CFA 16: The Firm & Market Structures

A company doing business in a monopolistically competitive market will most likely maximize profits when its output quantity is set such that: average cost is minimized. marginal revenue equals average cost. marginal revenue equals marginal cost.

C is correct. The profit maximizing choice is the level of output where marginal revenue equals marginal cost.

Aquarius, Inc. is the dominant company and the price leader in its market. One of the other companies in the market attempts to gain market share by undercutting the price set by Aquarius. The market share of Aquarius will most likely: increase. decrease. stay the same.

A is correct. As prices decrease, smaller companies will leave the market rather than sell below cost. The market share of Aquarius, the price leader, will increase.

A market structure with relatively few sellers of a homogeneous or standardized product is best described as: oligopoly. monopoly. perfect competition.

A is correct. Few sellers of a homogeneous or standardized product characterizes an oligopoly.

Companies most likely have a well-defined supply function when the market structure is: oligopoly. perfect competition. monopolistic competition.

B is correct. A company in a perfectly competitive market must accept whatever price the market dictates. The marginal cost schedule of a company in a perfectly competitive market determines its supply function.

Over time, the market share of the dominant company in an oligopolistic market will most likely: increase. decrease. remain the same.

B is correct. The dominant company's market share tends to decrease as profits attract entry by other companies.

An analyst gathers the following market share data for an industry: Company Sales (in millions of €) ABC 300 Brown 250 Coral 200 Delta 150 Erie 100 All others 50 The industry's four-company concentration ratio is closest to: 71%. 86%. 95%.

B is correct. The top four companies in the industry comprise 86 percent of industry sales: (300 + 250 + 200 + 150)/(300 + 250 + 200 + 150 + 100 + 50) = 900/1050 = 86%.

A government entity that regulates an authorized monopoly will most likely base regulated prices on: marginal cost. long run average cost. first degree price discrimination.

B is correct. This allows the investors to receive a normal return for the risk they are taking in the market.

Oligopolistic pricing strategy most likely results in a demand curve that is: kinked. vertical. horizontal.

A is correct. The oligopolist faces two different demand structures, one for price increases and another for price decreases. Competitors will lower prices to match a price reduction, but will not match a price increase. The result is a kinked demand curve.

One disadvantage of the Herfindahl-Hirschmann Index is that the index: is difficult to compute. fails to reflect low barriers to entry. fails to reflect the effect of mergers in the industry.

B is correct. The Herfindahl-Hirschmann Index does not reflect low barriers to entry that may restrict the market power of companies currently in the market.

In an industry comprised of three companies, which are small-scale manufacturers of an easily replicable product unprotected by brand recognition or patents, the most representative model of company behavior is: oligopoly. perfect competition. monopolistic competition.

B is correct. The credible threat of entry holds down prices and multiple incumbents are offering undifferentiated products.

If companies earn economic profits in a perfectly competitive market, over the long run the supply curve will most likely: shift to the left. shift to the right. remain unchanged.

B is correct. The economic profit will attract new entrants to the market and encourage existing companies to expand capacity.

The demand schedule in a perfectly competitive market is given by P = 93 - 1.5Q (for Q ≤ 62) and the long-run cost structure of each company is: Total cost: 256 + 2Q + 4Q2 Average cost: 256/Q + 2 + 4Q Marginal cost: 2 + 8Q New companies will enter the market at any price greater than: 8. 66. 81.

B is correct. The long-run competitive equilibrium occurs where MC = AC = P for each company. Equating MC and AC implies 2 + 8Q = 256/Q + 2 + 4Q. Solving for Q gives Q = 8. Equating MC with price gives P = 2 + 8Q = 66. Any price above 66 yields an economic profit because P = MC > AC, so new companies will enter the market.

Market competitors are least likely to use advertising as a tool of differentiation in an industry structure identified as: monopoly. perfect competition. monopolistic competition.

B is correct. The product produced in a perfectly competitive market cannot be differentiated by advertising or any other means.

An analyst gathered the following market share data for an industry comprised of five companies: Company Market Share (%) Zeta 35 Yusef 25 Xenon 20 Waters 10 Vlastos 10 The industry's three-firm Herfindahl-Hirschmann Index is closest to: 0.185. 0.225. 0.235.

B is correct. The three-firm Herfindahl-Hirschmann Index is 0.352 + 0.252 + 0.202 = 0.225.

Collusion is less likely in a market when: the product is homogeneous. companies have similar market shares. the cost structures of companies are similar.

B is correct. When companies have similar market shares, competitive forces tend to outweigh the benefits of collusion.

SigmaSoft and ThetaTech are the dominant makers of computer system software. The market has two components: a large mass-market component in which demand is price sensitive, and a smaller performance-oriented component in which demand is much less price sensitive. SigmaSoft's product is considered to be technically superior. Each company can choose one of two strategies: Open architecture (Open): Mass market focus allowing other software venders to develop products for its platform. Proprietary (Prop): Allow only its own software applications to run on its platform. Depending upon the strategy each company selects, their profits would be: The Nash equilibrium for these companies is: proprietary for SigmaSoft and proprietary for ThetaTech. open architecture for SigmaSoft and proprietary for ThetaTech. proprietary for SigmaSoft and open architecture for ThetaTech.

C is correct. In the Nash model, each company considers the other's reaction in selecting its strategy. In equilibrium, neither company has an incentive to change its strategy. ThetaTech is better off with open architecture regardless of what SigmaSoft decides. Given this choice, SigmaSoft is better off with a proprietary platform. Neither company will change its decision unilaterally.

A market structure characterized by many sellers with each having some pricing power and product differentiation is best described as: oligopoly. perfect competition. monopolistic competition.

C is correct. Monopolistic competition is characterized by many sellers, differentiated products, and some pricing power.

Upsilon Natural Gas, Inc. is a monopoly enjoying very high barriers to entry. Its marginal cost is $40 and its average cost is $70. A recent market study has determined the price elasticity of demand is 1.5. The company will most likely set its price at: $40. $70. $120.

C is correct. Profits are maximized when MR = MC. For a monopoly, MR = P[1 - 1/Ep]. Setting this equal to MC and solving for P: $40=P[1−1/1.5]=P*0.333P=$120

Deep River Manufacturing is one of many companies in an industry that make a food product. Deep River units are identical up to the point they are labeled. Deep River produces its labeled brand, which sells for $2.20 per unit, and "house brands" for seven different grocery chains which sell for $2.00 per unit. Each grocery chain sells both the Deep River brand and its house brand. The best characterization of Deep River's market is: oligopoly. perfect competition. monopolistic competition.

C is correct. There are many competitors in the market, but some product differentiation exists, as the price differential between Deep River's brand and the house brands indicates.