78 ❖ Chapter 16 /Monopolistic Competition
65. Which of the following statements regarding brand names in advertising is not correct?
a.
Brand names provide consumers with information about quality when quality cannot be easily
judged in advance of purchase.
b.
Brand names give firms an incentive to maintain high quality to maintain the reputation of the firm.
c.
Brand names allow firms to produce and sell inferior products in the long run since people will
continue to purchase the brand-name product.
d.
Brand names can cause consumers to perceive differences in products that do not actually exist.
66. Economists defend brand names as useful to consumers because brand names
a.
provide consumers with information about quality when quality cannot easily be judged in advance
of purchase.
b.
give firms a financial incentive to maintain the high quality associated with their brand name.
c.
convince consumers to spend more for products nearly identical to generic versions.
d.
Both a and b are correct.
67. When quality cannot be easily judged in advance, what provides consumers with information about the quality
of a product?
a.
a brand name
b.
a tie-in
c.
the quantity available for sale
d.
the amount of deadweight loss
68. When monopolistically competitive firms advertise, in the long run
a.
they will still earn zero economic profit.
b.
they can earn positive economic profit by increasing market share.
c.
the market price must fall.
d.
the market price must rise.
69. Which of the following statements is not correct?
a.
The typical monopolistically competitive firm could reduce its average total cost if it produced
more output.
b.
Monopolistically competitive firms advertise in order to increase the elasticity of the demand curve
they face.
c.
Expensive advertising might help consumers if it is a signal that the product is good.
d.
Brand names acquired at great cost might help consumers by assuring quality.
Chapter 16 /Monopolistic Competition ❖ 79
70. Which of the following statements is correct?
a.
The more similar Firm A’s product is to Firm B’s product, the more likely Firm A is to advertise.
b.
Monopolistically competitive firms advertise in order to increase the elasticity of the demand curve
they face.
c.
According to the signaling theory, the more product information an advertisement contains, the
more effective it is.
d.
Brand names may help consumers if they provide information about the quality of a product when
acquiring such information is difficult.
71. Which of the following statements is not correct?
a.
Critics of advertising argue that firms advertise to manipulate consumers’ tastes.
b.
Defenders of advertising argue that advertising provides valuable product information to
consumers.
c.
An industry with many brand name products will be more competitive than one with many generic
products.
d.
The willingness of a firm to spend a large amount of money on advertising can signal the quality of
the product.
Scenario 16-4
Consider the problem facing two firms, Burger Prince and McDaniel’s, in the fast-food restaurant market.
Each firm has just come up with an idea for a new fast-food menu item which it would sell for $5. Assume
that the marginal cost for each new menu item is a constant $3, and the only fixed cost is for advertising. Each
company knows that if it spends $16 million on advertising it will get 2 million consumers to try its new
product. Burger Prince has done market research which suggests that its product does not have any “staying”
power in the market. Even though it could get 2 million consumers to buy the product once, it is unlikely that
they will continue to buy the product in the future. McDaniel’s’s market research suggests that its product is
very good, and consumers who try the product will continue to be consumers over the ensuing year. On the
basis of its market research, McDaniel’s estimates that its initial 2 million customers will buy one unit of the
product each month in the coming year, for a total of 32 million units.
72. Refer to Scenario 16-4. If Burger Prince decides to advertise its product it can expect to
a.
incur a loss of $12 million.
b.
incur a loss of $5 million.
c.
earn a profit of $5 million.
d.
earn a profit of $12 million.
73. Refer to Scenario 16-4. If McDaniel’s decides to advertise its product it can expect to
a.
earn a profit of $48 million per year.
b.
earn a profit of $36 million per year.
c.
earn a profit of $16 million per year.
d.
incur a loss of $16 million per year.
80 ❖ Chapter 16 /Monopolistic Competition
74. Refer to Scenario 16-4. Suppose Burger Prince has an opportunity to create a cheaper advertising campaign
in newspapers rather than on television for its new product. This campaign will cost $5 million and is ex-
pected to result in the same 2 million one-time customers. Burger Prince should
a.
invest in the cheaper campaign because they will earn a profit.
b.
invest in the cheaper campaign because they will signal the high quality of their product.
c.
not invest in the cheaper campaign because they will incur a loss.
d.
not invest in the cheaper campaign because their brand name will be negatively affected.
