Study Questions for CH12

1) A market with few entry barriers and with many firms that sell differentiated products
is
A) purely competitive.
B) a monopoly.
C) monopolistically competitive.
D) oligopolistic.
Answer: C
2) The most important factor in determining the long-run profit potential in monopolistic
competition is
A) free entry and exit.
B) the elasticity of the market demand curve.
C) the elasticity of the firm's demand curve.
D) the reaction of rival firms to a change in price.
Answer: A
3) Monopolistically competitive firms have monopoly power because they
A) face downward sloping demand curves.
B) are great in number.
C) have freedom of entry.
D) are free to advertise.
Answer: A
4) A monopolistically competitive firm in long-run equilibrium:
A) will make negative profit.
B) will make zero profit.
C) will make positive profit.
D) Any of the above are possible.
Answer: B
5) Which of the following is true for both perfect and monopolistic competition?
A) Firms produce a differentiated product.
B) Firms face a downward sloping demand curve.
C) Firms produce a homogeneous product.
D) There is freedom of entry and exit in the long run.
Answer: D
6) Which of the following is true for both perfectly competitive and monopolistically
competitive firms in the long run?
A) P = MC.
B) MC = ATC.
C) P > MR.
D) Profit equals zero.
Answer: D

7) Which of the following is true in long-run equilibrium for a firm in monopolistic

competition?
A) MC = ATC.
B) MC > ATC.
C) MC < ATC.
D) Any of the above may be true.
Answer: C
Review Figure 12.1 panel (b) on page 445 that shows L-R eq.
8) Excess capacity in monopolistically competitive industries results because in
equilibrium
A) each firm's output level is too great to minimize average cost.
B) each firm's output level is too small to minimize average cost.
C) firms make positive economic profit.
D) price equals marginal cost.
Answer: B
9) Although firms earn zero profits in the long run, why is the outcome from
monopolistic competition considered to be inefficient?
A) Price exceeds marginal cost.
B) Quantity is lower than the perfectly competitive outcome.
C) Goods are not identical.
D) A and B are correct.
E) B and C are correct.
Answer: D
10) The market structure in which strategic considerations are most important is
A) monopolistic competition.
B) oligopoly.
C) pure competition.
D) pure monopoly.
Answer: B
11) In the Cournot duopoly model, each firm assumes that
A) rivals will match price cuts but will not match price increases.
B) rivals will match all reasonable price changes.
C) the price of its rival is fixed.
D) the output level of its rival is fixed.
Answer: D
12) A situation in which each firm selects its best action, given what its rivals are doing,
is called a
A) Nash equilibrium.
B) Cooperative equilibrium.
C) Stackelberg equilibrium.
D) zero sum game.
Answer: A

13) In the __________, each firm treats the output of its competitor as fixed and then
decides how much to produce.
A) Cournot model
B) model of monopolistic competition
C) Stackelberg model
D) kinked-demand model
E) none of the above
Answer: A
14) A __________ shows how much a firm will produce as a function of how much it
thinks its competitors will produce.
A) contract curve
B) demand curve
C) reaction curve
D) Nash equilibrium curve
E) none of the above
Answer: C
15) In comparing the Cournot equilibrium with the competitive equilibrium,
A) both profit and output level are higher in Cournot.
B) both profit and output level are higher in the competitive equilibrium.
C) profit is higher, and output level is lower in the competitive equilibrium.
D) profit is higher, and output level is lower in Cournot.
Answer: D
16) Suppose mountain spring water can be produced at no cost and that the demand and
marginal revenue curves for mountain spring water are given as follows:
Q = 6000 - 5P MR = 1200 - 0.4Q
What is the profit maximizing price of a monopolist?
A) $400
B) $600
C) $800
D) $900
E) none of the above
Answer: B
17) The Cournot equilibrium can be found by treating __________ as a pair of
simultaneous equations and by finding the combination of Q1 and Q2 that satisfy both
equations.
A) the reaction curves for firms 1 and 2
B) the market supply curve and the market demand curve
C) the contract curve and the market demand curve
D) the contract curve and the market supply curve
E) the firm's supply curve and the firm's demand curve
Answer: A

18) The oligopoly model that is most appropriate when one large firm usually takes the
lead in setting price is the __________ model.
A) Cournot
B) Stackelberg
C) game theory
D) prisoner's dilemma
Answer: B
19) What is one difference between the Cournot and Stackelberg models?
A) In Cournot, both firms make output decisions simultaneously, and in Stackelberg, one
firm sets its output level first.
B) In Stackelberg, both firms make output decisions simultaneously, and in Cournot, one
firm sets its output level first.
C) In Cournot, a firm has the opportunity to react to its rival.
D) Profits are zero in Cournot and positive in Stackelberg.
Answer: A
20) In the Stackelberg model, there is an advantage
A) to waiting until your competitor has committed herself to a particular output level
before deciding on your output level.
B) to being the first competitor to commit to an output level.
C) to the firm with a dominant strategy.
D) to producing an output level which is identical to a monopolist's output level.
Answer: B
21) Which one of the following statements is a common criticism of the original Bertrand
duopoly model?
A) Firms never choose optimal prices as strategic variables.
B) Firms would more naturally choose quantities if goods are homogenous.
C) The assumption that market share is split evenly between the firms is unrealistic.
D) A and B are correct.
E) B and C are correct.
Answer: E
22) Is there a first-mover advantage in the Bertrand duopoly model with homogenous
products?
A) Yes, first-movers always hold the advantage over other firms.
B) Yes, first-movers may have an advantage, but it depends on the model assumptions.
C) No, first-movers cannot choose a profit maximizing quantity because the secondmover can always produce a bit less and earn higher profits.
D) No, the second-mover would be able to set a slightly lower price and capture the full
market share.
Answer: D

