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AK Microeconomics – Chapter 11
CHAPTER ELEVEN
Answers to Self-Test Questions
1. a) Game theory analysis suggests that the other firm would be forced to respond with
a new advertising campaign possibly using another high profile sports figure.
b) Relative market share between the two firms probably would not change much
from what it was initially.
c) The two firms would be tempted to come to an (illegal) agreement avoiding
expensive adverting campaigns in the future.
2. a) 71.7% ($66/$92)
b) oligopoly industry (it is higher than the 40%,
which is the accepted break-off figure.)
3. The restaurant market is not considered to be perfectly competitive since there are
many differences between restaurants including location, service, quality of food, and
so on. This is evidenced by the fact that people do show preferences over which
restaurants they attend. Therefore, it is an example of a monopolistically competitive
market.
4. Some firms within the industry will go out of business (exit). Graphically, this would
shift the demand curve faced by each of the remaining firms to the right so that it once
again became tangent to the average cost curve.
5. a) Output Q2. (this is the profit-maximizing output where MC=MR.)
b) Excess capacity of Q4 – Q2. (economic capacity is the output where AC is
minimum.)
6. Oligopoly and monopolistic competition differ in that oligopoly is comprised of only a
few, relatively big, firms whereas in monopolistic competition there are a large number
of firms.
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AK Microeconomics – Chapter 11
7. a) See the following figure:
Spartan Inc
cheat
stick to agreement
Cell A
stick to
agreement
Cell B
$25
$35
$25
$15
Trojan Ltd
Cell D
Cell C
cheat
$15
$20
$20
$35
b) Cell D. They will end up both cheating.
8. a) Output: Q1
(where MC = MR)
b) Price: P1
9.
a) Oligopolies do not achieve economic capacity, which means that they do not
operate at minimum average cost. Furthermore, because of their market power, they
are able to charge prices in excess of average cost.
b) Oligopolies are able to capture economies of scale and they operate in an
environment that fosters technological change, which results in both the short-run and
long-run average costs being lower than for compettive firms. These lower costs lead
to lower prices.
Answers to Study Guide Questions
1. False: prices between firms are usually very similar; competition is focused on product
differentiation.
2. True.
3. False: economic profits are eliminated in the long run.
4. True.
5. False: this is a characteristic of an oligopoly market.
6. False: it is assumed that there is no collusion in these two variants.
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AK Microeconomics – Chapter 11
7. True.
8. True.
9. True.
10. False: the assumption is that they maximize profits.
11. b
12. a
13. b
14. b
15. b
16. c
17. c
18. c
19. c
20. d
21. a
22. e
23. b
24. a
25. b
26. d
27. d
28. b
29. b
30. c
31. b
32. d
33. c
34. b
35. c
Answered Problems
36A.
Key Problem
a) See following figure:
Figure 11.12 (completed)
b) Total cost is the area CbQ1F0 while total revenue is P1aQ1F0 and economic profit is
P1abC.
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AK Microeconomics – Chapter 11
c) See following figure:
Figure 11.13 (completed)
d) See following figure:
Figure 11.14 (completed)
Remember that the MR curve drops twice as quickly as the demand curve. The demand
curve has shifted to the left until it is just tangent to the AC curve. The new price is at
this point of tangency while the MC and MR curves intersect directly below the same
point of tangency.
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AK Microeconomics – Chapter 11
e) Total revenue: OP2aQ2F; total cost: OP2aQ2F (i.e., the same as the total revenue).
f) See Figure 11.14 (completed)
g) Excess capacity is the difference between the quantity at the lowest average cost, QC,
and the profit maximizing output, Q2F.
37A.
a)
Total revenue =
OPbQ.
Total cost
=
OfcQ.
Total loss
=
Pfcb.
b) OP (or Qb) (i.e. AVC must be below price).
38A.
a) See the following figure:
Figure 11.16 (Completed)
Moondance
cheat
stick to agreement
Cell A
stick to
agreement
Cell B
$120
$150
$120
$90
Sundance
Cell C
cheat
Cell D
$105
$90
$105
$150
b) They will choose option D because for each firm it is the best option. They will
each choose to cheat because it is the best option whether the other cheats or not.
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AK Microeconomics – Chapter 11
39A.
a) See the following table:
Table 11.4 (completed)
Quantity
0
1
2
3
4
5
6
7
8
9
10
Price
/
64
62
60
58
56
54
52
50
48
46
b) Price: $52;
TR
/
64
124
180
232
280
324
364
400
432
460
MR
/
64
60
56
52
48
44
40
36
32
28
TC
122
154
184
216
250
286
324
364
406
450
498
MC
/
32
30
32
34
36
38
40
42
44
48
AC
154
92
72
62.5
57.2
54
52
50.75
50
49.8
output: 7 (Where MC =MR)
b) MC = MR = $40
d) AC = $52;
AR (= price) = $52
e) Rising Moon must be operating in a monopolistically competitive market and is in
long-run equilibrium. (This is because at the profit maximizing output, the firm is
just breaking even and unlike perfect competition the firm is facing a downwardsloping demand curve.)
40A.
a) and b) See the following figure:
Figure 11.17 (completed)
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AK Microeconomics – Chapter 11
41A. a) 60% The top 4 sales = $48 (18 + 12 + 10 + 8). Total sales in the industry = $80.
Concentration ratio = $48/$80 x 100 = 60%.
b) Oligopoly (higher than 40% is regarded as oligopolistic)
42A. The four methods of product differentiation are:

