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Chapter 5
Market Power: Does It Help or Hurt the Economy?
True/False Questions
1. A monopoly is an industry with only one seller of a good that has many close substitutes.
ANSWER: F
2. Most U.S. industries with market power are oligopolies.
ANSWER: T
3. A monopolist's demand curve represents market demand for the good.
ANSWER: T
4. For a monopolist, price is greater than marginal revenue.
ANSWER: T
5. A monopolist's marginal revenue measures the marginal social benefit of selling an additional
unit.
ANSWER: F
6. A monopolist is a price taker in the market place.
ANSWER: F
7. Because the monopolist must lower price in order to sell more output, marginal revenue will be
less than the demand price.
ANSWER: T
8. Marginal revenue is the change in total revenue associated with a one-unit change in output.
ANSWER: T
9. According to the marginal principle, profits are maximized when marginal revenue exceeds
marginal cost.
ANSWER: F
10. According to the marginal principle, a monopolist should increase output if marginal cost
exceeds marginal revenue.
ANSWER: F
11. At the monopolist's profit maximizing level of output, price will exceed marginal revenue.
ANSWER: T
12. A monopolist will produce a greater level of output than a competitive industry.
ANSWER: F
13. A monopolist's profits will fall if output is increased when marginal revenue exceeds marginal
cost.
ANSWER: F
14. Economists object to monopoly because of the profits earned.
ANSWER: F
317
318  Chapter 5/Market Power: Does It Help or Hurt the Economy?
15. Market power in the U. S. economy has decreased over the last 50 years.
ANSWER: T
16. Increased competition from foreign producers in the manufacturing sector has increased market
power in the U. S.
ANSWER: F
17. Market power in the U. S. has decreased as a result of increased foreign competition,
deregulation, and the information revolution.
ANSWER: T
18. A natural monopoly will exist if demand conditions are such that only one firm can survive in an
industry.
ANSWER: T
19. Technical conditions may create a natural monopoly.
ANSWER: T
20. The larger the number of firms, the easier it will be for an industry to form a cartel.
ANSWER: F
21. The desire to increase profits may cause firms to cheat on an agreement reached by a cartel.
ANSWER: T
22. The less similar firms are, the easier it is to form a cartel.
ANSWER: F
23. Many economists argue for the passage of additional antitrust laws because they believe that
market power is a major problem in the economy.
ANSWER: F
24. Economists argue that government should not pass policies that would impede economic rent
seeking.
ANSWER: T
25. When firms have high up-front costs, they can recover development costs only if they can price
their successful products at monopoly levels.
ANSWER: T
26. The Organization of Petroleum Exporting Countries (OPEC) cartel had its biggest impact on oil
prices in the 1970s and 1980s.
ANSWER: T
27. To succeed, a cartel must restrict output and prevent entry of new firms. A successful cartel
requires an ACE in the hole: agreement, cooperation, and enforcement.
ANSWER: T
Test Bank  319
Multiple-Choice Questions
1. A firm is said to have market power if:
a. it takes market price as given.
b. its actions affect market price.
c. its actions cause other firms to enter the industry.
d. it does not earn a loss.
ANSWER: b
2. Cartels are defined as:
a. a single seller of a product.
b. oil producers and exporters.
c. an organized group of firms that acts like a monopoly.
d. a large group of firms that exerts little influence in the market.
ANSWER: c
3. A monopoly is an industry composed of:
a. a few interdependent firms.
b. a large number of firms that produce a similar product.
c. a small number of firms that produce dissimilar products.
d. a single seller of a product that has no close substitutes.
ANSWER: d
4. An oligopoly is an industry composed of:
a. a large number of firms that produce close substitutes.
b. a large number of firms that produce a no close substitutes.
c. a few producers or sellers of a good that recognize their interdependence.
d. a single seller of a product that has no close substitutes.
ANSWER: c
5. In a monopoly industry:
a. the firm is a price searcher.
b. the firm is a price taker.
c. markets are impersonal.
d. there are a large number of buyers and sellers.
