Monopolistic Competition Part 4 (156-179Q)

156. A law that restricts the ability of hotels/motels to advertise on billboards outside of a resort community would likely lead to a. a decrease in profits for all hotels/motels. b. reduced efficiency of local lodging markets. c. a request by consumers to increase the number of billboards. d. All of the above are correct. ANSWER: b. reduced efficiency of local lodging markets. Use the following information to answer questions 157 through 160. Consider the problem facing two firms in the fast-food restaurant market, Firm A and Firm B. Each company has just come up with an idea for a new fast-food menu item, which it would sell for $4. Assume that the marginal cost for each new menu item is a constant $2 and the only fixed cost is for advertising. Each company knows that if it spends $12 million on advertising, it will get 2 million consumers to try its new product. Firm A has done market research which suggests that its product does not have any "staying" power in the market. Even though it could get 2 million consumers to buy the product once, it is unlikely that they will continue to buy the product in the future. Firm B's market research suggests that its product is very good, and consumers who try the product will continue to be consumers over the ensuing year. On the basis of its market research, Firm B estimates that its initial 2 million customers will buy one unit of the product each month in the coming year, for a total of 24 million units. 157. If Firm A decides to advertise its product it can expect to a. get repeat sales above and beyond the initial 2 million consumers. b. increase its market power. c. incur a loss of $8 million. d. have a profit of $4 million. ANSWER: c. incur a loss of $8 million. 158. If firm B decides to advertise its product it can expect to a. have a profit of $48 million per year. b. have a profit of $36 million per year. c. incur a loss of $12 million per year. d. exit the industry. ANSWER: b. have a profit of $36 million per year. 159. By its willingness to spend money on advertising, Firm B a. signals the value of its new product to consumers. b. signals that it is not a profit maximizer. c. is detracting from the efficiency of markets. d. None of the above are correct. ANSWER: a. signals the value of its new product to consumers. 160. On the basis of a theory that people buy a product because it is advertised, the content of advertisements for Firm B's product a. should focus on quality comparisons in order to be successful. b should definitely include celebrity endorsements in order to be successful. c. is critical to the success of the product in the market. d. is irrelevant to the success of the advertisement. ANSWER: d. is irrelevant to the success of the advertisement. 161. It is a well-publicized fact that television advertisements aired during major sporting events are very expensive. A theory asserting that people buy a product simply because it is advertised would suggest that information on the cost of advertising a. enhances the effectiveness of the advertisement. b. reduces people's willingness to purchase advertised products. c. is leaked to discredit the firms that spend so much on advertising. d. reduces the effective staying power of a product. ANSWER: a. enhances the effectiveness of the advertisement. 162. In some countries, brand name fast-food restaurants are not allowed to operate. Such restrictions are likely to a. enhance the social well-being of society. b. enhance the choice set of consumers among local restaurants. c. reduce barriers to entry in imperfect markets. d. reduce the competitive nature of local fast-food markets. ANSWER: d. reduce the competitive nature of local fast-food markets. 163. Eunice consumes Coke exclusively. She claims that there is a clear taste difference and that competing brands of cola leave an unsavory residual taste in her mouth. However, in a blind taste test, Eunice is found to prefer generic store-brand cola to Coke eight out of ten times. The results of Eunice's taste test would reinforce claims by critics of brand names that a. consumers are always willing to pay more for brand names. b. brand names cause consumers to perceive differences that do not really exist. c. brand names cause consumers to be more sensitive to product differences. d. brand names are a form of socially efficient advertising. ANSWER: b. brand names cause consumers to perceive differences that do not really exist. 164. Your company has recently requested that you travel to Dhaka, Bangladesh, to work on negotiations for a new factory to be located in one of the port cities. Your travel agent provides a list of several hundred local hotels, and a Sheraton. In this case, the Sheraton brand-name is likely to be used as a signal of a. perceived differences that are not likely to exist among your various options. b. quality when quality cannot be easily judged. c. inefficiency in markets characterized by recognizable brand names. d. the quality of general lodging accommodations in Dhaka. ANSWER: b. quality when quality cannot be easily judged. 