201 EC Homework No. 5
Answer Key Spring 2007
INSTRUCTIONS: This homework includes Multiple Choice, True/False, and "Short Answer" questions. 1. Please submit answers to multiple-choice questions on a scantron. 2. Answers to True/False and Short Answer questions need to be typed out using a word processor of your choice. All graphs (if any) have to be neatly drawn and labeled - if a graph is unclear then it is incorrect (you are allowed to hand draw your graphs or hand write equations). 3. Paperclip all submitted material and remember to put your name and ID# on all items.
Multiple Choice Questions (2 points each)
1. Which of the following is not a barrier to entry in a monopolized market? *a. A single firm is very large. b. The costs of production make a single producer more efficient than a large number of producers. c. A key resource is owned by a single firm. d. The government gives a single firm the exclusive right to produce some good. 2. A firm whose average total cost continually declines at least to the quantity that could supply the entire market is known as a a. government monopoly. b. perfect competitor. *c. natural monopoly. d. regulated monopoly. 3. A monopolist maximizes profit by producing the quantity at which a. none of these answers. b. marginal cost equals price. c. marginal cost equals demand. d. marginal revenue equals price. *e. marginal revenue equals marginal cost. 4. Which of the following statements about price and marginal cost in competitive and monopolized markets is true? *a. In competitive markets, price equals marginal cost; in monopolized markets, price exceeds marginal cost. b. In competitive markets, price exceeds marginal cost; in monopolized markets, price exceeds marginal cost. c. In competitive markets, price equals marginal cost; in monopolized markets, price equals marginal cost. d. In competitive markets, price exceeds marginal cost; in monopolized markets, price equals marginal cost.
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Figure 1
5. Refer to Figure 1. The profit-maximizing monopolist will choose the price and quantity represented by point a. D. *b. A. c. C. d. B. e. none of these answers. 6. Refer to Figure 1. The profit earned by the profit-maximizing monopolist is represented by the area a. P4ABP2. b. P3DQ20. c. P4AQ10. *d. P4ACP1. e. none of these answers. 7. Refer to Figure 1. The deadweight loss associated with monopoly pricing is represented by the area *a. ABD. b. P2BCP1. c. P4ACP1. d. P4ABP2. e. none of these answers. 8. Refer to Figure 1. The efficient price and quantity are represented by point a. B. *b. D. c. A. d. C. e. none of these answers. 9. The inefficiency associated with monopoly is due to a. the monopoly's profits. *b. underproduction of the good. c. the monopoly's losses. d. overproduction of the good. 10. Compared to a perfectly competitive market, a monopoly market will usually generate a. higher prices and higher output. *b. higher prices and lower output. c. lower prices and lower output. d. lower prices and higher output.
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11. The monopolist's supply curve a. is the upward-sloping portion of the average variable cost. b. is the upward-sloping portion of the average total cost curve. c. is the marginal cost curve above average total cost. d. is the marginal cost curve above average variable cost. *e. does not exist. 12. Using government regulations to force a natural monopoly to charge a price equal to its marginal cost will *a. cause the monopolist to exit the market. b. attract additional firms to enter the market. c. improve efficiency. d. raise the price of good. 13. The purpose of antitrust laws is to *a. increase competition in an industry by preventing mergers and breaking up large firms. b. regulate the prices charged by a monopoly. c. increase merger activity to help generate synergies that reduce costs and raise efficiency. d. create public ownership of natural monopolies. e. do all of these answers. 14. If regulators break up a natural monopoly into many smaller firms, the cost of production a. will remain the same. b. will fall. c. could either rise or fall depending on the elasticity of the monopolist's supply curve. *d. will rise. 15. A monopoly is able to continue to generate economic profits in the long run because a. the monopolist is financially powerful. b. all of these answers c. potential competitors sometimes don't notice the profits. *d. there is some barrier to entry to that market. e. antitrust laws eliminate competitors for a specified number of years. 16. Which of the following is not a characteristic of a monopolistically competitive market? a. free entry and exit b. many sellers *c. long-run economic profits d. differentiated products 17. Which of the following products is least likely to be sold in a monopolistically competitive market? a. video games b. breakfast cereal c. beer *d. cotton 18. Which of the following is true regarding the similarities and differences in monopolistic competition and monopoly? a. Both the monopolist and the monopolistic competitor operate at the efficient scale. b. The monopolist faces a downward-sloping demand curve while the monopolistic competitor faces an elastic demand curve. *c. The monopolist makes economic profits in the long run while the monopolistic competitor makes zero economic profits in the long run. d. The monopolist charges a price above marginal cost while the monopolistic competitor charges a price equal to marginal cost.