75. Refer to Scenario 16-4. By its willingness to spend money on advertising, McDaniel’s
a.
signals the quality of its new product to consumers.
b.
signals that it is not a profit maximizer.
c.
is detracting from the efficiency of markets.
d.
will drive Burger Prince out of the market.
76. Refer to Scenario 16-4. On the basis of a theory that people buy a product because it is advertised, the content
of advertisements for McDaniel’s product
a.
should focus on quality comparisons in order to be successful.
b.
must include celebrity endorsements in order to be successful.
c.
is critical to the success of the product in the market.
d.
is irrelevant to the success of the advertisement.
77. Refer to Scenario 16-4. Which of the following is most likely?
a.
Both Burger Prince and McDaniel’s will advertise.
b.
Neither Burger Prince nor McDaniel’s will advertise.
c.
Burger Prince will advertise, but McDaniel’s will not advertise.
d.
McDaniel’s will advertise, but Burger Prince will not advertise.
CONCLUSION
1. Firms in a monopolistically competitive market
a.
are price takers.
b.
produce an output level that minimizes average total cost in the long run.
c.
maximize profits by producing where price equals marginal cost.
d.
cannot earn economic profits in the long run.
Chapter 16 /Monopolistic Competition ❖ 81
2. Which of the following statements is correct?
a.
Firms in monopolistic competition and monopoly can earn economic profits in both the short run
and the long run.
b.
Both perfectly competitive and monopolistically competitive firms charge a price equal to marginal
cost.
c.
Firms in perfect competition, monopolistic competition, and monopoly maximize profits by
producing where marginal revenue equals marginal cost.
d.
Both perfectly competitive and monopolistically competitive firms produce the welfare-maximizing
level of output.
3. Which of the following statements is correct?
a.
Firms in monopolistic competition and monopoly can earn economic profits in both the short run
and the long run.
b.
Both perfectly competitive and monopolistically competitive firms are price takers.
c.
Both a monopolistically competitive industry and a monopoly are characterized by a very small
number of (or one) firm(s).
d.
Firms can easily enter a perfectly competitive or monopolistically competitive industry.
4. Which of the following statements is not correct?
a.
Both monopolistically competitive and perfectly competitive firms can earn economic profits in the
short run.
b.
Both monopolies and monopolistically competitive firms can earn economic profits in the long run.
c.
Firms in perfect competition, monopolistic competition, and monopoly maximize profits by
producing where marginal revenue equals marginal cost.
d.
Only competitive firms produce the welfare-maximizing level of output.
5. Which of the following statements is not correct?
a.
Firms in monopolistic competition and monopoly can earn economic profits in the short run.
b.
Firms in monopolistic competition and perfect competition produce the welfare-maximizing level
of output.
c.
Monopolistically competitive firms price above marginal cost, whereas competitive firms price at
marginal cost.
d.
Firms wishing to enter a monopolistically competitive market can do so freely, whereas firms
wishing to enter a monopoly market will face barriers.
6. A market is comprised of many firms as opposed to just one firm or a few firms
a.
only when it is perfectly competitive.
b.
only when it is perfectly competitive or oligopolistic.
c.
only when it is perfectly competitive or monopolistically competitive.
d.
when it is perfectly competitive, monopolistically competitive, or oligopolistic.
82 ❖ Chapter 16 /Monopolistic Competition
7. A firm is a price taker
a.
only when the market is perfectly competitive.
b.
only when the market is perfectly competitive or monopolistic.
c.
only when the market is perfectly competitive or monopolistically competitive.
d.
when the market is perfectly competitive, monopolistically competitive, or monopolistic.
8. A firm maximizes its profit by producing output up to the point where marginal revenue equals marginal cost
a.
only when the market is a monopoly.
b.
only when the market is a monopoly or monopolistically competitive.
c.
only when the market is monopolistically competitive or perfectly competitive.
d.
when the market is perfectly competitive, monopolistically competitive, or monopolistic.
