The resulting marginal revenue function for the

cartel is: The marginal costs for producing Kryptonite for the 4

different producers are:

Determine the Cartel profit maximization output levels of each producer. If producer #2 cheats and produces 50% more than their collusive output level, determine their new revenue level.

Solution: Note that To maximize Cartel profits, marginal costs will be equated

across producers. These two facts imply: The profit maximizing Cartel output

level sets marginal revenue equal to marginal cost. This is:

Marginal costs are 4.636. This implies the Cartel profit maximization production levels for each

producer are: The market price for Kryptonite at these production levels is $203

per unit. If producer #2 produces 4.637 units instead, the market price for Kryptonite falls to $177.233. Total revenue for the second producer rises from $627.47 to $821.83. That is, producer #2 raises its own total revenue by 31% if it cheats.

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difficult 83. The demand for on-line brokerage services is: If the on-

line brokerage firms collude, the collusive marginal revenue function is:

The brokerage firm specific marginal cost functions are: Calculate the

collusive output level and market price. If the brokerage firms behaved competitively and each firm set its own marginal cost equal to price, what would be the output level and market price?

Solution: This implies the collusive supply sets

The collusive marginal cost function is: The

collusive profit maximization level sets marginal cost equal to marginal revenue. This is:

The resulting price is $63.81. If brokerage firms behave

competitively, each firm sets marginal cost equal to price. Thus,

This implies competitive supply is

Setting supply equal to demand and solving for market price

gives us the competitive solution. This is: The competitive

market output level is 121.182.

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Chapter 11 Monopolistic ion and Oligopoly

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Transcript of Chapter 11 Monopolistic ion and Oligopoly