Econ 1, Module 28, 34: Monopoly, Monopolistic Competition

Module 28: If the DeBeers diamond monopoly lowers the price of a diamond from $800 to $750 and sales increase from 4 to 5 diamonds, the price effect is

a decrease in total revenue of $200. → The price effect is a decrease in total revenue of $200 because DeBeers has to lower the price on all units sold. This decreases total revenue by $50 × 4 = $200.

Module 34: The long-run outcome in a monopolistically competitive industry results in

a trade-off between higher average total cost and more product diversity.

Module 28: Because of monopoly, consumers experience _____ than with perfect competition.

higher prices

Module 34: A long-run equilibrium in a monopolistically competitive industry is inefficient because

price is greater than marginal cost. → A long-run equilibrium in monopolistic competition is inefficient because price is greater than marginal cost.

Module 28: A firm that faces a downward-sloping demand curve is a:

price-setter.

Module 28: Suppose that a monopoly computer chip maker increases production from 10 microchips to 11 microchips. If the market price declines from $30 per unit to $29 per unit, marginal revenue for the eleventh unit is:

$19.

Module 28: If the DeBeers diamond monopoly lowers the price of a diamond from $800 to $750 and sales increase from 4 to 5 diamonds, total revenue changes from $_______ to $_______.

3,200; 3,750 → At $800, total revenue is 4 × $800 = $3200. At $750, total revenue is 5 × $750 = $3750.

Module 28: How does a monopoly differ from a perfectly competitive industry with the same costs? I. It produces a smaller quantity. II. It charges a higher price. III. It earns zero economic profit in the long run.

I and II only

Module 34: Which of the following results is possible for a monopolistic competitor in the short run? I. positive economic profit II. normal profit III. loss

I, II, and III

Module 34: Which of the following results is possible for a monopolistic competitor in the long run? I. positive economic profit II. normal profit III. loss

II only

Module 34: Why is it impossible for firms in a monopolistically competitive industry to join together to form a monopoly that is capable of maintaining positive economic profit in the long run?

If all the existing firms in the industry joined together to create a monopoly, they could achieve positive economic profit in the short run. But this would induce new firms to create new, differentiated products and then enter the industry and capture some of the profit. So, in the long run, thanks to the lack of barriers to entry, it would be impossible to maintain such a monopoly.

Module 28: Which statement about monopoly equilibrium and perfectly competitive equilibrium is false?

In the long run, economic profits are driven to zero in both a monopoly and a perfectly competitive market.

Module 34: Suppose a monopolistically competitive industry composed of firms with U-shaped average total cost curves is in long-run equilibrium. For each of the following changes, explain how the industry is affected in the short run and how it adjusts to a new long-run equilibrium. a. a technological change that increases fixed cost for every firm in the industry b. a technological change that decreases marginal cost for every firm in the industry

a. An increase in fixed cost shifts the average total cost curve upward. In the short run, firms incur losses because price is below average total cost. In the long run, some firms will exit the industry, resulting in a rightward shift of the demand curves for those firms that remain, since each firm now serves a larger share of the market. Long-run equilibrium is reestablished when the demand curve for each remaining firm has shifted rightward to the point where it is tangent to the firm's new, higher average total cost curve. At this point each firm's price just equals its average total cost, and each firm makes zero profit. b. A decrease in marginal cost shifts the average total cost curve and the marginal cost curve downward. In the short run, firms earn positive economic profit. In the long run new entrants are attracted into the industry by the profit. This results in a leftward shift of each existing firm's demand curve because each firm now has a smaller share of the market. Long-run equilibrium is reestablished when each firm's demand curve has shifted leftward to the point where it is tangent to the new, lower average total cost curve. At this point each firm's price just equals average total cost, and each firm makes zero profit.

Module 34: Are the following statements true or false? Explain your answers. a. Like a firm in a perfectly competitive industry, a firm in a monopolistically competitive industry is willing to sell a good at any price that equals or exceeds marginal cost. b. Suppose there is a monopolistically competitive industry in long-run equilibrium that possesses excess capacity. All the firms in the industry would be better off if they merged into a single firm and produced a single product, but whether consumers would be made better off by this is ambiguous. c. Fads and fashions are more likely to arise in industries characterized by monopolistic competition or oligopoly than in those characterized by perfect competition or monopoly.

a. False. As illustrated in panel (b) of Figure 34.4, a monopolistically competitive firm sells its output at a price that exceeds marginal cost—unlike a perfectly competitive firm, which sells at a price equal to marginal cost. b. True. Firms in a monopolistically competitive industry could achieve higher profit (monopoly profit) if they all joined together as a single firm with a single product. Because each of the smaller firms possesses excess capacity, a single firm producing a larger quantity would have a lower average total cost. The effect on consumers, however, is ambiguous. They would experience less choice. But if consolidation substantially reduced industry-wide average total cost and increases industrywide output, consumers could experience lower prices with the monopoly. c. True. Fads and fashions are promulgated by advertising and a desire for product differentiation, which are common in oligopolies and monopolistically competitive industries, but not in monopolies or perfectly competitive industries.

Module 34: If a firm operating within monopolistic competition is producing a quantity that generates MC < MR, then the marginal decision rule tells us that profit:

can be increased by increasing production.

Module 34: Which of the following best describes a monopolistic competitor's demand curve?

downward sloping

Module 34: General Snacks is a typical firm in a market characterized by the model of monopolistic competition. If the market is in long-run equilibrium, then the price General Snacks charges for its snack goods would:

equal average total cost.

Module 34: In the short run, if a monopolistically competitive firm has an average total cost curve that lies above the demand curve, then the firm is:

making a loss. → If average cost is above the demand curve, then the firm must be producing at a loss, as the average cost of 1 unit is less than the average revenue.

Module 34: Which of the following is a characteristic of monopolistic competition?

many sellers

Module 34: Suppose a monopolistically competitive firm can increase its profits by decreasing its output. Then it must be the case that at the current output:

marginal revenue is less than marginal cost.

Module 28: The ability of a monopolist to raise the price of a product above the competitive level by reducing the output is known as:

market power