9. A firm produces the welfare-maximizing level of output
a.
only when the market is perfectly competitive.
b.
only when the market is a monopoly or monopolistically competitive.
c.
only when the market is monopolistically competitive or perfectly competitive.
d.
when the market is perfectly competitive, monopolistically competitive, or monopolistic.
10. A firm can earn economic profits in the short run
a.
only when the market is perfectly competitive.
b.
only when the market is a monopoly or monopolistically competitive.
c.
only when the market is monopolistically competitive or perfectly competitive.
d.
when the market is perfectly competitive, monopolistically competitive, or monopolistic.
11. A firm can earn economic profits in the long run
a.
only when the market is a monopoly.
b.
only when the market is a monopoly or monopolistically competitive.
c.
only when the market is monopolistically competitive or perfectly competitive.
d.
when the market is perfectly competitive, monopolistically competitive, or monopolistic.
Chapter 16 /Monopolistic Competition ❖ 83
12. A firm charges a price that exceeds marginal cost
a.
when the market is a monopoly.
b.
when the market is a monopoly or monopolistically competitive.
c.
when the market is monopolistically competitive or perfectly competitive.
d.
when the market is perfectly competitive, monopolistically competitive, or monopolistic.
13. Firms can freely enter a market
a.
only when the market is a monopoly.
b.
only when the market is a monopoly or monopolistically competitive.
c.
only when the market is monopolistically competitive or perfectly competitive.
d.
when the market is perfectly competitive, monopolistically competitive, or monopolistic.
14. A monopolistically competitive market is like a monopoly in that
a.
both market structures feature easy entry by new firms in the long run.
b.
the main objective of firms in both market structures is something other than profit maximization.
c.
firms in both market structures produce the welfare-maximizing level of output.
d.
firms in both market structures set price above marginal cost.
15. A monopolistically competitive market is like a competitive market in that
a.
both market structures feature easy entry by new firms in the long run.
b.
the main objective of firms in both market structures is something other than profit maximization.
c.
firms in both market structures produce the welfare-maximizing level of output.
d.
firms in both market structures set price above marginal cost.
16. A monopolistically competitive market is like both a competitive market and a monopoly in that
a.
all three market structures feature easy entry by new firms in the long run.
b.
firms in all three market structures maximize profit by producing an output level where marginal
revenue equals marginal cost.
c.
firms in all three market structures produce the welfare-maximizing level of output.
d.
All of the above are correct.
17. A monopolistically competitive market is like both a competitive market and a monopoly in that firms in all
three market structures
a.
can earn economic profits in the short run.
b.
can earn economic profits in the long run.
c.
charge a price above marginal cost.
d.
All of the above are correct.
84 ❖ Chapter 16 /Monopolistic Competition
18. The theory of monopolistic competition is somewhat disappointing in that it fails to
a.
pinpoint a profit-maximizing level of output for monopolistically competitive firms.
b.
yield simple and compelling advice for public policy.
c.
explain why product differentiation is observed in monopolistically competitive markets.
d.
explain why monopolistically competitive firms have excess capacity.
TRUE/FALSE
1. There are four basic types of market structure.
2. The “competition” in monopolistically competitive markets is most likely a result of having many sellers in the
market.
3. The “monopoly” in monopolistically competitive markets is most likely a result of firms having some pricing
power due to product differentiation.
4. Monopolistic competition is characterized by many buyers and sellers, product differentiation, and free entry.
5. Monopolistic competition is characterized by many buyers and sellers, product differentiation, and barriers to
entry.
6. A monopolistically competitive market is characterized by barriers to entry.
7. The market for wheat is most likely considered a monopolistically competitive market.
8. Monopolistic competition is the only market structure that features many sellers.
9. Product differentiation always leads to some measure of market power.
Chapter 16 /Monopolistic Competition ❖ 85
10. Oligopoly is characterized by a few sellers offering similar products, whereas monopolistic competition is
characterized by many sellers offering differentiated products.
11. To be considered an oligopoly, the market must have a concentration ratio below 50%.
12. Monopolistic competition is characterized by a few sellers offering similar products, whereas oligopoly is
characterized by many sellers offering differentiated products.
