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1 1 of 18 11/12/ :52 AM In monopolistic competition, a firm Has no market power. Captures significant economies of scale. Has a downward-sloping demand curve. Has a standardized product that all firms produce. The competition is less intense in monopolistic competition than in a perfectly competitive market where firms have a horizontal demand curve. A monopolistically competitive firm confronts a downward-sloping demand curve for its output because of brand loyalty and product differentiation. Difficulty: 1 Easy Which of the following is not characteristic of monopolistic competition? Many firms in an industry. Low concentration ratios. Some market power. Firms have zero control over price. Monopolistic competition is a market in which many firms produce similar but somewhat differentiated goods or services, and therefore each maintains some independent control of its own price. Firms in perfect competition have zero control over price; they must accept the going equilibrium price.

2 2 of 18 11/12/ :52 AM A monopolistically competitive industry is characterized by concentration ratios and entry barriers. high; high high; low low; high low; low Monopolistically competitive markets have low barriers to entry and low or modest concentration ratios. Learning Objective: How monopolistically competitive firms maximize profits. Each producer in monopolistic competition has Complete market power. Substantial market power. Some market power. No market power. Monopolistic competition is a market in which many firms produce similar but somewhat differentiated goods or services, and therefore each maintains some independent control of its own price. Difficulty: 1 Easy The demand curve faced by a monopolistically competitive firm is Downward-sloping. Flat. Kinked. Upward-sloping. The competition is less intense in monopolistic competition than in a perfectly competitive market where firms have a horizontal demand curve. A monopolistically competitive firm confronts a downward-sloping demand curve for its output because of brand loyalty and product differentiation. Difficulty: 1 Easy

3 3 of 18 11/12/ :52 AM If a monopolistically competitive firm raises its price, it will Not lose any of its customers. Lose most of its customers. Lose some of its customers, but nowhere close to all its customers. Lose all of its customers. A monopolistically competitive firm confronts a downward-sloping demand curve for its output. So when a company increases the price of its product, it loses some customers, but not all or even most of them. Which of the following most characterizes monopolistic competition? Price leadership. Product differentiation. Price discrimination. Economies of scale. Product differentiation, a characteristic of monopolistic competition, occurs when one product is different (actually or perceived) from competing products in the same market. The cross-price elasticity of demand for the products of monopolistically competitive firms is Very high. Low. An indication that most of the products are complementary goods. The same as in perfect Cross-price elasticity is very low when consumers are brand loyal and do not view other available products as good substitutes. Remember that cross-price elasticity measures the change in quantity demanded of one good due to a price change of another good. For pure substitutes, the cross-price elasticity will be positive and high. Learning Objective: The unique behavior of monopolistically competitive firms.

4 4 of 18 11/12/ :52 AM When a monopolistically competitive firm advertises, it is attempting to increase The demand and decrease the price elasticity of demand for its product. The demand and increase the price elasticity of demand for its product. Long-run profits. Market demand. The more brand loyalty a firm can establish, the less likely consumers are to switch brands when price is increased. In other words, brand loyalty makes the demand curve facing the firm less price-elastic. A monopolistically competitive firm maximizes profits or minimizes losses in the short run by Setting price equal to marginal cost. Producing at the output level where ATC is minimized. Producing at the output level where MR equals MC. Producing at the output level where MC equals ATC. Profit-maximizing (or loss-minimizing) firms, regardless of the market structure, will choose to produce at the output level where MR = MC as long as P > AVC. Learning Objective: The unique behavior of monopolistically competitive firms.

5 5 of 18 11/12/ :52 AM Refer to Table At the profit-maximizing output and price, Sylvie's Shampoo Company. will earn a economic profit, and the market will occur. negative; entry into negative; exit from positive; entry into positive; exit from Positive economic profit ($36) entices firms to enter the market for the opportunity to earn greater-than-normal profits. Difficulty: 3 Hard Learning Objective: The unique behavior of monopolistically competitive firms.

