Part-3 Chapter-12

Aplia Homework: Between Competition and Monopoly

1. Conditions for monopolistic competition

Consider the monopolistically competitive market structure, which has some features of a perfectly competitive market and some features of a monopoly.

Complete the following table by indicating whether each attribute characterizes a perfectly competitive market, a monopolistically competitive market, both, or neither. Check all that apply.

2. How short-run profit or losses induce entry or exit

Fantastique Bikes is a company that manufactures bikes in a monopolistically competitive market. The following graph shows Fantastique’s demand curve, marginal revenue curve (MR), marginal cost curve (MC), and average cost curve (AC).

Place the black point (plus symbol) on the graph to indicate the short-run profit-maximizing price and quantity for this monopolistically competitive company. Then, use the green rectangle (triangle symbols) to shade the area representing the company’s profit or loss.

Note: Dashed drop lines will automatically extend to both axes. Select and drag the rectangles from the palette to the graph. To resize, select one of the points on the rectangle and move to the desired position.

Given the profit-maximizing choice of output and price, the shop is earning _______ profit, which means there are _______ shops in the industry than in long-run equilibrium.

Now consider the long run in which bike manufacturers are free to enter and exit the market.

Show the possible effect of free entry and exit by shifting the demand curve for a typical individual producer of bikes on the following graph.

Note: Select and drag the curve to the desired position. The curve will snap into position, so if you try to move a curve and it snaps back to its original position, just drag it a little farther.

3. Is monopolistic competition efficient?

Suppose that a firm produces footballs in a monopolistically competitive market. The following graph shows its demand (D) curve, marginal revenue (MR) curve, marginal cost (MC) curve, and average cost (AC) curve. Assume that all firms in the industry face the same cost structure.

Place the tan point (dash symbol) on the graph to indicate the long-run monopolistically competitive equilibrium price and quantity for this firm. Next, place the purple point (diamond symbol) to indicate the point at which this firm would produce in the long run if it operated in a perfectly competitive market.

Note: Dashed drop lines will automatically extend to both axes.

Compare the average cost and the production level in the long-run equilibrium for a monopolistically competitive firm and a perfectly competitive firm by completing the following table.

Because this market is a monopolistically competitive market, the firm's average cost in long-run equilibrium is ________ the long-run average cost it would achieve as a firm operating in a perfectly competitive market.

The production level of a monopolistically competitive firm in long-run equilibrium is _______ the production level of a perfectly competitive firm. This difference in output is predicted by the ___________.

4. Characteristics of oligopoly

An oligopoly market structure is distinguished by several characteristics, one of which is mutual interdependence. What are some other characteristics of this market structure?Check all that apply.

            Either identical or differentiated products

            Market control by many small firms

            Market control by a few large firms

            No entry

5. Oligopoly terminology

Two beer-brewing companies, Piwo and Olut, operate in a duopoly. Initially, they achieve tacit collusion, charging beer prices in excess of their marginal costs and earning substantial economic profit. Suppose new management at Piwo decides to cut prices in order to increase its market share and profit. In response, the management at Olut slashes its prices below marginal cost in an effort to push Piwo out of business.

This is an example of:

            Price leadership

            A cartel

            A price war

6. Sales maximization

Although economists normally assume that firms are profit-maximizing, firms may also have other objectives. For example, a firm might choose prices and output quantities that maximize total revenue, or sales, rather than profit. Although this objective may not be in the best interests of the firm's owners, the manager of the local branch of a firm may receive a bonus based on the branch's sales. Firms that maximize revenue, or sales, rather than profit are thus not uncommon.

Consider the daily market for DVDs. Assume that this firm is not a price taker and is therefore free to set prices according its own objective. The following graph shows the demand, marginal revenue (MR), average cost (AC), and marginal cost (MC) curves for this market.

Fill in the following table with the price and quantity the firm chooses when it aims to maximize profit versus sales. (Hint: You may use the purple point (diamond symbol) and green point (triangle symbol) to help you derive this answer. You will not be graded on where you place these points on the graph.)

If a firm aims to maximize sales revenue, it will charge a _______ price and produce _______ output than under profit maximization.

7. Understanding the kinked demand curve model

Happy land is one of five amusement parks on Sunshine Island. The following graph shows happy land’s kinked demand curve (D1−D2D1−D2) and the resulting marginal revenue curve (MR1−MR2MR1−MR2). The graph also shows two possible marginal cost curves (MC1MC1 and MC2MC2).

Assume happy land’s marginal cost is represented by MC1. Happy land will set a price of _____ per ticket.

According to the kinked demand curve model, if one firm ________ its price, other firms will do likewise to retain their market share, but if one firm ________ its price, other firms will not follow suit. Therefore, if one of happy land’s competitors increases its price to above the price you just found for happy land, happy land will _________.

The basic principle behind the kinked demand curve model explains why the D2 portion of the kinked demand curve is relatively _______ elastic than the D1 portion.