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19. In the short run, if the price is above average total cost in a monopolistically competitive market, the firm makes *a. profits and firms enter the market. b. losses and firms enter the market. c. losses and firms exit the market. d. profits and firms exit the market. Figure 2
20. If the monopolistic competitor described by Figure 2 is producing at the profit-maximizing (lossminimizing) level of output, it a. could be generating either profits or losses depending on what quantity it chooses to produce. b. is generating profits. *c. is generating losses. d. is generating zero profits. 21. The monopolistically competitive market shown in Figure 2 will, in the long run, a. attract new producers into the market, which will shift the demand faced by incumbent firms to the right. *b. cause producers to exit the market, which will shift the demand faced by incumbent firms to the right. c. attract new producers into the market, which will shift the demand faced by incumbent firms to the left. d. cause producers to exit the market, which will shift the demand faced by incumbent firms to the left. 22. Which of the following is true with regard to monopolistically competitive firms' scale of production and pricing decisions? Monopolistically competitive firms produce a. with excess capacity and charge a price equal to marginal cost. *b. with excess capacity and charge a price above marginal cost. c. at the efficient scale and charge a price equal to marginal cost. d. at the efficient scale and charge a price above marginal cost. 23. One source of inefficiency in monopolistic competition is that a. monopolistically competitive firms earn economic profits in the long run. b. monopolistically competitive firms produce beyond their efficient scale. c. since price is above marginal cost, surplus is redistributed from buyers to sellers. *d. since price is above marginal cost, some units are not produced that buyers value in excess of the cost of production and this causes a deadweight loss.
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24. When firms enter a monopolistically competitive market and the business-stealing externality is larger than the product-variety externality, then a. the number of firms in the market is optimal and the market is efficient. *b. there are too many firms in the market and market efficiency could be increased if firms exited the market. c. there are too few firms in the market and market efficiency could be increased with additional entry. d. the only way to improve efficiency in this market is for the government to regulate it like a monopoly. natural 25. The use of the word "monopoly" in the name of the market structure called "monopolistic competition" refers to the fact that *a. a monopolistically competitive firm faces a downward-sloping demand curve for its differentiated product and so does a monopolist. b. monopolistically competitive firms produce beyond their efficient scale and so do monopolists. c. monopolistically competitive markets have free entry and exit just like a monopolistic market. d. monopolistically competitive firms charge prices equal to their marginal costs just like monopolists. 26. Which of the following is not put forth as a criticism of advertising and brand names? *a. Advertising increases competition, which causes unnecessary bankruptcies and layoffs. b. Advertising manipulates people's tastes to create a desire that otherwise would not exist. c. All of these answers are criticisms of advertising and brand names. d. Brand names cause consumers to perceive differences between goods that do not exist. e. Advertising increases brand loyalty, causes demand to be more inelastic and, thus, increases markup over marginal cost. 27. Expensive television commercials that appear to provide no specific information about the product being advertised *a. may be useful because they provide a signal to the consumer about the quality of the product. b. should be banned by regulators because they add to the cost of the product without providing the consumer with any useful information about the product. c. are most likely used by firms that are perfect competitors. d. only affect the buying habits of irrational consumers. 28. Which of the following is not an argument put forth by economists in support of the use of advertising? a. Advertising increases competition. b. Advertising provides new firms with the means to attract customers from existing firms. c. Advertising provides information to customers about prices, new products, and location of retail outlets. *d. Advertising provides a creative outlet for artists and writers. 29. Defenders of the use of brand names argue that brand names a. provide information about the quality of the product. b. are useful even in socialist economies such as the former Soviet Union. *c. all of these answers d. give firms incentive to maintain high quality. 30. Which of the following firms has the least incentive to advertise? a. a manufacturer of breakfast cereal b. a restaurant c. a manufacturer of home heating and air conditioning *d. a wholesaler of crude oil
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True/False Questions (2 points each)
INSTRUCTIONS: Please type your answers to true/false questions below using a word processor of your choice. When answering true/false questions, you need to decide whether the following statements are true or false. If you believe that the statement is true, write "True" as an answer and continue on to the next question. If you believe that the statement is false, however, write "False" and provide a short (up to 5 sentences) explanation as to why the statement is false.