ANSWER: a
6. The benefit the monopolist receives when it produces and sells an additional unit of output is
measured by:
a. the monopolist's demand price.
b. the monopolist's total revenue.
c. the monopolist's marginal revenue.
d. the monopolist's profit
ANSWER: c
7. The monopolist's demand curve:
a. slopes down and to the right.
b. is a horizontal line.
c. shows that the firm must increase price to sell more output.
d. slopes up and to the right.
ANSWER: a
320  Chapter 5/Market Power: Does It Help or Hurt the Economy?
8. Marginal revenue is defined as:
a. the change in total revenue associated with a one-unit change in output.
b. total revenue minus total cost.
c. the profit associated with producing an additional unit of output.
d. the average revenue a firm receives per unit of output produced.
ANSWER: a
9. Because the monopolist must lower price in order to sell additional units of output:
a. marginal cost exceeds marginal revenue.
b. demand price exceeds marginal revenue.
c. marginal cost exceeds demand price.
d. marginal revenue exceeds demand price.
ANSWER: b
10. According to the marginal principle, a monopoly firm maximizes profits as the point where:
a. marginal revenue equals marginal cost.
b. marginal revenue equals average cost.
c. marginal cost equals price.
d. demand price equals supply price.
ANSWER: a
11. Suppose marginal revenue currently exceeds marginal cost. In order to maximize profits, the
firm should:
a. decrease output.
b. increase output.
c. advertise less.
d. cease production.
ANSWER: b
12. Suppose marginal cost currently exceeds marginal revenue. In order to maximize profits, the
firm should:
a. decrease output.
b. increase output.
c. advertise more.
d. cease production.
ANSWER: a
13. Relative to a competitive industry, a monopolist:
a. produces more output and charges a lower price.
b. produces less output and charges a higher price.
c. produces the same output and charges a higher price.
d. produces less output and charges a lower price.
ANSWER: b
14. The existence of market power:
a. makes markets impersonal because the firms are so large.
b. gives consumers greater choice.
c. makes firms more responsive to consumer demand.
d. give consumers less choice.
ANSWER: d
Test Bank  321
15. The efficient level of output occurs when:
a. a monopolist is maximizing profits.
b. marginal social benefit exceeds marginal social cost.
c. marginal social cost exceeds marginal social benefit.
d. marginal social benefit equals marginal social cost.
ANSWER: d
16. When a monopolist is maximizing profits:
a. marginal social benefit and marginal social cost are equal.
b. marginal social cost exceeds marginal social benefit.
c. output level is less than the efficient level of output.
d. no potential gains from trade exist.
ANSWER: c
17. The increased competitiveness of the U.S. economy can be explained by:
a. competition from imports.
b. government deregulation.
c. the information revolution.
d. All of the above.
ANSWER: d
18. A monopoly may be able to earn profits greater than a competitive firm because:
a. entry by new firms may be prevented.
b. government policies often ensure that certain industries such as utilities earn a guaranteed
rate of return on their investment.
c. consumers are unaware of the existence of such profits and unwittingly pay the higher price.
d. The above statement is false. In the long run a monopoly earns the same profit as a
competitive firm.
ANSWER: a
19. Which of the following is a source of market power in the United States?
a. low barriers to entry.
b. competition from foreign firms.
c. technical conditions.
d. the existence of a large number of substitute goods.
ANSWER: c
20. When demand and cost conditions are such that only one firm can exist in an industry:
a. government must enact regulations to protect consumers and ensure competition.
b. production costs could be decreased if government were to divide the single firm into several
smaller firms.
c. efficiency will be increased by dividing the single firm into several smaller firms.
d. a natural monopoly is said to exist.
ANSWER: d
21. Which of the following is not a source of market power in the United States?
a. low barriers to entry.
b. the cost advantages existing firms may have over potential new firms.
c. technical conditions of production.
d. a single firm having exclusive access to an essential input.
