A town has dozens of restaurants, each with a somewhat different menu, atmosphere and location, and new restaurants can open easily. Which market structure does this describe?
Monopolistic competition
✓
Oligopoly
Monopoly
Perfect competition
Correct Answer
Monopolistic competition
Many sellers, products that differ from one another and easy entry are the marks of monopolistic competition. Oligopoly has only a few large firms. Monopoly has a single seller. Perfect competition requires identical products, not differentiated menus and atmospheres.
Category: Monopolistic Competition
Question 2
Which industry is the clearest example of an oligopoly?
Wheat farming
Commercial airlines
✓
Neighborhood restaurants
First-class mail delivery
Correct Answer
Commercial airlines
Commercial air travel is dominated by a few large firms whose decisions affect one another, which is an oligopoly. Wheat farming has many sellers of an identical product, close to perfect competition. Neighborhood restaurants are many sellers of differentiated products, which is monopolistic competition. First-class mail delivery in the United States is a legal monopoly.
Category: Oligopoly Basics
Question 3
A smartphone maker sets its phone apart from rivals by giving it a longer-lasting battery and a sharper camera. Which type of product differentiation is this?
Location
Intangible aspects
Physical features
✓
Buyer perceptions
Correct Answer
Physical features
A longer battery life and a better camera are differences in the product itself, so this is differentiation by physical features. Location differentiation depends on where the good is sold or produced. Intangible aspects include warranties, service and reputation. Buyer perceptions are views shaped by brand names and advertising rather than by real physical differences.
Category: Product Differentiation
Question 4
In blind taste tests shoppers cannot tell two bottled waters apart, yet many insist that one brand tastes purer because of its ads. Which type of product differentiation is this?
Physical features
Location
Intangible aspects
Buyer perceptions
✓
Correct Answer
Buyer perceptions
When the goods are physically alike but advertising and brand image lead buyers to see them as different, the differentiation rests on buyer perceptions. Physical features would require a real difference in the water. Location refers to where the product is sold. Intangible aspects are things like guarantees, service or a reputation for quality attached to the purchase, not beliefs about a physically identical product.
Category: Product Differentiation
Question 5
How do firms in a monopolistically competitive market differ from perfectly competitive firms?
They sell differentiated rather than identical products
✓
They face high barriers to entry
They are too few to ignore each other's choices
They are price takers at the market price
Correct Answer
They sell differentiated rather than identical products
Monopolistically competitive firms sell products that buyers see as distinct, which gives each firm a downward-sloping demand curve. They face high barriers to entry is wrong because entry and exit are easy. They are too few to ignore each other's choices describes oligopoly, not a market with many firms. They are price takers at the market price describes perfectly competitive firms.
Category: Monopolistic Competition
Question 6
How does a monopolistically competitive firm choose its output and price?
It produces where price equals marginal cost
It produces where MR = MC and charges the price on its demand curve
✓
It produces where average total cost is lowest
It charges whatever price its rivals have agreed on
Correct Answer
It produces where MR = MC and charges the price on its demand curve
Like a monopolist, a monopolistically competitive firm faces a downward-sloping demand curve, so it picks the quantity where marginal revenue equals marginal cost and then charges the price buyers will pay for that quantity. Producing where price equals marginal cost is the perfectly competitive rule. Producing where average total cost is lowest is not the profit-maximizing choice. Charging a price its rivals agreed on describes collusion, not monopolistic competition.
Category: Monopolistic Competition
Question 7
A monopolistically competitive pizza shop maximizes profit by selling 40 pizzas at $16 each. Its average total cost at that output is $14. What is its economic profit?
$640
$560
$80
✓
$2
Correct Answer
$80
Profit equals (price - average total cost) x quantity = ($16 - $14) x 40 = $80. $640 is total revenue (40 x $16). $560 is total cost (40 x $14). $2 is the profit per pizza, not total profit.
Category: Monopolistic Competition
Question 8
In the long run, what draws new firms into a monopolistically competitive market?