developing a recognized brand name, product logo, or packaging

securing a superior location or developing a reputation for exceptional service

engaging in product development and improvement

developing an effective advertising strategy
43A. A cartel is an association of sellers acting in unison. Since the market system
requires that firms act separately and individually and do not collude, they are
considered illegal in most countries.
44A. Popsi should cheat and increase its advertising budget. If Popsi instead sticks to the
agreement, then the best that can happen will be $30 profit (if Cuke also sticks to the
agreement) and the worst will be $15 (if Cuke cheats). But by cheating, the best
outcome ($35 profit if Cuke doesn’t cheat) is better, and the worst outcome ($20 if
Cuke also cheats) is also better.
45A.
a)
Price: $60;
output: 800. (Where demand (D) = supply (MC)
b)
Price: $90; output: 400. (Where MR = MC. To find MR draw a line
from a price of $120 to quantity of 800.)
c)
Price: $90; output of each firm: 100. (The same price as in b) with each
firm producing a quarter of the output in b).)
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AK Microeconomics – Chapter 11
46A.
a)
Price: $24;
mid-point);
output: 240 (where MR will cut the horizontal axis at the
total revenue: $5760 ($24 x 240)
b), c) d) and e) See the following figure:
Figure 11.21 (completed)
c) If Ace increases his output by one-third (to 160) and Pace continues to sell 120, the
total output (280) can only be sold if the price falls to $20. Pace’s total revenue will
fall to $2400 (120 x $20) and Ace’s increase to $3200 (160 x $20). These amounts
are shown in the top right box of Figure 11.20 (Completed) above.
d) This is the same as c) with the positions reversed. The amounts are shown in the
bottom left box of the figure.
e) If they both cheat and increase their outputs to 160 each, the total output of 320 can
only be sold at a price of $16. The total revenue of each will be $2560 (160 x $16).
These amounts are shown in the bottom right box in the figure.
47A. In the short-run, it is possible for the monopolistically competitive firm to make an
economic profit (or loss or break even.), like all firms in all markets,.
48A. Mutual interdependence is the condition in which a firm’s actions depend on the
reaction of rival firms in the industry. A firm cannot make a decision without
considering the possible actions of the competition.
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AK Microeconomics – Chapter 11
49A. a)
Price: $3;
output: 90
A table might be helpful:
Price
Quantity
$5.00
4.50
4.00
3.50
3.00
2.50
2.00
1.50
1.00
.50
0
30
45
60
75
90
105
120
135
150
165
180
b) Output: 45;
Total Revenue
=Total Profit
$150.00
202.50
240.00
262.50
270.00
262.50
240.00
202.50
150.00
82.50
0
new price: $1.50
Again, a table will be helpful:
Price
3.00
2.50
2.00
1.50
1.00
0.50
0
Quantity for
Tienshan
90
90
90
90
90
90
90
Quantity for
Endless
0
15
30
45
60
75
90
TR = TProfit for
Endless
0
37.50
60.00
67.50
60.00
37.50
0
50A. Tic: Cheat (His best outcome is better and his worst is also better.)
Tac: Cheat (He’s better off by $40 by cheating if Tac doesn’t; and only $10 worse
off if Tac also cheats). On balance, it’s better to cheat.
Tow: Either cheat or don’t cheat; it makes no difference. (He’s better off by $20
by cheating if Tac doesn’t; and $20 worse off if Tac also cheats).
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AK Microeconomics – Chapter 11
51A. In Chapter 9, productive efficiency was defined as the production of that output
which achieved the lowest possible average cost. Thus, while it is true that, in the long
run, a monopolistically competitive firm produces an output where AC equals price,
this doesn’t occur at the minimum AC. Economic capacity also refers to the output
where AC is minimum, and since the firm is producing less than this output it
experiences excess capacity.
52A. No, this is unlikely to be the motto of technostructure who would not aim to make
high profits because they might risk failure and therefore their own jobs. And if they
were successful they would presumably channel the profits into the firm rather than
into their own pockets. Galbraith and others consider this type of behaviour unlikely.
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