13. Oligopoly and monopolistic competition are examples of a market structure called imperfect competition.
14. Monopolistic competition and monopoly are examples of a market structure called imperfect competition.
15. A markup of price over marginal cost is inconsistent with free entry and zero profit.
16. Monopolistically competitive firms, like monopoly firms, maximize their profits by charging a price that ex-
ceeds marginal cost.
17. A profit-maximizing firm in a monopolistically competitive market charges a price equal to marginal cost.
18. For a profit-maximizing firm in a monopolistically competitive market, when price is equal to average total
cost, price must lie above marginal cost.
19. A profit-maximizing firm in a monopolistically competitive market can earn positive, negative, or zero profits
in the short run.
86 ❖ Chapter 16 /Monopolistic Competition
20. A firm in a monopolistically competitive market can earn both short-run and long-run profits.
21. A firm in a monopolistically competitive market can earn short–run profits but not long-run profits.
22. In the long run, monopolistically competitive firms produce where demand equals marginal cost.
23. When a firm in a monopolistically competitive market earns zero economic profit, its product price must equal
marginal cost.
24. In the long run, monopolistically competitive firms produce where demand equals average total cost.
25. In a long-run equilibrium, both perfectly competitive markets and monopolistically competitive markets have
price equal to average total cost.
26. In a long-run equilibrium, firms in both perfectly competitive markets and monopolistically competitive mar-
kets produce a quantity below the efficient scale of production.
27. When a monopolistically competitive firm is in a long-run equilibrium, the values of marginal cost, average
total cost, and price are all the same.
28. In a monopolistically competitive market, the number of firms adjusts until economic profits are driven to
zero.
29. When a profit-maximizing firm in a monopolistically competitive market is in long–run equilibrium, marginal
cost must lie below average total cost.
Chapter 16 /Monopolistic Competition ❖ 87
30. In a monopolistically competitive market, the demand curves faced by incumbent firms are unaffected by the
entry of new firms into the market.
31. A monopolistically competitive firm faces a downward-sloping demand curve because there are few firms in
the market.
32. A firm in a monopolistically competitive market is usually indifferent to an additional customer walking
through the door, since a sale to that customer will not increase the firm’s profit.
33. The term excess capacity refers to the fact that a firm operates on the upward–sloping portion of its average-
total-cost curve.
34. The term excess capacity refers to the fact that a firm produces a lower quantity than it would if it operated at
the efficient scale.
35. Excess capacity characterizes firms in monopolistically competitive markets, even in situations of long-run
equilibrium.
36. When a firm operates with excess capacity, it must be in a monopolistically competitive market.
37. A firm that would experience higher average total cost by increasing production is operating with excess ca-
pacity.
38. When a firm operates at efficient scale, it is producing at the minimum point on its average total cost curve.
39. The product-variety externality states that entry of a new firm conveys a negative externality on consumers.
88 ❖ Chapter 16 /Monopolistic Competition
40. The product-variety externality states the benefits to consumers from the introduction of a new product.
41. The business-stealing externality states that entry of a new firms imposes a cost on existing firms because they
lose customers.
42. The product-variety externality and the business-stealing externality are both spillover costs of new firms en-
tering a monopolistically competitive market.
43. The product-variety externality and the business-stealing externality are both spillover benefits of new firms
entering a monopolistically competitive market.
44. Defenders of advertising argue that firms use advertising as a signal of quality, even if the advertising delivers
little helpful information about the product.
45. Critics of advertising argue that advertising leads to less elastic demand for products and a larger markup of
price over marginal cost.
46. The claim that advertising reduces the elasticity of demand is likely to be made by a defender of advertising.
47. Critics of advertising argue that firms use advertising to manipulate consumers’ tastes.
48. One thing that both critics of advertising and defenders of advertising agree on is that advertising fosters com-
petition.
49. When advertising is used to relay information about price, each firm is able to enhance market power.
Chapter 16 /Monopolistic Competition ❖ 89
50. Policymakers have generally come to accept the view that advertising enhances the efficiency of markets.
51. Economists are unanimous in their belief that advertising is socially inefficient.
52. When McDonald’s opens a store in Dhaka, Bangladesh, it has a strong incentive to enforce product quality
consistent with stores in the United States.
