Chapter 10 Monopolistic Competition and Oligopoly

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Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises

Chapter 10 Monopolistic Competition and Oligopoly

Review Questions

2.False. In the long run, a monopolistic competitor will not produce at minimum ATC. In long-run equilibrium, there are too many firms producing too little output to achieve minimum ATC.

4.In oligopoly there are fewer firms than in perfect competition or monopolistic competition, but more than in monopoly. Unlike perfectly or monopolistically competitive markets, there are barriers to entry and exit.

6.In a natural monopoly, economies of scale extend over a wide-enough range of output that the lowest cost per unit is attained when a single firm produces for the entire market. In a natural oligopoly, economies of scale do not extend over as wide a range of output, allowing more than one competitor to enter.

8.Difficulty observing other firms’ prices, unstable market demand, and a large number of firms promote cheating—since they lessen the probability of detection. In addition, unstable market demand means new terms for collusion must be periodically renegotiated, giving firms the opportunity to cheat in the interim. Finally, if many firms are involved in collusion, any individual firm may face a smaller chance of getting caught and facing punishment, thereby increasing the probability of cheating.

10.New technologies limit the degree of concentration in an industry by creating new substitute goods and by breaking down barriers to entry. Two examples are cable television and local phone companies; both face new competition made possible by technological advances (satellite dishes in the case of cable TV, and cell phones in the case of local phone companies).

12.It is difficult to apply the definition of oligopoly to real-world markets since doing so involves defining the relevant market, deciding what number qualifies as “a few,” and deciding whether market domination by a few firms occurs.

Problems and Exercises

2.

Initially, the monopolist earns an economic profit by producing where MR = MC. Entry will occur, shifting the firm’s demand and marginal revenue curves leftward (to D2 and MR2). Long run equilibrium will occur at a point like B, where the firm earns zero economic profit.

4.a.

Price per Taco Plate / Taco plates per Week / Total Cost per Week / Total Revenue per Week / Marginal Revenue / Marginal Cost
$5 / 50 / $30 / $250
$2.33 / $0.67
4 / 80 / $50 / $320
$1.86 / $1.80
3 / 150 / $176 / $450
$1.77 / $2.00
2 / 800 / $1476 / $1600
-$1.67 / $2.20
1 / 1100 / $2136 / $1100

Tino should expand his output as long as MR exceeds MC. His profit-maximizing price is $3 and his profit-maximizing number of taco plates is 150.

1. Tino’s customers will substitute away from Tino’s tacos towards food from his competitor. Demand for Tino’s tacos will fall, and Tino’s profits will fall.

c.

Price per Taco Plate / Taco plates per Week / Total Cost per Week / Total Revenue per Week / Marginal Revenue / Marginal Cost
$5 / 60 / $130 / $300
$2.33 / $0.55
4 / 96 / $150 / $384
$1.86 / $1.50
3 / 180 / $276 / $540
$1.76 / $1.66
2 / 960 / $1576 / $1920
-$1.67 / $1.83
1 / 1320 / $2236 / $1320

Tino’s profit-maximizing price is $2, and his profit-maximizing number of taco plates is 960. Since Tino earns an economic profit of $344 with this combination, entry will occur until Tino’s economic profit falls to $0.

6.a.

The typical plastics firm produces the output level where MC = MR, charges the corresponding price given by the demand curve, and earns zero economic profit.

b.

Oil is a variable input, so when oil prices increase, the ATC curve and the MC curve at all firms shift upward. In the short run, the typical plastics firm suffers economic losses.

c.If prices remained high, and profits remained negative, some firms would exit. Other firms would experience a rightward shift of their demand curves, and in long-run equilibrium, the remaining firms would earn zero economic profit.

8.a.In the payoff matrices below, Road Kill’s payoffs are listed on the left side of each square:

b.Both Road Kill Café and Sal Monella have a dominant strategy to clean up.

c.If Road Kill Café and Sal Monella act independently, they’ll both clean up and earn $5,000.

d.When facing the same decision repeatedly, Sal Monella and Road Kill Café might decide to cooperate. By both agreeing to not clean up, they can each increase their income to $7,000 each.

e.

The restaurants no longer have dominant strategies. For example, Road Kill’s best action now depends on what Sal Monella chooses. Without cooperation, we would need a more sophisticated analysis to predict an outcome. With cooperation, however, the firms will decide not to clean up, and each will earn $7000.

10.a.Nike has a dominant strategy to go “high.” Adidas does not have a dominant strategy.

b.This game will still have an outcome: Adidas can determine that Nike will go high, so it will go high also.

c.Nike would choose the outrageously high price if it believed that Adidas would follow. Nike would earn $1.2 million in profits and Adidas would earn $600,000 in profits. While Nike would have an incentive to charge the high price if Adidas charged the outrageously high price, Nike would know that Adidas would follow Nike’s pricing, and this would reduce Nike’s profit. Therefore, the outcome of the game with Nike as price leader is that both charge the outrageously high price.

Challenge Questions

2.a.Neither player has a dominant strategy.

b.The outcome of the game cannot be determined from the information in the payoff matrix using the tools learned in this chapter.

1. Player 2 has a dominant strategy; it is to choose “B”. When one player has a dominant strategy, we can predict the outcome. Since Player 1 knows that Player 2 will choose “B,” Player 1 will maximize his payoff by also choosing “B.”

Economics Applications Exercises

2.a. Answers may vary.

b. Answers may vary.

c. Answers may vary.