If happy land’s marginal cost decreased from MC1 to  MC2on the graph, happy land would __________.

8. Game theory terminology

Select the term that best describes each definition listed in the following table.

9. Using a payoff matrix to determine the equilibrium outcome

Suppose there are only two firms that sell digital cameras, Picturesque and Capture mania. The following payoff matrix shows the profit (in millions of dollars) each company will earn, depending on whether it sets a high or low price for its cameras.

For example, the lower left cell shows that if Picturesque prices low and Capture mania prices high, Picturesque will earn a profit of $15 million and Capture mania will earn a profit of $2 million. Assume this is a simultaneous game and that Picturesque and Capture mania are both profit-maximizing firms.

If Picturesque prices high, Capture mania will make more profit if it chooses a _____ price, and if Picturesque prices low, Capture mania will make more profit if it chooses a _____ price.

If Capture mania prices high, Picturesque will make more profit if it chooses a _____ price, and if Capture mania prices low, Picturesque will make more profit if it chooses a _____ price.

Considering all of the information given, pricing high is not a dominant strategy for both Picturesque and Capture mania.

If the firms do not collude, which strategy will they end up choosing?

            Picturesque will choose a high price and Capture mania will choose a low price.

            Picturesque will choose a low price and Capture mania will choose a high price.

            Both Picturesque and Capture mania will choose a high price.

            Both Picturesque and Capture mania will choose a low price.

True or False: The game between Picturesque and Capture mania is not an example of the prisoners' dilemma.

            True

            False

10. Collusive outcome versus Nash equilibrium

Consider a remote town in which two restaurants, All-You-Can-Eat Café and GoodGrub Diner, operate in a duopoly. Both restaurants disregard health and safety regulations, but they continue to have customers because they are the only restaurants within 80 miles of town. Both restaurants know that if they clean up, they will attract more customers, but this also means that they will have to pay workers to do the cleaning.

If neither restaurant cleans, each will earn $12,000; alternatively, if they both hire workers to clean, each will earn only $9,000. However, if one cleans and the other doesn't, more customers will choose the cleaner restaurant; the cleaner restaurant will make $16,000, and the other restaurant will make only $4,000.

Complete the following payoff matrix using the previous information. (Note: All-You-Can-Eat Café and Good Grub Diner are both profit-maximizing firms.)

If All-You-Can-Eat Café and Good Grub Diner decide to collude, the outcome of this game is as follows: All-You-Can-Eat Café _______ and Good Grub Diner ______.

If both restaurants decide to cheat and behave no cooperatively, the outcome reflecting the unique Nash equilibrium of this game is as follows: All-You-Can-Eat Café ______, and Good Grub Diner _______.

11. Games in which timing matters

Consider an economy in which there is initially one firm, Healthy Bran, in the market for breakfast cereal. A new firm, Tasty Cereal, is deciding whether to enter the market, which would then change the market to a duopoly.

Healthy Bran can choose to sell its cereal to grocery stores at either a high or a low price. As a monopolist, it can earn $5.5 million by selling at a high price or $2.5 million by selling at a low price. If Tasty Cereal enters the market and Healthy Bran sells at a high price, each firm makes $0.5 million; if Tasty Cereal enters the market and Healthy Bran sells at a low price, each firm has a loss of $3.5 million.

Suppose that Healthy Bran can't set long-term contracts with the grocery stores that sell its cereal. The following diagram shows this game: first, Tasty Cereal decides whether to enter or not, and then Healthy Bran decides whether to sell at a high or low price.

Suppose Healthy Bran issues a press release saying that if Tasty Cereal enters the market, it will sell at a low price.

If Tasty Cereal decides to enter the market despite the threat, Healthy Bran would earn _______ if it chose to set a low price, and it would earn _______ if it chose to set a high price. Therefore, Healthy Bran's threat _______ credible, and Tasty Cereal _______ enter the market.

Now suppose that Healthy Bran can sign long-term contracts with grocery stores at a set price before Tasty Cereal decides whether or not to enter. The following diagram shows this game:

If Healthy Bran decides to sign a contract at a low price, Tasty Cereal would earn ________ if it chose to enter the market, and it would earn _______ if it chose to stay out. Therefore, if Healthy Bran signed a contract at a low price, Tasty Cereal _______ enter the market, and Healthy Bran would earn _______.

On the other hand, if Healthy Bran decides to sign a contract at a high price, Tasty Cereal would earn _______ if it chose to enter the market, and it would earn _______ if it chose to stay out. Therefore, if Healthy Bran signed a contract at a high price, Tasty Cereal _______ enter the market, and Healthy Bran would earn ________.

Anticipating Tasty Cereal's response to its pricing contract, Healthy Bran will sign a contract at a _____ price.

12. Market structures

For each of the following scenarios, identify the number of firms present, the type of product, and the appropriate market model. Select the matching entry for each dropdown box in the following table.