Department of Economics
University of California
PROBLEM SET 5 ANSWER SHEET
I. TRUE or FALSE or UNCERTAIN and EXPLAIN
Regular and organic whole milk are
differentiated products, whereas 2% and nonfat milk
True: If organic simply eliminates actual or perceived harmful substances from the milk, then we
would expect that if the price was the same for a gallon of the two kinds, then all would choose
In comparison, if price of 2% and nonfat were identical, some may prefer one while other
prefer the other type of milk.
In that case the two varieties of milk would be horizontally
For an individual firm in a monopolistically competitive industry, the firm can earn short-run
economic profits but cannot earn long-run economic profits.
A market that is monopolistically competitive has several key features.
First, each firm
produces a horizontally differentiated product.
Second, consumers allocate their purchases
symmetrically across all available brands.
Third, there are many firms and in the long run, free entry
Because the products are horizontally differentiated, each firm’s demand curve is
rather than flat as in the case of perfect competition, and so each firm operates
much like a monopolist on its demand despite the existence of many competitors.
the short run (which means fixed number of firms in the industry) each firm will earn positive
economic profits as price exceeds average cost.
Over the long run, this will attract new entrants who
will garner their proportionate share of the sales, reducing residual demand facing each incumbent
Entry continues until each firm in the market earns zero profit.
Hence, the firm can earn
positive profits in the short run but, due to free entry, cannot earn profits in the long run.
The higher the interest rate, the easier it is for firms in the same industry to collude on the joint profit
According to the Coase Theorem, in the absence of bargaining costs, if polluters have the right to
pollute, then they will fare better than when recipients of the pollution have right to clean air and
The Coase Theorem states that, regardless of how property rights are assigned with regard to
an externality (i.e., whether the producer of the externality has the right to do so, or whether the
receiver of the externality has the right to be free of it), the allocation of resources will be efficient
when the parties can bargain costlessly with each other.
Put differently, the Coase Theorem states
that the social optimum can result from bargaining between the parties producing and receiving an
externality if property rights are clearly defined.
II. MULTI-PART QUESTIONS