Monopolistic Competition Tutorial Solutions

Monopolistic Competition 1. Which of the following are attributes of a monopolistic competitive market? (i) many firms competing for the same group of sellers (ii) each firm produces a product that is slightly different from the other firms (iii) in the long run, entry into the industry is restricted A. (i) only B. (i) and (ii) only C. (ii) and (ii) only D. (i), (ii), and (iii) ANS: B Graph 17-1 2. Refer to Graph 17-1. Which of the following graphs would most likely represent a profit-maximising firm in a monopolistically competitive market? A. panel a B. panel b C. panel c D. panel d ANS: A 3. Refer to Graph 17-1. If a firm in a monopolistically competitive market was producing the level of output depicted as Qd in panel d, it would: A. be minimising its losses B. be losing market share to other firms in the market C. be operating at excess capacity D. not be maximising its profit ANS: D 4. Refer to Graph 17-1. The firm depicted in panel b faces a horizontal demand curve. If panel b depicts a profit-maximising firm: A. it would not be operating in a monopolistically competitive market B. it would not have excess capacity in its production as long as it is earning zero economic profit C. it is not able to choose the price at which it sells its product D. all of the above are true ANS: D 5. Refer to Graph 17-1, panel A. Assume the market is monopolistically competitive and in long-run equilibrium. If drawn in, the average total cost curve would be: a A. tangent to the demand curve at the market price, P B. tangent to the demand curve where marginal cost intersects demand C. tangent to the marginal revenue curve at the market price, Pa D. tangent to the marginal revenue curve at the point where marginal cost intersects marginal revenue ANS: A 6. A monopolistically competitive firm chooses: A. price, but output is determined by cartel production quota B. the quantity of output to produce and the price at which it will sell its output C. the quantity of output to produce, but the market determines price D. price, but competition in the market determines the quantity ANS: B 7. If firms in a monopolistically competitive market are earning economic profits, which of the following scenarios would best reflect the change facing incumbent firms as the market adjusts to its new equilibrium? A. a downward shift in their marginal cost curve B. an upward shift in their marginal cost curve C. an increase in demand D. a decrease in demand ANS: D Graph 17-4 8. Refer to Graph 17-4. Which of the panels shown reflects a long-run equilibrium for a firm in a monopolistically competitive market? A. panel a B. panel b C. panel c D. panel d ANS: A 9. Refer to Graph 17-4. Which of the panels shown could not characterise a short-run equilibrium for a firm in a monopolistically competitive market? A. panel a B. panel b C. panel c D. panel d ANS: D 10. Refer to Graph 17-4. Panel b in the set of figures shown is consistent with a firm in a monopolistically competitive market that is: A. incurring economic gains B. in a short-run equilibrium, but not a long-run equilibrium C. in both a short-run and a long-run equilibrium D. in a long-run equilibrium, but not a short-run equilibrium ANS: B 11. Refer to Graph 17-4. Which of the panels shown depicts a firm in a monopolistically competitive market earning economic profits in the short run? A. B. C. D. both panels c and d panel d panel c none of the above ANS: C 12. In the long-run equilibrium, a difference between monopolistically competitive firms and perfectly competitive firms is: A. monopolistically competitive firms produce on the downward sloping section of their ATC curves, while perfectly competitive firms produce at the minimum of ATC B. monopolistically competitive firms set P=MC, while competitive firms set P=MR C. individual firm demand slopes down for monopolistically competitive firms, while market demand is horizontal for perfectly competitive markets D. average total cost is U-shaped for monopolistically competitive firms, while it is downward sloping for perfectly competitive firms ANS: A 13. Hotels in Sydney observe that on most nights, about 80 per cent of their rooms are occupied, with the remainder being empty. This kind of excess capacity is indicative of what kind of market? A. tourist markets B. competitive C. oligopoly D. monopolistically competitive ANS: D 14. A new brewing company announces that it is releasing a new organic ale into the beer market. You can assume that the market for beer is characterised by monopolistic competition. According to the information provided, beer consumers are likely to experience what kind of externality as a result of the new ale? A. product-variety B. business-stealing C. market price D. advertising ANS: A 15. A new brewing company announces that it is releasing a new organic ale into the beer market. You can assume that the market for beer is characterised by monopolistic competition. According to the information provided, existing brewing companies are likely to experience what kind of externality as a result of the new ale? A. product-variety B. competitive C. advertising D. business-stealing ANS: D 16. A new brewing company announces that it is releasing a new organic ale into the beer market. You can assume that the market for beer is characterised by monopolistic competition. According to the information provided, the beer market is likely to be more efficient if the: A. product-variety externality exceeds the business-stealing externality B. business-stealing externality exceeds the product-variety externality C. competitive externality exceeds the advertising externality D. advertising externality exceeds the competitive externality ANS: A 17. Critics of advertising make which of the following claims? (i) advertising is informational rather than psychological (ii) advertising manipulates people’s tastes (iii) advertising costs generally exceed labour costs A. (i) and (ii) only B. (i) only C. (ii) only D. (i), (ii) and (iii) ANS: C 18. If the principal effect of advertising is to decrease the elasticity of demand, the critics argue that firms will be able to: A. lower their