1. The most common source of a barrier to entry into a monopolist's market is that the monopolist owns a key resource necessary for production of that good. Answer: FALSE. Owning a scarce resource is the rarest form of barriers to entry. 2. The demand curve facing a monopolist is the market demand curve for its product. Answer: TRUE 3. For the monopolist, marginal revenue is always less than the price of the good. Answer: TRUE 4. The monopolist chooses the quantity of output at which marginal revenue equals marginal cost and then uses the demand curve to find the price that will induce consumers to buy that quantity. Answer: TRUE 5. A monopolist produces an efficient quantity of output but it is still socially inefficient because it charges a price that exceeds marginal cost and the resulting profit is a social cost. Answer: FALSE. The inefficiency generated by a monopoly results from the failure of the monopolist to produce units of output where the value to consumers equals or exceeds the cost of production. The monopolist's profits are not a cost to society but are just a redistribution from consumer to producer surplus. 6. Similar to firms in perfectly competitive markets, firms in monopolistically competitive markets can enter and exit the market without restriction so profits are driven to zero in the long run. Answer: TRUE 7. Both monopolists and monopolistically competitive firms produce the quantity at which marginal revenue equals marginal cost and then use the demand curve facing the firm to determine the price consistent with that quantity. Answer: TRUE 8. Since a monopolistically competitive firm charges a price that exceeds marginal cost, the firm fails to produce some units that the buyers value in excess of the cost of production and, thus, monopolistic competition is inefficient. Answer: TRUE 9. Firms that sell highly differentiated consumer products are more likely to spend a large percentage of their revenue on advertising. Answer: TRUE 10. In the long run, a monopolistically competitive firm produces at the efficient scale while a competitive firm has excess capacity. Answer: FALSE. Monopolistically competitive firms have excess capacity while competitive firms produce at the efficient scale.
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Short Answer Question (20 points total) Please type out all answers
Suppose a firm has a patent on a special process to make a unique smoked salmon. The following table provides information about the demand facing this firm for this unique product. a. Complete the table above. Answer:
b. Plot the demand curve and the marginal revenue curve in Exhibit 1. Answer:
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c. Suppose that there are no fixed costs and that the marginal cost of production of smoked salmon is constant at $6 per pound. (Thus, the average total cost is also constant at $6 per pound.) What is the quantity and price chosen by the monopolist? What is the profit earned by the monopolist? Show your solution on the graph you created in part (b) above. Answer: Q = between 3 and 4 units (say 3.5), P = between $12 and $14, (say $13). Profit = TR TC or profit = (3.5 x $13) (3.5 x $6) = $45.50 $21.00 = $24.50. (Or profit = (P ATC) x Q = ($13 $6) x 3.5 = $24.50.) See Exhibit 6.
d. What is the price and quantity that maximizes total surplus? Answer: 7 units at $6 each. (The efficient solution is where the market produces all units where benefits exceed or equal costs of production which is where demand intersects MC.) e. Compare the monopoly solution and the efficient solution. That is, is the monopolist's price too high or too low? Is the monopolist's quantity too high or too low? Why? Answer: he monopolist's price is too high and quantity produced too low because the monopolist faces a downward-sloping demand curve that makes MR < P. Therefore, when the profit-maximizing monopolist sets MR = MC and the MR curve is below the demand curve, the quantity is less than optimal and the price charged exceeds the MC of production. f. Is there a deadweight loss in this market if the monopolist charges the monopoly price? Explain. Answer: Yes. Units from 3.5 to 7, or an additional 3.5 pounds of salmon are valued by the consumer at values in excess of the $6 per pound MC of production and these units are not produced and consumed when the price is $13. (Deadweight loss = the deadweight loss triangle = 1/2 (7 3.5) x ($13 $6) = $12.25.) g. If the monopolist is able to costlessly and perfectly price-discriminate, is the outcome efficient? Explain. What is the value of consumer surplus, producer surplus, and total surplus? Explain. Answer: Yes, all units are produced where the value to buyers is greater than or is equal to the cost of production (7 units). Total surplus is now producer surplus and there is no consumer surplus. Total surplus and producer surplus is the area under the demand curve and above the price or 1/2($20 $6) x 7 = $49. Consumer surplus = $0.
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