ANSWER: a
322  Chapter 5/Market Power: Does It Help or Hurt the Economy?
22. A likely source of market power in the United States is:
a. the explicit cooperation of firms on price and output decisions.
b. government licensing and regulations.
c. a single firm's control over a vital input.
d. voluntary export restrictions.
ANSWER: b
23. A cartel would most likely form if:
a. there are a small number of firms that have similar production costs.
b. there are a large number of firms that have similar production costs.
c. there are a small number of firms that have different costs of production.
d. there are a large number of firms that have different costs of production.
ANSWER: a
24. Which of the following would contribute to the break-up of a cartel?
a. There are a small number of firms.
b. The firms produce a similar product.
c. The firms' desire to increase their profits.
d. The firms have similar production costs.
ANSWER: c
25. Although cartels can increase the profits of their members, they are often difficult to maintain for
extended periods of time because:
a. consumer pressure often forces cartels to disband.
b. managers realize that while the cartel increases profits in the short run, profits in the long run
will be lower because of cartel activity.
c. there is an incentive for each member to further increase its profits by cheating on the cartel
agreement.
d. producers may not understand the benefits of maintaining the cartel.
ANSWER: c
26. Cartel members have an incentive to cheat by:
a. lowering price and selling less output.
b. lowering price and selling more output.
c. raising price and selling less output.
d. raising price and selling more output.
ANSWER: b
27. The problems encountered by the OPEC cartel can be explained by:
a. relatively high barriers to entry existing in the petroleum industry.
b. the fact that most OPEC producers had similar levels of reserves.
c. the small number of producers who made up the cartel having the same objectives.
d. the fact that OPEC did not have significant barriers to entry for new producers.
ANSWER: d
Test Bank  323
28. The existence of market power in an industry implies that:
a. government should enact regulations to make the industry more competitive.
b. consumers should form consumer protection groups to offset the market power in the
industry.
c. government should provide subsidies to encourage firms to enter the industry. As the
number of firms increases market power will decline.
d. price is greater than marginal cost.
ANSWER: d
29. Government encourages market power when it:
a. promotes international trade.
b. restricts imports.
c. enacts antitrust legislation.
d. eliminates licensing systems.
ANSWER: b
30. Market power can be beneficial to the economy if:
a. it decreases entrepreneurial activity.
b. it encourages political rent seeking.
c. it encourages economic rent seeking.
d. it discourages ruinous competition.
ANSWER: c
31. Government might grant patents in order to:
a. increase private-sector research.
b. enhance competition.
c. decrease market power.
d. ensure that politicians are re-elected to office.
ANSWER: a
32. Government may allow monopolies to exist in knowledge-based industries because:
a. of relatively low up-front costs.
b. of relatively high up-front costs.
c. of the fear of inferior products.
d. too much competition will result in allocative inefficiency.
ANSWER: b
33. Which is probably NOT a reason why Microsoft had very high up-front costs?
a. Extensive research was required.
b. Huge initial investments in plant and equipment were required.
c. The search for knowledge is costly.
d. The plastic used for making individual diskettes is very expensive.
ANSWER: d
34. Which reason(s) might explain why Microsoft’s DOS operating system was chosen over Apple’s
Mac operating system?
a. DOS used less computing power and thus was cheaper.
b. DOS was faster.
c. Mac had limited hard drive capacity
d. All of the above are possible explanations.
ANSWER: d
324  Chapter 5/Market Power: Does It Help or Hurt the Economy?
35. Which statement best describes the contentions of Liebowitz and Margolis concerning
Microsoft?
a. Microsoft had a superior product in terms of consumer preferences and cost considerations
b. Microsoft’s success is the result of their use of market power.
c. DOS and Windows are both economically and technically superior to Mac.
d. All of the above statements are correct.
ANSWER: a
36. According to the box titled, “QWERTY vs. DSK,” the familiar QWERTY typewriter keyboard:
a. Is technically inferior.
b. Is a good example of “lock in” where a superior technology is not adopted because an
inferior one got there first.
c. Achieved dominance because it passed the market test in competition.
d. Is dominant because it would be too costly to convert computer keyboards to DSK.