165. During a recent visit to Miami, Florida, you stay in a “brand-name” hotel located in a deteriorating section of the inner city. You feel threatened by the location and are hesitant about leaving your hotel room during your stay. As a result of your experience, you vow never to stay with that particular hotel chain again. This example would reinforce the claim that a. firms have a financial stake in maintaining the reputation of their brand names. b. brand names are a signal of quality. c. advertising is a waste of money for brand-name products. d. None of the above are correct. ANSWER: a. firms have a financial stake in maintaining the reputation of their brand names. 166. On a vacation to Cancun, Mexico, you find yourself eating every meal at the local McDonald's rather than having a hamburger from one of the street vendors. Your traveling companion claims that you are irrational, since you never eat McDonald's hamburgers when you are home and McDonald's hamburgers cost more than those prepared and sold by Cancun's street vendors. An economist would most likely explain your behavior by suggesting that a. your behavior is rational, but your friend’s behavior is clearly irrational. b. you are clearly irrational. c. the McDonald's brand name guarantees consistent quality. d. the advertising by McDonalds in Cancun is more persuasive than the advertising by McDonalds in your home town. ANSWER: c. the McDonald's brand name guarantees consistent quality. 167. Which of the following is unique to a monopolistically competitive firm when compared to an oligopoly? a. The monopolistically competitive firm advertises. b. The monopolistically competitive firm produces a quantity of output that falls short of the socially optimal level. c. Monopolistic competition features many buyers. d. Monopolistic competition features many sellers. ANSWER: d. Monopolistic competition features many sellers. 168. In dollar terms, the largest form of advertising in the United States is (are) a. billboards. b. newspaper and magazine ads. c. radio ads. d. television ads. ANSWER: b. newspaper and magazine ads. 169. Firm A produces and sells in a market that is characterized by highly differentiated consumer goods. Firm B produces and sells industrial products. Firm C produces and sells an agricultural commodity. Which firm is likely to spend the greatest portion of its total revenue on advertising? a. Firm A b. Firm B c. Firm C d. There is no reason to believe that any one of the three firms would spend a greater portion of its total revenue on advertising than the other two firms. ANSWER: a. Firm A 170. The fact that there is a great deal of advertising of men’s shaving products indicates that a. the market for those products is perfectly competitive. b. it costs firms very little to produce those products. c. those products are highly differentiated. d. All of the above are correct. ANSWER: c. those products are highly differentiated. 171. In which of the following product markets are we likely to observe the largest amount of advertising? a. markets in which price exceeds marginal cost b. perfectly competitive markets c. markets in which industrial products are sold d. markets in which there is very little difference between different firms’ products ANSWER: a. markets in which price exceeds marginal cost 172. Critics of advertising argue that advertising a. creates desires that otherwise might not exist. b. hinders competition. c. often fails to convey substantive information. d. All of the above are correct. ANSWER: d. All of the above are correct. 173. Relative to other advertising expenditures, the largest number of dollars is spent on a. television and radio commercials. b. billboards and other signs. c. space in magazines and newspapers. d. direct mail. ANSWER: c. space in magazines and newspapers. 174. A study of the market for optometrists’ services in the 1960s showed that a. all states in the United States prohibited advertising by optometrists. b. almost all professional optometrists opposed legal restrictions on their rights to advertise. c. the average price of eyeglasses would be reduced by the removal of legal restrictions on advertising by optometrists. d. All of the above are correct. ANSWER: c. the average price of eyeglasses would be reduced by the removal of legal restrictions on advertising by optometrists. 175. Which of the following statements is correct? All theoretical arguments point to the fact that advertising leads to a. higher prices and less competitive markets. b. higher prices and more competitive markets. c. lower prices and less competitive markets. d. None of the above are correct; theoretical arguments fail to resolve the question of advertising’s effect on prices and competition. ANSWER: d. None of the above are correct; theoretical arguments fail to resolve the question of advertising’s effect on prices and competition. 