53. The Mikati Philippines Hard Rock Cafe has the exact same menu as the Hard Rock Cafe in New York. This is
an example of a brand name enhancing market efficiency for U.S. tourists visiting the Philippines.
54. Empirical evidence suggests that advertising usually leads to an increase in the price for advertised products.
55. Economists who argue that advertising enhances market efficiency suggest that celebrity advertising signals
inferior product quality.
56. Advertising during the Super Bowl is an example of information about quality contained primarily in the ex-
istence and expense of the advertising.
57. Brand names are rarely used to convey information about product quality.
58. The government of Italy will not allow any Hard Rock Cafe restaurants to open in Italy. Defenders of the effi-
ciency of brand-name markets would argue that this has hindered restaurant market efficiency in Italy.
59. The debate over whether advertising serves a valuable purpose in society is definitively answered by econo-
mists who study the tastes and preferences of individuals.
90 ❖ Chapter 16 /Monopolistic Competition
60. If advertising decreases the elasticity of demand for specific brand names of hard liquor, we would expect
firms to be able to charge a larger markup over marginal cost.
61. There is general disagreement among economists about the role of advertising, but there is widespread agree-
ment about the role of brand names on market efficiency.
62. The government may not be able to improve the inefficiencies of a monopolistically competitive market.
63. Firms in monopolistically competitive markets and monopolies can earn long-run profits due to barriers to
entry.
64. Free entry eliminates long-run profits for firms in competitive and monopolistic industries.
SHORT ANSWER
1. List five goods that are likely sold in a monopolistically competitive market.
2. Why does a typical monopolistically competitive firm face a downward-sloping demand curve?
3. In many college towns, private independent bookstores typically locate on the periphery of the college cam-
pus. However, in some college towns, the university has used political power to restrict private bookstores
near campus through community zoning laws. Use your knowledge of markets to predict the price and quality
of service differences in the market for college textbooks under the two different market regimes.
4. Use a graph to demonstrate why a profit-maximizing monopolistically competitive firm must operate at excess
capacity. Explain why a perfectly competitive firm is not subject to the same constraint.
Chapter 16 /Monopolistic Competition ❖ 91
5. In a small college town, four microbreweries have opened in the last two years. Demonstrate the effect of new
market entrants on demand for existing firms (microbreweries) that already served this market. Assume that
the local community now places a moratorium on new liquor licenses for microbreweries. How will this mora-
torium affect the long-run profitability of incumbent firms?
92 ❖ Chapter 16 /Monopolistic Competition
6. What is meant by the term “excess capacity” as it relates to monopolistically competitive firms?
7. Entry of firms in a monopolistically competitive industry is characterized by two externalities. List them and
briefly describe how consumers and existing firms are influenced by them.
8. Evaluate the following statement in the context of business-stealing and product-variety externalities: “We
have too many student apartments in this town already. Statistics show that vacancy rates average 15 percent
during any given semester.”
9. Assume the role of a critic of advertising. Describe the characteristics of advertising that reduce the effective-
ness of markets and decrease the social welfare of society.
10. Assume the role of a defender of advertising. Describe the characteristics of advertising that enhance the effec-
tiveness of markets and increase the social welfare of society.
Chapter 16 /Monopolistic Competition ❖ 93
11. Evaluate the following statement: “Advertisements that use celebrity endorsements are devoid of any value
and do not enhance the efficient functioning of markets.”
12. Professional organizations (for example, the American Medical Association and the American Bar Associa-
tion) have been active advocates for regulation to restrict the right of professionals to advertise. Describe what
economic incentives might exist for existing professionals to restrict advertising.
13. Discuss how brand names may enhance the efficiency of markets in a less developed country.
14. As developing countries make a transition to market-based economies, one of the first major capital invest-
ments is in “Western-quality” hotels. Explain why brand-name hotel accommodations are a critical step in at-
tracting foreign investment.
15. In markets where the government imposes an excise tax on unit sales, it also has a tendency to dabble with
restrictions on advertising (for example, cigarettes and hard liquor). Do potential (or actual) restrictions on ad-
vertising in these markets serve the interest of a government that is interested in maximizing its tax revenue
from the sale of these products? Explain your answer.