6 6 of 18 11/12/ :52 AM Which of the following characterizes the difference between oligopoly and monopolistic competition? Oligopolists are independent of each other; monopolistically competitive firms are interdependent. Monopolistically competitive firms experience zero long-run economic profit; oligopolists may experience positive long-run economic profit. There are many oligopolists but only a few monopolistically competitive firms. Monopolistically competitive firms face horizontal demand curves; oligopolists face downward-sloping demand curves. Given the ease of entry and exit in perfect and monopolistic competition, as long as firms are making a profit or losing money, firms will enter or exit the market and the disappearance of economic profits (losses) is inevitable. Oligopoly markets have high barriers to entry; therefore it is likely that profits will persist in the long run. Difficulty: 3 Hard Learning Objective: Why economic profits tend toward zero in monopolistic Which of the following market structures will have only normal profit in the long run? Monopoly. Duopoly. Monopolistic Oligopoly. Given the ease of entry and exit in perfect and monopolistic competition markets, as long as firms are making a profit or losing money, firms will enter or exit the market and the disappearance of economic profits (losses) is inevitable. This means that firms will produce where MR = MC and where price = ATC. Economic profit of zero is a normal profit just not more than if those same resources were being used in a different capacity. Learning Objective: Why economic profits tend toward zero in monopolistic Which of the following is true about a monopolistically competitive industry? Marginal cost pricing occurs. There is excess capacity. Resources are allocated efficiently. It produces at the minimum of ATC. The typical firm in a monopolistically competitive market produces at a rate of output that is less than its minimum-atc output rate. This implies that the same level of industry output could be produced at lower cost with fewer firms.

7 7 of 18 11/12/ :52 AM Which of the following real-world situations is the result of excess capacity in a monopolistically competitive market? A factory producing women's clothing produces more than it can sell during a season. Gas stations with infrequently used pumps are located at all four corners of an intersection. A retail auto tire store orders too much inventory. Monopolistically competitive firms do not exist in the real world. One symptom of the inefficiencies associated with monopolistic competition is industrywide excess capacity. Each firm tries to gain market share by building more outlets, and the result is more locations at less than full utilization. Difficulty: 3 Hard Marginal cost pricing means that Goods are offered for sale at prices equal to average total cost. Firms produce where marginal cost equals marginal revenue. Firms produce where marginal cost equals zero. Goods are offered for sale at prices equal to marginal cost. Perfectly competitive firms charge a price equal to marginal costs, which is the practice of marginal cost pricing. Learning Objective: Why economic profits tend toward zero in monopolistic Suppose that an economy wants to eliminate the resource waste associated with excess capacity in monopolistically competitive markets. Which of the following would achieve this goal? Firms are allowed to establish significant barriers to entry. Firms are encouraged to produce less output. Firms are required to set price equal to marginal cost. Firms are required to charge the same price. Competitive firms compete by achieving greater efficiency and offering their products at the lowest possible price. Firms in imperfectly competitive markets don't "compete" in the same way. In monopolistic competition, firms have their own captive markets consumers who prefer their particular brands over competing brands and therefore price reductions by one firm won't induce many consumers to switch brands. In this case, the only way to achieve efficiency is to require firms to charge a price equal to marginal cost. Difficulty: 3 Hard

8 8 of 18 11/12/ :52 AM In monopolistic competition there is allocative inefficiency because Price is greater than the minimum ATC. Production is not at the minimum ATC. Of excess capacity. Price is greater than MC. Because the demand curve facing a firm in monopolistic competition slopes downward, firms will charge a price greater than marginal cost (higher price) and will produce to the left of the efficient point (less output).

9 9 of 18 11/12/ :52 AM Refer to Figure 26.1 for a monopolistically competitive firm. The profit-maximizing output and price combination for this firm in the short run is Q, P. 1 1 Q 2, P 4. Q 2, P 1. Q 4, P 3. Profit is maximized at the output level where the MR is equal to MC, at an output level of Q 2 and a price of P 4. Learning Objective: The unique behavior of monopolistically competitive firms.

10 10 of 18 11/12/ :52 AM Refer to Figure The output that maximizes production efficiency for this firm is Q. 1 Q. 2 Q. 3 Q. 4 Production efficiency is at the output level that minimizes ATC; that output in Figure 26.1 is Q 3. Learning Objective: The unique behavior of monopolistically competitive firms.

