ps6 answers - PROBLEM SET 6 SOLUTIONS ch17 3....

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PROBLEM SET 6 SOLUTIONS ch17 3. Monopolistically competitive firms don't increase the quantity they produce to lower the average cost of production because doing so would require them to lower their price. The loss in revenue from the lower price outweighs the benefits of the lower cost of production. 4. a. Figure 4 illustrates the market for Sparkle toothpaste in long-run equilibrium. The profit-maximizing level of output is Q M and the price is P M . Figure 4 b. Sparkle's profit is zero, since at quantity Q M , price equals average total cost. c. The consumer surplus from the purchase of Sparkle toothpaste is area A + B. The efficient level of output occurs where the demand curve intersects the marginal-cost curve, at Q C . So the deadweight loss is area C, the area above marginal cost and below demand, from Q M to Q C . d. If the government forced Sparkle to produce the efficient level of output, the firm would lose money because average cost would exceed price, so the firm would shut down. If that happened, Sparkle's customers would earn no consumer surplus. 5. Since each firm in a monopolistically competitive market produces a product that is slightly different from other products, a monopolistically competitive market
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has a large number of products. But whether that number is optimal or not depends on two key externalities: the product-variety externality and the business- stealing externality. The product-variety externality is a positive externality to consumers from the introduction of a new product. The business-stealing externality is a negative externality because other firms lose customers and profits from the addition of a new product. Since the entrant doesn't take these externalities into account in deciding whether or not to enter the market, it isn't clear whether the actual number of products will be optimal, above optimal, or below optimal. 9. a. A family-owned restaurant would be more likely to advertise than a family-owned farm because the output of the farm is sold in a perfectly competitive market, in which there is no reason to advertise, while the output of the restaurant is sold in a monopolistically competitive market. b. A manufacturer of cars is more likely to advertise than a manufacturer of forklifts because there is little difference between different brands of industrial products like forklifts, while there are greater perceived differences between consumer products like cars. The possible return to advertising is greater in the case of cars than in the case of forklifts. c. A company that invented a reliable watch is likely to advertise more than a company that invented a less reliable watch that costs the same amount to make because the company with the reliable watch will get many repeat sales over time to cover the cost of the advertising, while the company with the less reliable watch will not. 11.
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ps6 answers - PROBLEM SET 6 SOLUTIONS ch17 3....

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