Problem set 9 OLIGOPOLY The following table shows the four topic sections of this chapter and the associated study guide problems that pertain to each topic section. Section Topic 1 Oligopoly Problems M1-M7, S1-S3, L1-L3. 2 Quantity Competition Problems M8-M13, S4-S5, L4-L5. 3 Price Competition Problems M14-M18, S6-S9, L6-L7. 4 Other Dimensions of Competition Problems M19-M20, L8-L9. Multiple Choice M1 In an oligopolistic market, The profits of the leading firms are interdependent.A few firms sell to a few large buyers.Numerous firms compete for a market of fixed size.A few large firms dominate the market.Answers a and d are both correct. M2 In a particular market, price exceeds average cost over an extended interval of time. This suggests that the market Has few barriers to entry.Has numerous small competitors.Is an oligopoly.Is characterized by monopolistic competition.Is perfectly competitive. M3 As usually defined, market power is the ability of a firm to Increase significantly its market share.Innovate faster than its rivals.Raise price significantly above the competitive level.Enjoy economies of scale in production.Answers a, b, and c are all correct. M4 An industry with a four-firm concentration ratio of 40% or less is A tight oligopoly.A loose oligopoly.A newly evolving industry.Effectively competitive.Answers c and d are both correct. M5 Five firms, each with a 20% market share, supply a market. The Herfindahl-Hirschman Index is 2,000.20%.100%.A value between 1,000 and 10,000.There is not enough information to answer. M6 By acquiring smaller rivals, Airline A now controls over 90 percent of all flights to and from its major hub airport. Following these mergers, the airline’s average ticket prices increased (though air travel prices were generally falling in comparable markets). This result suggests the market for air travel to and from A’s hub Is monopolistically competitive.Has been monopolized.Has become more competitive due to oligopolistic rivalries.Exhibits few barriers to entry.Suffers from decreasing returns to scale. M7 Statistical studies confirm that Greater market concentration is associated with higher prices.Lower market concentration is associated with higher pricesThere is no association between market concentration and prices.Industry profits are inversely related to market concentration.Greater market concentration is associated with increasing average cost. M8 Price leadership assumes that Firms struggle to assume the lead in setting price.One firm is able to set price for the entire industry.The lowest-cost firm establishes the market price.Several firms agree explicitly to set price at the monopoly level.No firm can control the market; the “invisible hand” leads to an efficient price. M9 A price leader’s net demand curve Is total market demand minus the supply of smaller rival suppliers.Is more inelastic than total market demand.Becomes more elastic as the number of rival suppliers increases.Presumes that rival suppliers set prices independently.Answers a and c are both correct. M10 In the Cournot model of oligopoly, firms Seek to gain market share, while not competing on price.Seek to gain a price advantage, frequently leading to price wars.Face kinked demand curves and rarely alter their prices.Sell differentiated products, so price competition is blunted.Answers a and d are both correct. M11 To maximize profit, an oligopolist will produce a level of output Consistent with the principle of cost minimization.At a price that is equal to MC.Where MR = MC.At a price that is equal to MR.Where LAC = LMC. M12 In general, as the number of firms in an oligopoly industry increases, each firm Increases its level of output.Sees its economic profit decrease.Raises its price but sells less output.Reduces its level of output.Answers b and d are both correct. M13 The kinked demand curve faced by oligopolistic firms is one important reason for Price rigidity.Fluctuating prices.Frequent price wars.The relative stability of marginal cost.Downward sloping marginal revenue. M14 Under quantity competition, if a rival increases its output level, The firm should increase its output as well.The firm’s demand curve and its MR are adversely affected.There is no effect on the firm’s optimal price.The rival enjoys economies of scale.Answers a and b are both correct. M15 A price war is likely to occur when Any firm’s price change causes large market share swings.Some oligopolists irrationally cut prices.It is more profitable to match a price cut than to be undercut.Competing firms sell differentiated products.Answers a and c are both correct. M16 In the paradigm of the prisoner’s dilemma, Pursuit of each person’s self-interest leads to a poor group outcome.Participants’ interests are strictly opposed.Cooperation is achieved by the freedom to communicate.Mutual interests can be achieved provided there is a binding agreement.Answers a and d