ANSWER: c
Critical Thinking Multiple-Choice Questions
37. Stuff-It Corporation is the sole producer of Trindles, a new toy. Stuff-It would be an example of:
a. a cartel.
b. a monopoly.
c. an oligopoly.
d. a competitive firm.
ANSWER: b
Use the following information to answer questions 38 – 39.
__________________________________
Quantity of
Price
Pharmaceuticals Demanded
Per Unit
__________________________________
1
$50
2
45
3
40
__________________________________
38. The total revenue associated with selling 3 units of pharmaceuticals is:
a. $120.
b. $90.
c. $50.
d. $45.
ANSWER: a
39. The marginal revenue associated with the second unit of pharmaceuticals is:
a. $120.
b. $90.
c. $50.
d. $40.
ANSWER: d
Test Bank  325
40. For a monopolist, marginal revenue is less than demand price because:
a. the firm must take the market price as given.
b. the firm must raise price in order to sell additional units of output.
c. the firm must lower price in order to sell additional units of output.
d. the firm cannot raise price too much or additional firms will be attracted to the industry.
ANSWER: c
41. Suppose a monopolist is currently producing at a point where marginal revenue is $25 and
marginal cost is $18. This monopolist should:
a. decrease output in order to increase profits.
b. increase output in order to increase profits.
c. advertise more to encourage consumers to buy more of the product.
d. cease production to cut its losses.
ANSWER: b
42. Suppose the Ding-Dong Doorbell Co., a monopoly, finds that at current production levels
marginal revenue is $15 while marginal cost is $10. This company should:
a. make no change in present production level.
b. without further information on average production cost there is no way to determine what
actions the company should take.
c. decrease production, as this will allow price and marginal revenue to increase, thereby
increasing profits.
d. increase output as this will result in higher profits.
ANSWER: d
43. Suppose a monopolist is currently producing at a point where marginal revenue is $20 and
marginal cost is $25. This monopolist should:
a. decrease output in order to increase profits.
b. increase output in order to increase profits.
c. make no change in output. It is maximizing profits at its current level of production.
d. advertise less. This would cut its costs and bring it to a profit maximizing position.
ANSWER: a
44. Suppose We Are Unique Corporation, a monopoly, finds that at its current production levels
marginal revenue is $18 while marginal cost if $20. This company should:
a. make no change in present production level.
b. without further information on average production cost there is no way to determine what
actions the company should take.
c. decrease production, as this will allow price and marginal revenue to increase, thereby
increasing profits.
d. increase output as this will result in higher profits.
ANSWER: c
45. Suppose Kris Kraf, a monopolist is producing the profit-maximizing level of output. At this
level of output we know that:
a. marginal revenue and marginal social benefit are equal.
b. marginal revenue exceeds marginal social benefit..
c. marginal social benefit exceeds marginal revenue.
d. marginal revenue exceeds price.
ANSWER: c
326  Chapter 5/Market Power: Does It Help or Hurt the Economy?
Use the following diagram to answer questions 46 – 50.
Price per Unit (Dollars)
P3
P2
MC
P1
D
MR
0
Q
1
Q2
Q
3
Quantity per Month
46. What level of output should the monopolist produce?
a. Q1.
b. Q2.
c. Q3.
d. Output should be between Q2 and Q3, depending upon the level of market power the firm
has.
ANSWER: b
47. What price should the monopolist charge?
a. P1.
b. P2.
c. P3.
d. a price between P1 and P2.
ANSWER: b
48. A competitive industry would charge what price and produce what level of output?
a. P1 and Q1, respectively.
b. P2 and Q2, respectively.
c. P1 and Q2, respectively.
d. P1 and Q3, respectively.
ANSWER: d
49. If the firm were currently producing output level Q1, we know that:
a. marginal revenue would exceed marginal cost.
b. marginal cost would exceed marginal revenue.
c. marginal revenue and marginal cost would be equal.
d. demand price and marginal revenue would be equal.