Losses suffered by existing firms
Rising average costs at existing firms
Agreements among existing firms to share output
Economic profits earned by existing firms
✓
Correct Answer
Economic profits earned by existing firms
Because entry is easy, economic profits signal that new firms can do well and attract them into the market. Losses suffered by existing firms cause exit rather than entry. Rising average costs at existing firms would reduce profits and discourage entry. Agreements among existing firms to share output describe collusion, which would not invite new rivals.
Category: Monopolistic Competition
Question 9
In long-run equilibrium, how does a monopolistically competitive firm's price compare with its average total cost?
Price equals average total cost
✓
Price is above average total cost
Price is below average total cost
Price equals the minimum of marginal cost
Correct Answer
Price equals average total cost
Entry and exit continue until economic profit is zero, which happens when price equals average total cost. Price is above average total cost would mean economic profits that attract more entry. Price is below average total cost would mean losses that push firms to exit. Price equals the minimum of marginal cost is not the long-run condition.
Category: Monopolistic Competition
Question 10
According to the kinked demand curve model, why might an oligopoly firm leave its price unchanged?
Its rivals have signed a contract to hold prices
Raising price loses many sales and cutting it gains few
✓
Government regulators set its price
Its marginal cost is zero at every output
Correct Answer
Raising price loses many sales and cutting it gains few
The model assumes rivals will not follow a price increase, so a firm that raises its price loses many customers, while rivals will match a price cut, so a firm that cuts its price gains few customers. A contract among rivals to hold prices would be illegal collusion, not the kinked demand logic. Government regulators setting the price is not part of the model. A marginal cost of zero at every output is not an assumption of the model.
Category: Kinked Demand
Question 11
At its profit-maximizing output, a monopolistically competitive firm charges $20, but its average total cost is $22. It sells 30 units. What is the result?
A profit of $60
A loss of $2
A loss of $60
✓
A profit of $600
Correct Answer
A loss of $60
Profit equals ($20 - $22) x 30 = -$60, so the firm loses $60. A profit of $60 gets the sign wrong, since price is below average total cost. A loss of $2 is the loss per unit, not the total. A profit of $600 is total revenue (30 x $20), not profit.
Category: Monopolistic Competition
Question 12
Why is a monopolistically competitive firm not allocatively efficient?
Its price is less than its marginal cost
It earns economic profit in the long run
It produces where average total cost is lowest
Its price is greater than its marginal cost
✓
Correct Answer
Its price is greater than its marginal cost
Allocative efficiency requires price, which reflects marginal benefit, to equal marginal cost, but a firm with a downward-sloping demand curve charges a price above marginal cost. Its price is less than its marginal cost is the opposite of what happens. It earns economic profit in the long run is false because entry drives long-run profit to zero. It produces where average total cost is lowest is false and would describe productive efficiency anyway.
Category: Monopolistic Competition
Question 13
Why might the market for large passenger jets have room for only two or three firms?
Economies of scale are large relative to market demand
✓
Each firm faces a horizontal demand curve
Products in the industry are identical
New firms can enter and exit freely
Correct Answer
Economies of scale are large relative to market demand
When average cost keeps falling until output is a large share of the whole market, only a few firms can produce at a competitive cost. Each firm faces a horizontal demand curve describes perfect competition. Products in the industry are identical does not explain why the number of firms is small. New firms can enter and exit freely would lead to many firms, not a few.
Category: Oligopoly Basics
Question 14
Which statement describes firms in an oligopoly?
Each is too small to affect the market price
Their decisions are mutually interdependent
✓
Each sells an identical product with free entry
Each faces no rivals at all
Correct Answer
Their decisions are mutually interdependent
With only a few large firms, each firm's best price and output depend on what its rivals do, so their decisions are mutually interdependent. Each is too small to affect the market price describes perfect competition. Each sells an identical product with free entry also describes perfect competition. Each faces no rivals at all describes monopoly.