176. According to the “signaling theory” of advertising, consumers a. pay little or no attention to which firms advertise and which firms do not advertise. b. are often more impressed by a firm’s willingness to spend money on advertising than they are by the content of the advertisement. c. are often more impressed by low-cost advertisements than they are by high-cost advertisements. d. gain little or no information about product quality from advertisements. ANSWER: b. are often more impressed by a firm’s willingness to spend money on advertising than they are by the content of the advertisement. 177. ABC Company knows that it produces and sells a very good mouse trap. XYZ Company knows that it produces and sells a lousy mouse trap. According to the “signaling theory” of advertising, the quality difference likely produces the result that a. both ABC and XYZ have incentives to spend large amounts of money on advertising their mouse traps. b. ABC has an incentive to spend a large amount of money on advertising its mouse trap, but XYZ does not. c. XYZ has an incentive to spend a large amount of money on advertising its mouse trap, but ABC does not. d. neither ABC nor XYZ has an incentive to spend a large amount of money on advertising their mouse traps. ANSWER: c. XYZ has an incentive to spend a large amount of money on advertising its mouse trap, but ABC does not. 178. Two soft drinks sit side-by-side in a grocery store: A six-pack of Coca-Cola (a brand name) sells for $3.00, while a six-pack of Uncle Don’s cola (not a brand name) sells for $1.50. Even defenders of brand names would have to admit that a. no rational consumer would spend twice as much for Coca-Cola as he would for Uncle Don’s cola. b. the side-by-side presence of these two colas conveys no useful information to consumers. c. Coca-Cola has no incentive to maintain the quality of its product just because of the Coca-Cola brand name. d. None of the above are correct. ANSWER: d. None of the above are correct. 179. Which of the following statements is false? a. The typical monopolistically competitive firm could reduce its average total cost if it produced more output. b. Monopolistically competitive firms advertise in order to increase the elasticity of the demand curve they face. c. Expensive advertising might help consumers if it is a signal that the product is good. d. Brand names acquired at great cost might help consumers by assuring quality. ANSWER: b. Monopolistically competitive firms advertise in order to increase the elasticity of the demand curve they face. TRUE/FALSE 1. For a profit-maximizing firm in a monopolistically competitive market, when price is equal to average total cost, price must lie above marginal cost. ANSWER: T 2. Product differentiation always leads to some measure of market power. ANSWER: T 3. A monopolistically competitive market is characterized by barriers to entry. ANSWER: F 4. A profit-maximizing firm in a monopolistically competitive market always prices its product at some markup over marginal cost. ANSWER: T 5. Monopolistic competition is the only market structure that features “many sellers.” ANSWER: F 6. Excess capacity characterizes firms in monopolistically competitive markets, even in situations of long-run equilibrium. ANSWER: T 7. When a firm operates at excess capacity, it must be in a monopolistically competitive market. ANSWER: F 8. When a firm operates at efficient scale, it is producing at the minimum point on its average-total-cost curve. ANSWER: T 9. A firm that would experience higher average total cost by increasing production is operating with excess capacity. ANSWER: F 10. A profit-maximizing firm in a monopolistically competitive market always operates on the downward-sloping portion of its marginal cost curve. ANSWER: F 11. A price markup over marginal cost is inconsistent with market attributes of free entry and zero profit. ANSWER: F 12. When a firm in a monopolistically competitive market earns zero economic profit, its product price must equal marginal cost. ANSWER: F 13. When a profit-maximizing firm in a monopolistically competitive market is in long-run equilibrium, marginal cost must lie below average total cost. ANSWER: T 14. A firm in a monopolistically competitive market is usually indifferent to an additional customer walking through the door, since a sale to that customer will not increase the firm’s profit. ANSWER: F 15. When advertising is used to relay information about price, each firm is able to enhance market power. ANSWER: F 16. Policymakers have generally come to accept the view that advertising enhances the efficiency