ANSWER: a
Test Bank  327
50. If the firm were currently producing output level Q3, we know that:
a. profits are being maximized.
b. increasing output would increase profits.
c. decreasing output would increase profits.
d. there should be no change in output.
ANSWER: c
Use the following diagram to answer questions 51 – 54.
Price per Unit (Dollars)
P3
P
.A
P1
.C
2
.B
MC
D
MR
0
Q1
Q2
Quantity per Month
51. The price and output that maximize the monopolist's profits are:
a. P1 and Q1, respectively.
b. P1 and Q2, respectively.
c. P2 and Q1, respectively.
d. P2 and Q2, respectively.
ANSWER: c
52. The monopolist's profits are given by area:
a. P1P2AC.
b. OP1CQ1.
c. P1P3AC.
d. P1P3B.
ANSWER: a
53. The price and output that would emerge under a competitive industry are:
a. P1 and Q1, respectively.
b. P1 and Q2, respectively.
c. P2 and Q1, respectively.
d. P2 and Q2, respectively.
ANSWER: b
54. Efficiency occurs at:
a. point A.
b. point B.
c. point C.
d. because points A and B both lie on the demand curve, they are both efficient.
ANSWER: b
328  Chapter 5/Market Power: Does It Help or Hurt the Economy?
55. Which of the following would be least likely to have market power?
a. An industry in which there are a small number of producers and low entry barriers.
b. An industry in which there are a small number of producers and significant entry barriers.
c. An industry consisting of a single firm that faces little competition from imports.
d. An industry with a small number of firms that produce differentiated products.
ANSWER: a
Use the following diagram to answer question 56
Price per Unit (Dollars)
S
1
S
2
S
0
3
Quantity per Month
56. Which of the following statements is correct?
a. A cartel would be least successful is supply were represented by S1.
b. A cartel would be least successful is supply were represented by S2.
c. A cartel would be least successful if supply were represented by S3.
d. A cartel would be most successful if supply were represented by S2.
ANSWER: c
Essay and Discussion Questions
1. Evaluate the following statement. "When a regulatory agency such as a public utilities
commission is established, it will ultimately be controlled by the people it was intended to
regulate."
In this case, the student should recognize the incentive for political rent-seeking. Continuous
lobbying on the part of the regulated firm (which in general is not countered by lobbying on the
part of the consumer) may eventually influence the regulators. There is also the problem that
commission members may expect to move to higher-paying jobs in the regulated industry. If this
is true, the regulator may take a less rigorous approach to regulation.
2. Suppose Ms. Rich owns several gasoline stations. In Smalltown she owns the only station
while in Biggington she owns one of several stations. Compare and contrast the price that
Ms. Rich will charge at her stations.
The discussion should center on the fact that in the case of owning the only station Ms. Rich has
market power and may therefore charge a higher price. When she owns one of several stations
she must act as a price taker and will charge a lower, competitive price.
Test Bank  329
3. Suppose that because of the need to establish plants, entry into the boxwood industry can
occur only after several years. What are the implications for price and output?
In this case market power, in the short run, can exist. This will allow an industry with just one
price to have a price higher than the competitive price. However, since entry is possible
eventually, it is unlikely that the price charged will be as great as the monopoly price. In this
case, the threat of potential competition will work to impede monopoly behavior.
4. Evaluate the following statement. “Because of numerous merger, market power in the U.
S. has increased over the last 50 years.”
The student should discuss the fact that market power in the U. S. has probably declined over the
past 50 years. Increased competition from foreign competition in the manufacturing sector,
government deregulation, government policies making mergers and price fixing more difficult,
and the impact of the information revolution should all be discussed.
5. Evaluate the following statement. "Government regulation should be used to eliminate
any market power that exists in the U.S. economy."
The student should recognize the problems with such a policy. For example, one outcome of
such a policy might be increases in the cost of production as large, low-cost producers were
broken up into smaller firms. An even greater problem is the decrease in incentives to pursue
economic rent through innovations and entrepreneurial activity. Thus, totally eliminating
market power through the use of government regulation may not be beneficial to the economy.