23) Which oligopoly model(s) have the same results as the competitive model?
A) Cournot
B) Bertrand
C) Stackelberg
D) Both Cournot and Stackelberg
Answer: B
24) In which oligopoly model(s) do firms earn zero profit?
A) Cournot
B) Bertrand
C) Stackelberg
D) Oligopoly firms always earn positive economic profits.
Answer: B
25) In the __________, two duopolists compete by simultaneously selecting price.
A) Cournot model
B) Nash model
C) Bertrand model
D) kinked-demand model
E) none of the above
Answer: C
26) Two firms operating in the same market must choose between a collude price and a
cheat price. Firm A's profit is listed before the comma, B's outcome after the comma.

If each firm tries to choose a price that is best for it, regardless of the other firm's price,
which of these statements is correct?
A) Firm A should charge the collude price, Firm B should charge a cheat price.
B) Firm A should charge a cheat price, Firm B should charge a collude price.
C) Both firms should charge a collude price.
D) Both firms should charge a cheat price.
Answer: D
27) The Prisoners' Dilemma is a particular type of game in which negotiation and
enforcement of binding contracts is not possible, and such games are known as:
A) cooperative games.
B) noncooperative games.
C) collusive games.
D) Cournot games.
Answer: B

28) Consider the following payoff matrix for a game in which two firms attempt to
collude under the Bertrand model:

6,6

Firm B
colludes
24,0

0,24

12,12

Firm B cuts
Firm A cuts
Firm A
colludes

Here, the possible options are to retain the collusive price (collude) or to lower the price
in attempt to increase the firm's market share (cut). The payoffs are stated in terms of
millions of dollars of profits earned per year. What is the Nash equilibrium for this
game?
A) Both firms cut prices.
B) A cuts and B colludes.
C) B cuts and A colludes.
D) Both firms collude.
Answer: A
29) In the kinked demand curve model, if one firm reduces its price
A) other firms will also reduce their price.
B) other firms will compete on a non-price basis.
C) other firms will raise their price.
D) Both A and B are correct.
E) Both B and C are correct.
Answer: A
Scenario 12.2:
You are studying a market for which the kinked demand curve model applies. The
kinked demand curve is as follows:
Q = 1200 - 5P
for 0 Q < 150
Q = 360 - P
for 150 Q
The marginal cost is given as:
MC = Q
30) Refer to Scenario 12.2. What is the profit maximizing level of output?
A) 171.43
B) 120
C) 150
D) all of the above
E) none of the above
Answer: C

31) Refer to Scenario 12.2. What is the profit maximizing price?

A) 205.72
B) 240
C) 210
D) all of the above
E) none of the above
Answer: C
Problems:
1) A firm operating in a monopolistically competitive market faces demand and marginal
revenue curves as given below:
P = 10 - 0.1Q
MR = 10 - 0.2Q
The firm's total and marginal cost curves are:
where P is in dollars per unit, output rate Q is in units per time period, and total cost C is
in dollars.
a. Determine the price and output rate that will allow the firm to maximize profit or
minimize losses.
b. Compute a Lerner index.
Answer:
a. Calculate MR and equate it to MC.
MC = MR
-10 + 0.10Q2 = 10 - 0.2Q
0.1Q2 + 0.2Q - 20 = 0
The quadratic formula yields:
Q1 = 13.17 Q2 = -15.15.
Use Q1 since negative quantities are not meaningful.
At Q1 = 13.17
P = 10 - 0.1(13.17) = 8.68
b. Computation of monopoly power. The Lerner index is computed below:
P - MC
L=
P
At Q = 13.17, P = 8.68, and MC = 7.34
L = (8.68 - 7.34)/8.68 = 0.154

2) Suppose that the market demand for mountain spring water is given as follows:
P = 1200 - Q
Mountain spring water can be produced at no cost.
a. What is the profit maximizing level of output and price of a monopolist?
b. What level of output would be produced by each firm in a Cournot duopoly
in the long run? What will the price be?
Answer:
a. The monopoly level of output is found where marginal revenue equals marginal cost.
The marginal revenue curve has the same price intercept as the demand curve and twice
the slope. Thus:
MR = 1,200 - 2Q
Setting MR equal to MC (which is zero in this problem) yields:
1,200 - 2Q = 0
Q = 600
P = 1,200 - 600 = 600
b. The Cournot equilibrium is found by using the reaction curves of the two firms to
solve for levels of output. The reaction curve for firm 1 is found as follows:
R1 = PQ1 = (1,200 - Q)Q1
= 1,200Q1 - (Q1 + Q2)Q1
= 1,200Q1 - Q12 - Q2Q1
The firm's marginal revenue MR1 is just the incremental revenue R1 resulting from an
incremental change in output Q1:
Setting MR1 equal to zero (the firm's marginal cost) and solving for Q1 yields the
reaction curve for Q1:
Firm 1's Reaction Curve: Q1 = 600 - (1/2)Q2
Going through the same calculations for firm 2 yields:
Firm 2's Reaction Curve: Q2 = 600 - (1/2)Q1
Solving the reaction curves simultaneously for Q1 and Q2 yields:
the total output is 800 and the price will be $400.

Thus