of markets. ANSWER: T 17. Critics of advertising that focuses on product characteristics argue that it leads to less elastic demand for products. ANSWER: F 18. Economists who argue that advertising enhances market efficiency suggest that celebrity advertising signals inferior product quality. ANSWER: F 19. When McDonalds opens a store in Dhaka, Bangladesh, it has a strong incentive to enforce product quality consistent with stores in the United States. ANSWER: T 20. The Mikati Philippines Hard Rock Cafe has the exact same menu as the Hard Rock Cafe in New York. This is an example of a brand name enhancing market efficiency for U.S. tourists visiting the Philippines. ANSWER: T 21. Empirical evidence suggests that advertising usually leads to an increase in the price for advertised products. ANSWER: F 22. Advertising during the Super Bowl is an example of information about quality contained primarily in the existence and expense of the advertising. ANSWER: T 23. Brand names are rarely used to convey information about product quality. ANSWER: F 24. The "competition" in monopolistically competitive markets is most likely a result of having many sellers in the market. ANSWER: T 25. There is general disagreement among economists about the role of advertising but there is widespread agreement about the role of brand names on market efficiency. ANSWER: F 26. The government of Italy will not allow any Hard Rock Cafe restaurants to open in Italy. Defenders of the efficiency of brandname markets would argue that this has hampered restaurant market efficiency in Italy. ANSWER: T 27. The debate over whether advertising serves a valuable purpose in society is definitively answered by economists who study the tastes and preferences of individuals. ANSWER: F 28. The claim that advertising reduces the elasticity of demand is likely to be made by a defender of advertising. ANSWER: F 29. If advertising decreases the elasticity of demand for specific brand names of hard liquor, we would expect firms to be more able to exercise market power as a result. ANSWER: T 30. When poor-quality products are advertised using cheap advertising consumers learn to ignore such cheap advertising. ANSWER: T SHORT ANSWER 1. Entry of firms in a monopolistically competitive industry is characterized by two "external" effects. List these effects and briefly describe how consumers and incumbent firms are influenced by these externalities. ANSWER: Business-stealing effect—incumbent firms are affected through the loss of sales, consumers are affected by lower price. Product-variety effect—incumbent firms face a market with more substitutes, consumers have more product variety from which to choose. 2. Evaluate the following statement in the context of business-stealing and product-variety externalities: "We have too many student apartments in this town already; statistics show that vacancy rates average 15 percent during any given semester." ANSWER: business-stealing effect—if new entrants into the market can be profitable then average vacancy rates are likely to rise above 15 percent. Product-variety effect—if new entrants to the market are able to identify niche markets which are profitable (i.e., offer club rooms, pools, athletic facilities, etc.) then product variety will increase, and average vacancy rates are likely to rise above 15 percent. 3. Use a graph to demonstrate why a profit-maximizing monopolistically competitive firm must operate at excess capacity. Explain why a perfectly competitive firm is not subject to the same constraint. ANSWER: Competitive firms do not face downward-sloping demand. The graph shows the firm choosing a level of production in which the intersection of marginal revenue and marginal cost occurs at an output level where average total cost is decreasing. This profit-maximizing output level is less than the efficient scale (minimum of average total cost) and therefore the firm is said to be operating at excess capacity. 4. In a small college town, four microbreweries have opened in the last two years. Demonstrate the effect of these new market entrants on demand for incumbent firms (microbreweries) that already served this market. Assume that the local community now places a moratorium on new liquor licenses for microbreweries. How will this moratorium affect the long-run profitability of incumbent firms? ANSWER: The arrival of a new entrant should be graphically depicted by a leftward shift in the demand curves faced by all incumbent firms. If firms are able to make economic profits, these will be able to be maintained in the long run if new entrants are not allowed. 