6. Evaluate the following statement. "Because people's lives often depend on the drugs made
available from pharmaceutical companies, these companies should not be allowed to profit
at the expense of these lives."
The student should discuss the role that profits play in providing an incentive for pharmaceutical
companies to engage in research. This research is quite costly and evidence tends to show that in
the absence of economic reward, research in this industry tends to be stifled. Thus, new drugs
that patients may need for survival may not be developed in the presence of strict controls.
Problems
1. Given the information in the following table find:
a. Total revenue for each quantity sold.
b. Marginal revenue for each quantity sold.
c. Total cost of producing each quantity.
d. Profit associated with each quantity.
______________________________________
Quantity
Price
Marginal Cost
______________________________________
0
$35
1
31
$7
2
27
7
3
23
7
4
19
7
5
15
7
6
11
7
______________________________________
330  Chapter 5/Market Power: Does It Help or Hurt the Economy?
a. Total revenue is price times quantity.
____________________________________________________
Price x
Quantity
=
Total Revenue
____________________________________________________
$35
0
$0
31
1
31
27
2
54
23
3
69
19
4
76
15
5
75
11
6
66
b. Marginal revenue is the change in total revenue divided by the change in quantity.
___________________________________________________________
Change in
Total
Change in
Marginal
Quantity
Quantity
Revenue Total Revenue
Revenue
___________________________________________________________
0
1
$0
1
1
31
$31
$31
2
1
54
23
23
3
1
69
15
15
4
1
76
7
7
5
1
75
-1
-1
6
1
66
-9
-9
c. Total cost is the sum of all the marginal costs.
_________________________________________
Quantity
Marginal Cost
Total Cost
_________________________________________
1
$7
$7
2
7
14
3
7
21
4
7
28
5
7
35
6
7
42
d. Profit is total revenue minus total cost.
________________________________________________________
Quantity
Total Revenue
–
Total Cost
=
Profit
_________________________________________________________
1
$31
$7
$24
2
54
14
40
3
69
21
48
4
76
28
48
5
75
35
35
6
66
42
24
Test Bank  331
2. Given the following information, find the monopolist's total revenue, marginal revenue,
and the profit maximizing level of output.
______________________________
Marginal
Quantity
Price
Cost
______________________________
1
$45
$15
2
40
15
3
35
15
4
30
15
5
25
15
Total revenue is price times quantity. Marginal revenue is the change in total revenue divided by
the change in quantity. The profit maximizing level of output occurs at the point where marginal
revenue equals marginal cost.
______________________________________________________________
Total
Marginal
Marginal
Quantity
Price
Revenue
Revenue
Cost
______________________________________________________________
1
$45
$45
$45
$15
2
40
80
35
15
3
35
105
25
15
4
30
120
15
15
5
25
125
5
15
When output is four units, marginal revenue and marginal cost are equal. Thus, the profit maximizing level of
output is four units.
3. Use the following diagram to find:
a. the price and quantity that would prevail if the industry were competitive.
b. the price and quantity that would prevail if the industry were a monopoly.
c. the profits earned by the monopolist.
332  Chapter 5/Market Power: Does It Help or Hurt the Economy?
Price per Unit (Dollars)
25
20
10
C
B
E
A
G
F
MC
D
MR
0
100
300
Quantity per Month
a. A competitive industry produces at the point where quantity demanded and quantity
supplied are equal. This occurs at point F in the diagram above. The price charged would be
$10 and the quantity exchanged would be 300.
b. In order to maximize profits, a monopolist produces at the point where marginal revenue and
marginal cost are equal. This means that the monopolist would produce output of 100. The
price consumers are willing to pay for this output (as indicated by the demand curve) is $20.
c. Monopoly profits are equal to total revenue minus total cost. Total revenue is $20 x 100 or
$2,000. Total cost is $10  100 or $1,000. Total profits, then, are $1,000.