11 11 of 18 11/12/ :52 AM Refer to Figure 26.3 for a monopolistically competitive firm. The allocatively efficient output for this firm is Q. 1 Q. 2 Q. 3 Zero. The firm should shut down because it is not earning an economic profit. The allocative efficient output and price combination is where price is equal to marginal cost, at Q. 2 Learning Objective: How monopolistically competitive firms maximize profits.

12 12 of 18 11/12/ :52 AM Refer to Figure 26.4 for a monopolistically competitive firm. In the long run this firm is most likely to face Demand and MR. 1 1 Demand and MR. 1 2 Demand and MR. 2 2 A demand curve between Demand and Demand. 1 2 In the long run the firm will produce where MR is equal to MC and price is just tangent to ATC. Learning Objective: How monopolistically competitive firms maximize profits.

13 13 of 18 11/12/ :52 AM Refer to Figure 26.4 for a monopolistically competitive firm. If the firm currently faces Demand and MR, then it will 2 2 earn A positive economic profit, and firms will enter the industry. A positive economic profit, and firms will exit the industry. A negative economic profit, and firms will exit the industry. Zero economic profit, and neither entry nor exit will occur. If the firm currently faces Demand and MR, then its price is equal to ATC, profits are zero, and no firms will be 2 2 inclined to enter or exit with normal profits being made. Difficulty: 3 Hard Learning Objective: Why economic profits tend toward zero in monopolistic

14 14 of 18 11/12/ :52 AM Refer to Figure 26.4 for a monopolistically competitive firm. If the firm currently faces Demand and MR, then it will 1 1 earn A positive economic profit, and firms will enter the industry. A negative economic profit, and firms will enter the industry. A negative economic profit, and firms will exit the industry. Zero economic profit, and neither entry nor exit will occur. If the firm currently faces Demand and MR, then its price is less than ATC, profits are negative, and firms will exit 1 1 the market. Difficulty: 3 Hard Learning Objective: Why economic profits tend toward zero in monopolistic

15 15 of 18 11/12/ :52 AM Refer to Figure Which firm faces possible retaliation from rival firms? Firm C. Firm A. Firm D. Firm B. Oligopolists are interdependent and face a kinked demand curve, which is illustrated by Firm C's diagram. Difficulty: 3 Hard Learning Objective: The unique behavior of monopolistically competitive firms.

16 16 of 18 11/12/ :52 AM Which firm in Figure 26.5 is using marginal cost pricing? Firms B and D only. Firm B only. Firm C only. All of the firms are using marginal cost pricing. Firm B's price is equal to MC; therefore this firm is using marginal cost pricing. Difficulty: 3 Hard Learning Objective: The unique behavior of monopolistically competitive firms.

17 17 of 18 11/12/ :52 AM An In the News article titled "Water, Water Everywhere" refers to the use of advertising. Successful advertising can do all of the following except Differentiate products. Create brand loyalty. Decrease the price elasticity of demand for the product. Maximize efficiency. By differentiating their products through advertising, monopolistic competitors establish brand loyalty. Brand loyalty gives producers greater control over the price of their products by making the demand less elastic. An In the News article titled "Water, Water Everywhere" refers to the use of advertising. When a firm successfully advertises its product, the firm Has more control over its price. Has less control over its price. Still has no control over its price because all firms are price takers. Has total control over its price. By differentiating their products through advertising, monopolistic competitors establish brand loyalty. Brand loyalty gives producers greater control over the price of their products by making the demand less elastic. According to the article "What's Behind Starbucks' Price Hike?" in October 2006, Starbucks raised the price of its lattes, cappuccinos, drip coffee, and other drinks because of increases in wages and fuel costs. When it chose to hike prices, Starbucks was Losing sales to its competitors and therefore needed higher prices to maintain revenue. Relying on the economy to improve in order to offset the loss in sales as a result of the price hikes. Relying on brand loyalty to prevent a significant loss in sales. Relying on very elastic demand. Brand loyalty gives producers greater control over the price of their products. Learning Objective: The unique behavior of monopolistically competitive firms.

18 18 of 18 11/12/ :52 AM A World View article titled "The Best Global Brands" discusses the value of brand names. In 2008 which of the following was the most valuable brand name? Coca-Cola. Google. Intel. McDonalds. The most valuable brand names in 2008 from highest to lowest were Coca-Cola, IBM, Microsoft, and GE. Difficulty: 1 Easy

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