5. In many college towns, private independent bookstores typically locate on the periphery of the college campus. However, in some college towns, the University has used political power to restrict private bookstores near campus through community zoning laws. Use your knowledge of markets to predict the price and quality of service difference in the market for college textbooks under these two different market regimes. ANSWER: In monopoly markets, price will be higher and the quality of service will be lower than in monopolistically competitive markets. 6. List five goods that are sold in a monopolistically competitive market. ANSWER: books, CDs, movies, computer games, and piano lessons are some examples. 7. Why does a typical monopolistically competitive firm face a downward-sloping demand curve? ANSWER: Because its product is different from those offered by other firms. 8. What is meant by the term “excess capacity” as it relates to monopolistically competitive firms? ANSWER: In the long run, monopolistically competitive firms produce a level of output lower than the efficient scale and are therefore said to have excess capacity. 9. Assume the role of a critic of advertising. Describe the characteristics of advertising that reduce the effectiveness of markets and decrease the social well-being of society. ANSWER: Advertising manipulates people's tastes and is psychological rather than informational; as a result it creates a desire that might not otherwise exist. Advertising may also impede competition by convincing consumers that products that are identical have significant differences. 10. Assume the role of a defender of advertising. Describe the characteristics of advertising that enhance the effectiveness of markets and increase the social well-being of society. ANSWER: advertising provides information to consumers and thus allows consumers to make more informed (and thus better) choices. Advertising fosters competition by making consumers more aware of prices and product characteristics in a market. 11. Evaluate the following statement: "Advertisements that use celebrity endorsements are devoid of any value and do not enhance the efficient functioning of markets." ANSWER: Some people argue that celebrity endorsements are a signal of quality. If so, then they relay information and enhance the effective functioning of markets. 12. Discuss how "brand names" may enhance the efficiency of markets in a less developed country. ANSWER: Recognizable brand names signal quality products. In the tourist and business services market this signal can be critical at the early stages of development to ensure visitors have a quality experience when other information is unavailable or unreliable. 13. For many years, Pepsi operated a "taste test" booth at local fairs across the United States. Visitors to the booth would be encouraged to take a blind "taste test" between Pepsi and its primary market competitor, Coke. Pepsi then used the taste test results in advertising Pepsi. What advertising theory does such an approach support? Pepsi no longer uses this as an advertising strategy, but rather, relies on celebrity endorsements and other forms of advertising. What advertising theory do you think now dominates the market between Pepsi and Coke? Explain. ANSWER: The taste test used the "advertising as information" theory of advertising. Celebrity endorsement is the "advertising as a signal of quality" theory of advertising. 14. Professional organizations (e.g., American Medical Association and American Bar Association) have been active advocates for regulation to restrict the right of professionals to advertise. Describe what economic incentives might exist for incumbent professionals to restrict advertising. ANSWER: If advertising increases information about prices and services, then providers of professional services will be required to compete with each other on the basis of price and service. As such, incumbent professionals will be subject to more competitive pressure in the markets they service, and individual profits are likely to fall. 15. In markets where the government imposes an excise tax on unit sales, it also has a tendency to dabble with restrictions on advertising (i.e., cigarettes, hard liquor). Do potential (or actual) restrictions on advertising in these markets serve the interest of a government that is interested in maximizing its tax revenue from the sale of these products? Explain your answer. ANSWER: In the case of the examples given, demand is quite inelastic, so restrictions on advertising are not likely to have a large impact on total sales, but may have an impact on the distribution of sales across brand names. As such, government revenue is largely unaffected if the tax is on unit sales. 16. As developing countries make a transition to market-based economies, one of the first major capital investments is in "Westernquality" hotels. Explain why "brand-name" hotel accommodations are a critical step in attracting foreign investment. ANSWER: Brand-name hotels are a critical first step to economic development because their recognized signal of quality reduces the