Category: Oligopoly Basics
Question 15
Why are OPEC's agreements on oil production hard to enforce?
Members cannot observe the world price of oil
Every member is required to produce the same amount
No court will enforce them as binding contracts
✓
The demand for oil is perfectly elastic
Correct Answer
No court will enforce them as binding contracts
Agreements among cartel members to restrict output are not legally enforceable, so OPEC must rely on monitoring and pressure, and members are tempted to exceed their quotas. Members cannot observe the world price of oil is false because the price is public. Every member is required to produce the same amount is not how quotas work. The demand for oil is perfectly elastic is false and does not explain enforcement problems.
Category: Collusion and Cartels
Question 16
Under U.S. law, what is the status of an explicit agreement among competing firms to cut output and raise prices?
It is legal if every firm signs a contract
It is legal if the firms are small
It is required in regulated industries
It is illegal under antitrust law
✓
Correct Answer
It is illegal under antitrust law
Explicit agreements among competitors to fix prices or restrict output violate U.S. antitrust law, which is why collusion among U.S. firms is often tacit rather than written. It is legal if every firm signs a contract is wrong because the contract itself would be illegal. It is legal if the firms are small is wrong because size does not make price fixing lawful. It is required in regulated industries confuses government regulation with private collusion.
Category: Collusion and Cartels
Question 17
When oligopoly firms agree to restrict output, why does the agreement tend to break down?
Each firm gains by producing more than its share
✓
Each firm gains by producing less than its share
The government enforces the agreement too strictly
Consumers refuse to buy at any higher price
Correct Answer
Each firm gains by producing more than its share
With the price held high, any single firm can earn more by quietly selling extra output, so each firm is tempted to cheat on the deal. Producing less than its share would lower the firm's own profit. The government enforces the agreement too strictly is wrong because such agreements are not enforceable at all. Consumers refusing to buy at any higher price contradicts a downward-sloping demand curve, along which some buyers still purchase at higher prices.
Category: Collusion and Cartels
Question 18
Two firms each choose either a low or a high output level. If both choose low, each earns $1,000. If both choose high, each earns $400. If one chooses high and the other low, the high-output firm earns $1,200 and the low-output firm earns $200. What is each firm's dominant strategy?
Produce a low output
Produce a high output
✓
Copy the rival's choice
Alternate between the two levels
Correct Answer
Produce a high output
If the rival chooses low, choosing high pays $1,200 instead of $1,000; if the rival chooses high, choosing high pays $400 instead of $200, so high output is best no matter what the rival does. Produce a low output is what both would prefer jointly, but each firm can do better by deviating. Copy the rival's choice is not best when the rival chooses low. Alternate between the two levels gives up profit in the periods spent at low output.
Category: Game Theory
Question 19
What is the central lesson of the prisoner's dilemma?
Players can always enforce a cooperative deal
The player who moves first wins the game
Pursuing self-interest can leave both players worse off
✓
Players choose randomly when payoffs are close
Correct Answer
Pursuing self-interest can leave both players worse off
In a prisoner's dilemma, each player's self-interested choice leads to an outcome that is worse for both than if they had cooperated. Players can always enforce a cooperative deal is wrong because the lack of enforceable trust is what creates the dilemma. The player who moves first wins the game is not part of the setup, since players choose without knowing the other's choice. Players choose randomly when payoffs are close is not what the game shows.
Category: Game Theory
Question 20
In the kinked demand curve model, how are an oligopoly firm's rivals assumed to react to its price changes?
They match price increases but not price cuts
They match every price change
They ignore every price change
They match price cuts but not price increases
✓
Correct Answer
They match price cuts but not price increases
Rivals follow a price cut to avoid losing customers but do not follow a price increase, hoping to win customers from the firm that raised its price; this creates the kink at the current price. Matching increases but not cuts reverses the assumption. Matching every price change would give a demand curve with no kink. Ignoring every price change would also give a demand curve with no kink.
Category: Kinked Demand