are both correct. M17 Under Bertrand price competition, The lowest price firm claims the entire market.There is the danger that the firms rigidly adhere to high prices.The result can lead to the perfectly competitive outcome.Answers a and c are both correct.Market shares are relatively stable. M18 Which of the following is not a reason to cut price? Market skimming.The Learning curve.A reduction in the firm’s fixed cost.Boosting sales of related products.Strategic response to rivals’ price cuts. M19 High advertising spending by oligopolists is likely to be profitable if it Helps buyers compare competing products.Is spread over multiple brands.Generates some additional sales.Reduces the cross-price elasticity of demand.Answers a and d are both correct. M20 Competition involves strategic complements when One firm’s best response varies in the same direction as its rival’s behavior.Competing goods are very close substitutes for one another.One firm’s best response varies inversely with its rival’s behavior.Firms have many choices – price, quantity, advertising – as to how to compete.Answers a, b, and d are all correct. Short Problems and Questions S1 Define concentration ratio and explain its advantages and disadvantages in measuring the degree of market competition. S2 In a $100 million market, the four largest firms have sales of $40 million, $28 million, $15 million, and $5 million, respectively. a. Compute the four-firm concentration ratio. Is the industry an oligopoly? Explain. b. The remaining sales are accounted for by 6 firms with sales of $2 million each. Compute the Herfindahl-Hirschman Index for this industry. S3 Statistical evidence suggests that concentrated industries have higher profits than competitive industries. Is this necessarily harmful to consumer interests? S4 What conditions must prevail in a market if a dominant firm is to be a successful price leader? If the four largest firms in the market each have 15% to 20% market shares, can price leadership still occur? S5 In the Cournot model of quantity competition, duopolists compete for a market where demand is described by: P = 120 – (Q1 + Q2). For each firm, MC = AC = 30. a. Find the equilibrium outputs of the firms, the resulting market price, and the firms’ profits. b. Suppose the firms decide to form a cartel. Determine the optimal total output of the cartel and the cartel’s total profit. Is the cartel advantageous for the firms? S6 For each payoff table, determine each oligopolist’s most profitable price. Firm 2 Firm 1 High PriceLow Price High Price 10, 105, 14 Low Price 13, 67, 9 b. Firm 2 Firm 1 High PriceLow Price High Price 10, 1014, 6 Low Price 6, 137, 9 c. Firm 2 Firm 1 High PriceLow Price High Price 10, 108, 14 Low Price 6, 87, 11 S7 What are the assumptions of the kinked demand curve model? Is the model realistic? S8 What are the assumptions of the Bertrand model of oligopoly? How realistic are they? S9 In the Bertrand model of oligopoly, two competing firms produce the same (identical) good. Firm 1 has a marginal cost of $5, while firm 2 has a marginal cost of $4. What price will prevail in the market? Will both firms survive in the market? Explain. Longer Problems and Discussion Questions L1 In what sense are firms interdependent in oligopolies? Give three examples of the types of interdependence that might occur. L2 The Antitrust Division of the Department of Justice carefully scrutinizes many proposed mergers. Explain why? L3 Compare the concentration ratio and the Herfindahl-Hirschman Index as alternative measures of the degree of monopoly prevailing in a given industry. What are the main advantages of the HHI? L4 What are the assumptions of the kinked demand curve model? What is its main conclusion about oligopoly behavior? L5 Is it likely that oligopolistic firms will be in both a kinked demand curve situation and also engage in price leadership? Why or why not? L6 In an oligopolistic market, if firms produce substitutable goods (like oil for instance), there can be a high degree of competition. Explain how the firms might benefit from forming a cartel (compared to both Cournot and Bertrand competition). Why might government authorities prohibit such cartels? L7 During your summer vacation, you have decided to sell ice cream from a portable stand along a beachfront. Another vendor has already set up a stand to sell ice cream there at a spot in the exact midpoint of the beach. Where should you locate your ice cream stand to attain maximum customers and profit? L8 a. How does advertising serve as an entry barrier? b. How does advertising increase consumer well being? Suppose that other firms in the industry in which you sell spend a large portion of revenue on advertising. What should you do? Explain. L9 Compare and contrast equilibrium profitability for strategic substitutes versus strategic complements.
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