30 How do oligopolists determine price? They play the game “follow the leader” that economists call price leadership
31 What is price leadership? A pricing strategy in which a dominant firm sets the price for an industry and the other firms follow
32 What is a cartel? A group of firms formally agreeing to control the price and output of a product
33 What are examples of cartels? Organization of Petroleum Exporting Countries (OPEC) International Telephone Cartel (CCITT) International Airline Cartel (IATA)
34 What is the major weakness of a cartel? Member firms cheating
35 $30 6 $20 $15 $10 $ $25 $35 $ LRAC MC Why a Cartel Member Has an Incentive to Cheat P Q MR 2 Price & Cost per unit MR 1
36 Key Concepts
37 Key Concepts What is imperfect competition? What is monopolistic competition? What is product differentiation? What is nonprice competition? Why is a monopolistic competitive firm a price maker?Why is a monopolistic competitive firm a price maker? How does a firm decide what price to charge and how many units to produce?How does a firm decide what price to charge and how many units to produce? Why is a normal profit made in the long-run?
38 How efficient is monopolistic competition? What is oligopoly? What is nonprice competition? What is the distinguishing feature of oligopoly?What is the distinguishing feature of oligopoly? What does a kinked demand curve show? How do oligopolists determine price? What is a cartel? Key Concepts cont.
40 Imperfect competition is the market structure between the extremes of perfect competition and monopoly Monopolistic competition and oligopoly belong to the imperfect competition category.
41 Monopolistic competition is a market structure characterized by (1) many small sellers, (2) a differentiated product, and (3) easy market entry and exit. Given these characteristics, firms in monopolistic competition have a negligible effect on the market price.
42 Product differentiation is a key characteristic of monopolistic competition. It is the process of creating real or apparent differences between products.
43 Nonprice competition includes advertising, packaging, product development, better quality, and better service. Under imperfect competition, firms may compete using nonprice competition, rather than price competition.
44 Short-run equilibrium for a monopolistic competitor can yield economic losses, zero economic profits, or economic profits. In the long run, monopolistic competitors make zero economic profits.
45 $20 $15 $10 $ $25 $30 $40 $ ATC MC MR=MC D MR Profit AVC P Q
46 Comparing monopolistic competition with perfect competition, we find that the monopolistic competitive firm does not achieve allocative efficiency,charges a higher price, restricts output, and does not produce where average costs are at a minimum.
47 $20 $15 $10 $ $25 $30 $35 $ ATC MC D MR Monopolistic Competition AVC Minimum LRAC P Q
48 $20 $15 $10 $ $25 $30 $35 $ LRAC MC MR Price & Cost per unit Minimum LRAC Perfect Competition P Q
49 Oligopoly is a market structure characterized by (1) few sellers, (2) a homogeneous or differentiated product, and (3) difficult market entry. Oligopolies are mutually interdependent because an action by one firm may cause a reaction on the part of other firms.
50 The nonprice competition model is a theory that might explain oligopolistic behavior. Under this theory, firms use advertising and product differentiation, rather than price reductions, to compete.
51 The kinked demand curve is a model that explains why prices may be rigid in an oligopoly. The kink is established because an oligopolist assumes that rivals will match a price decrease, but ignore a price increase.
58 1. An industry with many small sellers, a differentiated product, and easy entry would best be described as which of the following? a. Oligopoly. b. Monopolistic competition. c. Perfect competition. d. Monopoly. B. An oligopoly has only a few sellers. A monopoly only has one, and perfect competition has homogeneous products.
59 2. Which of the following industries is the best example of monopolistic competition? a. Wheat. b. Restaurant. c. Automobile. d. Water service. B. Wheat would be in a perfectly competitive market. Automobiles would be an oligopoly. And the water service is an example of a regulated monopoly.
60 3. Which of the following is not a characteristic of monopolistic competition? a. A large number of small firms. b. A differentiated product. c. Easy market entry. d. A homogeneous product. D. A characteristic of monopolistic competition is differentiated products.
61 4. A monopolistically competitive firm in the long run earns the same economic profit as a a. perfectly competitive firm. b. monopolist. c. cartel. d. none of the above. A. In the long-run, a normal profit is made because of the ease of entry and exit. Once economic profits are made, more firms will enter the industry, driving price down. When losses are made, firms leave the industry, driving price up, restoring profits.
62 5. The theory of monopolistic competition predicts that in long-run equilibrium a monopolistically competitive firm will a. produce the output level at which price equals long-run marginal cost. b. operate at minimum long-run average cost. c. overutilize its insufficient capacity. d. produce the output level at which price equals long-run average cost. D
63 $20 $15 $10 $ $25 $30 $35 $ ATC MC D MR Monopolistic Competition AVC Minimum LRAC P Q
64 6. A monopolistically competitive firm is inefficient because the firm a. earns positive economic profit in the long run. b. is producing at an output where marginal cost equals price. c. in not maximizing its profit. d. produces an output where average total cost is not minimum. D.
65 $20 $15 $10 $ $25 $30 $35 $ ATC MC D MR Monopolistic Competition AVC Minimum LRAC P Q
66 7. A monopolistically competitive firm in the long run earns the same economic profit as a a. perfectly competitive firm. b. monopolist. c. cartel. d. none of the above. A. In the long-run, a normal profit is made because of the ease of entry and exit. Once economic profits are made, more firms will enter the industry, driving price down. When losses are made, firms leave the industry, driving price up, restoring profits.
67 8. One possible effect of advertising on a firm’s long-run average cost curve is to a. raise the curve. b. lower the curve. c. shift the curve rightward. d. shift the curve leftward. A. The ATC curve is raised because of the added expense of the advertising.
68 9. Monopolistic competition is an inefficient market structure because a. firms earn zero profit in the long-run. b. marginal cost is less than price in the long-run. c. there is a wider variety of products available compared to perfect competition. d. all of the above. B. In the long-run, marginal cost is less than price because of the downward sloping demand curve and a marginal revenue curve that is more steeply sloped beneath the demand curve.
The “Big Three” U.S. automobile industry is described as a (an) a. monopoly. b. perfect competition. c. monopolistic competition. d. oligopoly. D. An oligopoly is a market form with only a few sellers.
The cigarette industry in the United States is described as a (an) a. monopoly. b. perfect competition. c. monopolistic competition. d. oligopoly. D. The cigarette industry has only a few sellers.
A characteristic of an oligopoly is a. mutual interdependence in pricing decisions. b. easy market entry. c. both (a) and (b). d. neither (a) nor (b). A. The distinguishing feature of an oligopoly is mutual interdependence. No one firm will make a decision without first considering the reaction of its competitors to its policy change.
The kinked demand curve theory attempts to explain why an oligopolistic firm a. has relatively large advertising expenditures. b. fails to invest in research and development (R and D). c. infrequently changes its price. d. engages in excessive brand proliferation. C. Everything else being equal, if firm A raises its price, other firms will not raise theirs, and A will experience a big decline in sales. If A lowers its price, other firms will follow suit and A will not gain many sales.
According to the kinked demand theory, when one firm raises its price, other firms will a. also raise their price. b. refuse to follow. c. increase their advertising expenditures. d. exit the industry. B. They will refuse to follow firm A because they can gain more by charging a lower price, their sales will increase because fewer people will buy from firm A.
Which of the following is evidence that OPEC is a cartel? a. Agreement on price and output quotas by oil ministries. b. Ability to raise prices regardless of demand. c. Mutual interdependence in pricing and output decisions. d. Ability to completely control entry. A. A cartel is characterized by collusion, the coming together and agreeing to certain policies, for example, the level of prices.