Classify the following markets as perfectly competitive

Economics

. Describe the three attributes of monopolistic competition. How is monopolistic competi- tion like monopoly? How is it like perfect competition?

2. Draw a diagram depicting a firm that is mak- ing a profit in a monopolistically competitive market. Now show what happens to this firm as new firms enter the industry.

3. Draw a diagram of the long-run equilibrium in a monopolistically competitive market. How is price related to average total cost? How is price related to marginal cost?

1. Among monopoly, oligopoly, monopolistic competition, and perfect competition, how would you classify the markets for each of the following drinks? a. tap water b. bottled water c. cola d. beer

2. Classify the following markets as perfectly competitive, monopolistic, or monopolistically competitive, and explain your answers. a. wooden no. 2 pencils b. copper c. local telephon~ service d. peanut butter e. lipstick

3: For each of the following characteristics, say whether it describes a perfectly competitive firm, a monopolistically competitive fimi, both, or neither. a. Sells a product differentiated from that of its

competitors b. Has marginal revenue less than price

4. Does a monopolistic competitor produce too much or too little output compared to the most efficient level? What practical considerations it difficult for policymakers to solve this problem~

5. How might advertising reduce economic well-being? How might advertising increase economic well-being?

6. How might advertising with no apparent mational content in fact convey information to consumers?

7. Explain two benefits that might arise from the existence of brand names.

c. Earns economic profit in the long run d. Produces at the minimum of average total

cost in the long run e. Equates marginal revenue and marginal cost f. Charges a price above marginal cost

4. For each of the following characteristics, say whether it describes a monopoly firm, a monopo- istically competitive firm, both, or neither, a. Faces a downward-sloping demand curve b. Has marginal revenue less than price c. Faces the entry of new firms selling similar

products d: Earns economic profit in the long run e. Equates marginal revenue and marginal cost f. Produces the socially efficient quantity of

output 5. You are hired as the consultant to a monopo-

listically competitive firm. The firm reports the following information about its price, marginal cost, and average total cost. Can the firm possi- bly be maximizing profit? H not, what should it do to increase profit? If the firm is profit maxi- mizing, is the firm in a long-run equilibrium?

368 PARTV FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY

the prisoners' dilemma shows why oligopolies can fail to maintain cooperation, even when cooperation is in their best interest.

Policymakers regulate the behavior of oligopolists through the antitrust laws. The proper scope of these laws is the subject of ongoing controversy. Although price fixing among competing firms clearly reduces economic welfare and should be illegal, some business practices that appear to reduce competition may have legitimate if subtle purposes. As a result, policymakers need to be careful when they use the substantial powers of the antitrust laws to place limits on firm behavior.

• Oligopolists maximize their total profits by forming a cartel and acting like a monopolist. Yet, if oligopolists make decisions about production levels individually, the result is a greater quantity and a lower price than under the monopoly outcome. The larger the number of firms in the oligopoly, the closer the quantity and price will be to the levels that would prevail under perfect competition.

• The prisoners' dilemma shows that self- interest can prevent people from maintaining

cartel, p. 351

cooperation, even when cooperation is in mutual interest. The logic of the prisoners' dilemma applies in many situations, including arms races, common-resource problems, and oligopolies.

• Policymakers use the antitrust laws to prevent oligopolies from engaging in behavior. that reduces competition. The application of these laws can be controversial, because some behavior that can appear to reduce competition may in fact have legitimate busiriess purposes.

oligopoly, p. 349 game theory, p. 349 collusion, p. 351 Nash equilibrium, p. 353

prisoners' dilemma, p. 355

dominant strategy, p. 356

1. If a grOup of sellers could form a cartel, what quantity and price would they try to set?

2. Compare the quantity and price of an oligopoly to those of a monopoly.

3. Compare the quantity and price of an oligopoly to those of a competitive market.

4. How does the number of firms in an oligopoly affect the outcome in its market?

5. What is the prisoners' dilemma, and what does it have to do with oligopoly?

6. Give two examples other than oligopoly that show how the prisoners' dilemma helps to explain behavior.

7. What kinds of behavior do the antitrust laws prohibit?

8. What is resale price mairitenance, and why is it controversial?

1. A large share of the world supply of diamonds comes from Russia and South Africa. Suppose that the marginal cost of mining diamonds is constant at $1,000 per diamond, and the demand for diamonds is described by the following schedule:

Price Quantity

$8,000 · 5,000 diamonds 7,000 6,000 6,000 7,000 5,000 8,000 4,000 9,000 3,000 10,000 2,000 11,000 1,000 12,000

a. If there were many suppliers of diamonds, what woulq be the price and quantity?

b. If there were only one supplier of diamonds, what would be the price and quantity?

c. If Russia and South Africa formed a cartel, what would be the price and quantity? If the countries split the market evenly, what would be South Africa's production and profit? What would happen to South Africa's profit if it increased its production by 1,000 while Russia stuck to the cartel agreement?

d. Use your answers to part (c) to explain why cartel agreements are often not successful.

The New York Times (Nov. 30, 1993) reported that "the inability of OPEC to agree last week to cut production has sent the oil market into turmoil ... [leading to] the lowest price for domestic crude oil since June 1990." a. Why were the members of OPEC trying to

agree to cut production? b. Why do you suppose OPEC was unable to

agree on cutting production? Why. did the oil market go into "turmoil" as a result?

c. The newspaper also noted OPEC's view "that producing nations outside the organization, like Norway and Britain, should do their share and cut production." What does the phrase "do their share" suggest about OPEC's desired relationship with Norway and Britain?

This chapter discusses companies that are oligopolists in the market for the goods they

sell. Many of the same ideas apply to companies that are oligopolists in the market for the inputs they buy. a. If sellers who are oligopolists try to increase

the price of goods they sell, what is the goal of buyers who are oligopolists? ·

b. Major league baseball team own~ have an oligopoly in the market for baseball players. What is the owners' goal-regarding players' salaries? Why is' this goal difficult to achieve?

c. Baseball players went on strike in 1994 because they would not accept the salary cap that the owners wanted to impose. If the owners were already colluding over salaries, why did the owners feel the need for a salary cap?

4. Consider trade relations between the United States and Mexico. Assume that the leaders of the two countries believe the payoffs to alternative trade policies are as follows:

Low Tariffs

High Tariffs

Low Tariff$ High Tariffs

a. What is the dominant strategy for the United States? For Mexico? Explain.

b. Define Nash equilibrium. What is the Nash equilibrium for trade policy?

c. In 1993, the U.S. Congress ratified the North American Free Trade Agreement, in which the United States and Mexico agreed to reduce trade barriers simultaneously. Do the perceived payoffs shown here justify this approach to trade policy? Explain.

d. Based on your understanding of the gains from trade (discussed in Chapters 3 and 9), do you think that these payoffs actually reflect a nation's welfare under the four possible outcomes?