advertising budget B. charge a lower mark-up over marginal cost C. increase their advertising budget D. charge a larger mark-up over marginal cost ANS: D 19. Advertisements that appear to convey no information at all: A. are typically ‘infomercials’ B. may still be valuable by their mere existence and expense C. are often useless to consumers D. are general ignored by consumers ANS: B 20. If advertising reduces a consumer’s price sensitivity between identical goods, it is likely to: A. enhance competition and reduce social wellbeing B. enhance competition and increase social wellbeing C. impede competition and increase social wellbeing D. impede competition and reduce social wellbeing ANS: D For the following questions, provide a short answer: SHORT ANSWER SECTION IS REPLACED BY THE CASE STUDY DISCUSSION ADDITIONAL PRACTICE QUESTIONS Note: For the following questions, correct answers are provided at the end of this section. If you provide an incorrect answer, you have to truly understand why your answer is incorrect and why the provided one is correct. Otherwise, no learning takes place. Keep in mind that simply memorizing answers will not help pass the exams. True or False Questions. 1. Firms in monopolistic competition sell products that are identical to those produced by other firms. 2. Like a competitive firm, a monopolistically competitive firm maximises profit by setting P=MC. 3. Excess capacity occurs whenever a firm is operating at an output level below where average total cost is minimised. 4. A price mark-up over marginal cost is inconsistent with market attributes of free entry and zero profit. 5. A firm in a monopolistically competitive market is usually concerned about each additional customer walking through the door, since it will always end up earning additional economic profits. 6. Advertising may impede competition by fostering brand loyalty and allowing firms to increase their mark-up. 7. The Pizza Hut in Agra, India has a very similar menu design, layout and content as the Pizza Hut in Bondi Junction, Sydney. This is an example of a brand name enhancing market efficiency for Australian tourists visiting India. 8. Brand names can improve product quality because firms will want to avoid the financial loss that would follow a fall in reputation. Firms will thus work harder to maintain high quality. 9. Advertising can be used as a signal of product quality, even if the advertisement contains little information about the product. 10. In the short run, a firm in a monopolistically competitive market operates much like a monopolist. Multiple Choice questions 11. The reason that monopoly remains a root-word for monopolistically competitive market is because of: A. strategic interactions among sellers B. there being many sellers C. sellers being price makers rather than price takers D. the homogeneous products that are produced 12. In equilibrium, product differentiation in monopolistically competitive markets ensures that: A. price will exceed marginal cost B. price will equal marginal cost C. average revenue will equal marginal revenue D. average variable cost will be declining 13. In the market for hotel rooms in large metropolitan markets, the cost of a single night’s stay can be several times higher than that of a similar room in a suburban market. If the market for hotel rooms is characterised by monopolistic competition, this difference in price can be partially explained by: A. a higher cost for accommodations to compensate for the lower cost of airfare into metropolitan markets B. the mark-up of price over a higher marginal cost in large metropolitan markets C. the cost of living in a large city D. transportation access 14. The administrative burden of regulating price in a monopolistically competitive market is: A. large because there are a large number of firms that produce differentiated products B. small due to economies of scale C. large because price is usually below marginal cost D. small because firms produce at under-capacity 15. Suppose a firm enters a monopolistically competitive market with a new product. Consumers now have more choice. This increase in choice means that: A. a product-variety externality has occurred B. an advertising externality has occurred C. consumers are now worse off as they must visit more shops D. consumers are likely to experience negative consumption externalities 16. Advertising will be more common in markets that are: A. homogenous B. expensive C. industrial D. highly differentiated 17. You intend travelling to Shanghai, China, to market truck-parts to local manufacturers. Your travel agent provides a list of 120 local hotels and a Sheraton. In this case, the Sheraton brand-name is likely to be used as a signal of: A. quality when quality cannot be easily judged B. perceived differences that are not likely to exist among your various options C. inefficiency in markets characterised by recognisable brand names D. the quality of general lodging accommodations in Shanghai Short Answer Questions 18. For many years, Pepsi operated a ‘taste-test’ booth across the US. 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, instead relying on celebrity endorsements and other forms of advertising. What advertising theory do you think now dominates the market between Pepsi and Coke? Explain. Answers Answers to True/False and Multiple Choice Questions 1. ANS: 2. ANS: short-run 3. ANS: 4. ANS: 5. ANS: 6. ANS: 7. ANS: 8. ANS: 9. ANS: 10. ANS: short run 11. ANS: 12. ANS: 13. ANS: 14. ANS: society 15. ANS: society 16. ANS: 17. ANS: F F Introduction The monopolistically competitive firm in the T F T T T T T T Excess capacity Mark-up over marginal cost Introduction Brand names Brand names Brand names Advertising as a signal of quality The monopolistically competitive firm in the C A B A Introduction Introduction Mark-up over marginal cost Monopolistic competition and the welfare of A Monopolistic competition and the welfare of D A Advertising Brand names Answers to Short Answer Questions 18. ANS: The taste-test used the ‘advertising as information’ theory of advertising. Celebrity endorsement is an example of the ‘advertising as a signal of quality’ theory of advertising.