Economics

Please complete on first page of document Questions for Review #1,5-7 Problems and Applications # 1-4. On second page of document Questions for Review #2-4, 7,8 and Problems and Applications on third page #2 only. Thank you

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1. Describe the three attributes of monopolistic
competition. How is monopolistic competi-
tion like monopoly? How is it like perfect
competition?

2. Draw a diagram depicting a firm that is mak-
ing a profit in a monopolistically competitive
market. Now show what happens to this firm
as new firms enter the industry.

3. Draw a diagram of the long-run equilibrium in
a monopolistically competitive market. How is
price related to average total cost? How is price
related to marginal cost?

1. Among monopoly, oligopoly, monopolistic
competition, and perfect competition, how
would you classify the markets for each of the
following drinks?
a. tap water
b. bottled water
c. cola
d. beer

2. Classify the following markets as perfectly
competitive, monopolistic, or monopolistically
competitive, and explain your answers.
a. wooden no. 2 pencils
b. copper
c. local telephon~ service
d. peanut butter
e. lipstick

3: For each of the following characteristics, say
whether it describes a perfectly competitive
firm, a monopolistically competitive fimi, both,
or neither.
a. Sells a product differentiated from that of its

competitors
b. Has marginal revenue less than price

4. Does a monopolistic competitor produce too
much or too little output compared to the most
efficient level? What practical considerations
it difficult for policymakers to solve this problem~

5. How might advertising reduce economic
well-being? How might advertising increase
economic well-being?

6. How might advertising with no apparent
mational content in fact convey information to
consumers?

7. Explain two benefits that might arise from the
existence of brand names.

c. Earns economic profit in the long run
d. Produces at the minimum of average total

cost in the long run
e. Equates marginal revenue and marginal cost
f. Charges a price above marginal cost

4. For each of the following characteristics, say
whether it describes a monopoly firm, a monopo-
istically competitive firm, both, or neither,
a. Faces a downward-sloping demand curve
b. Has marginal revenue less than price
c. Faces the entry of new firms selling similar

products
d: Earns economic profit in the long run
e. Equates marginal revenue and marginal cost
f. Produces the socially efficient quantity of

output
5. You are hired as the consultant to a monopo-

listically competitive firm. The firm reports the
following information about its price, marginal
cost, and average total cost. Can the firm possi-
bly be maximizing profit? H not, what should it
do to increase profit? If the firm is profit maxi-
mizing, is the firm in a long-run equilibrium?

368 PARTV
FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY

the prisoners’ dilemma shows why oligopolies can fail to maintain cooperation,
even when cooperation is in their best interest.

Policymakers regulate the behavior of oligopolists through the antitrust laws.
The proper scope of these laws is the subject of ongoing controversy. Although
price fixing among competing firms clearly reduces economic welfare and should
be illegal, some business practices that appear to reduce competition may have
legitimate if subtle purposes. As a result, policymakers need to be careful when
they use the substantial powers of the antitrust laws to place limits on firm behavior.

• Oligopolists maximize their total profits by
forming a cartel and acting like a monopolist.
Yet, if oligopolists make decisions about
production levels individually, the result is a
greater quantity and a lower price than under
the monopoly outcome. The larger the number
of firms in the oligopoly, the closer the quantity
and price will be to the levels that would prevail
under perfect competition.

• The prisoners’ dilemma shows that self-
interest can prevent people from maintaining

cartel, p. 351

cooperation, even when cooperation is in
mutual interest. The logic of the prisoners’
dilemma applies in many situations, including
arms races, common-resource problems, and
oligopolies.

• Policymakers use the antitrust laws to prevent
oligopolies from engaging in behavior. that
reduces competition. The application of these
laws can be controversial, because some behavior
that can appear to reduce competition may in
fact have legitimate busiriess purposes.

oligopoly, p. 349
game theory, p. 349
collusion, p. 351 Nash equilibrium, p. 353

prisoners’ dilemma, p. 355

dominant strategy, p. 356

1. If a grOup of sellers could form a cartel,
what quantity and price would they try
to set?

2. Compare the quantity and price of an oligopoly
to those of a monopoly.

3. Compare the quantity and price of an oligopoly
to those of a competitive market.

4. How does the number of firms in an oligopoly
affect the outcome in its market?

5. What is the prisoners’ dilemma, and what does
it have to do with oligopoly?

6. Give two examples other than oligopoly that
show how the prisoners’ dilemma helps to
explain behavior.

7. What kinds of behavior do the antitrust laws
prohibit?

8. What is resale price mairitenance, and why is it
controversial?

1. A large share of the world supply of diamonds
comes from Russia and South Africa. Suppose
that the marginal cost of mining diamonds
is constant at $1,000 per diamond, and the
demand for diamonds is described by the
following schedule:

Price Quantity

$8,000 · 5,000 diamonds
7,000 6,000
6,000 7,000
5,000 8,000
4,000 9,000
3,000 10,000
2,000 11,000
1,000 12,000

a. If there were many suppliers of diamonds,
what woulq be the price and quantity?

b. If there were only one supplier of diamonds,
what would be the price and quantity?

c. If Russia and South Africa formed a cartel,
what would be the price and quantity? If
the countries split the market evenly, what
would be South Africa’s production and
profit? What would happen to South Africa’s
profit if it increased its production by 1,000
while Russia stuck to the cartel agreement?

d. Use your answers to part (c) to explain why
cartel agreements are often not successful.

The New York Times (Nov. 30, 1993) reported
that “the inability of OPEC to agree last week
to cut production has sent the oil market into
turmoil … [leading to] the lowest price for
domestic crude oil since June 1990.”
a. Why were the members of OPEC trying to

agree to cut production?
b. Why do you suppose OPEC was unable to

agree on cutting production? Why. did the oil
market go into “turmoil” as a result?

c. The newspaper also noted OPEC’s view “that
producing nations outside the organization,
like Norway and Britain, should do their
share and cut production.” What does
the phrase “do their share” suggest about
OPEC’s desired relationship with Norway
and Britain?

This chapter discusses companies that are
oligopolists in the market for the goods they

sell. Many of the same ideas apply to companies
that are oligopolists in the market for the inputs
they buy.
a. If sellers who are oligopolists try to increase

the price of goods they sell, what is the goal
of buyers who are oligopolists? ·

b. Major league baseball team own~ have
an oligopoly in the market for baseball
players. What is the owners’ goal-regarding
players’ salaries? Why is’ this goal difficult
to achieve?

c. Baseball players went on strike in 1994
because they would not accept the salary
cap that the owners wanted to impose. If the
owners were already colluding over salaries,
why did the owners feel the need for a salary
cap?

4. Consider trade relations between the United
States and Mexico. Assume that the leaders
of the two countries believe the payoffs to
alternative trade policies are as follows:

Low
Tariffs

High
Tariffs

Low Tariff$ High Tariffs

a. What is the dominant strategy for the United
States? For Mexico? Explain.

b. Define Nash equilibrium. What is the Nash
equilibrium for trade policy?

c. In 1993, the U.S. Congress ratified the North
American Free Trade Agreement, in which
the United States and Mexico agreed to
reduce trade barriers simultaneously. Do the
perceived payoffs shown here justify this
approach to trade policy? Explain.

d. Based on your understanding of the gains
from trade (discussed in Chapters 3 and 9),
do you think that these payoffs actually
reflect a nation’s welfare under the four
possible outcomes?

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