Chapter 13 Suppose That A Small Town Has Seven Burger Shops

Chapter 13 – Monopolistic Competition and Oligopoly

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Chapter 13 – Monopolistic Competition

McConnell Brue Flynn 21e

DISCUSSION QUESTIONS

1. How does monopolistic competition differ from pure competition in its basic characteristics?

From pure monopoly? Explain fully what product differentiation may involve. Explain how the

entry of firms into its industry affects the demand curve facing a monopolistic competitor and

how that, in turn, affects its economic profit. LO1

2. Compare the elasticity of a monopolistic competitor’s demand with that of a pure competitor

and a pure monopolist. Assuming identical long-run costs, compare graphically the prices and

outputs that would result in the long run under pure competition and under monopolistic

competition. Contrast the two market structures in terms of productive and allocative efficiency.

Explain: “Monopolistically competitive industries are populated by too many firms, each of

which produces too little.” LO2

9.6 (pure competition) and Figure 11.1 (monopolistic competition). Price is higher and

output lower for the monopolistic competitor. Pure competition: P = MC (allocative

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3. “Monopolistic competition is monopolistic up to the point at which consumers become willing

to buy close-substitute products and competitive beyond that point.” Explain. LO2

4. “Competition in quality and service may be just as effective as price competition in giving

buyers more for their money.” Do you agree? Why? Explain why monopolistically competitive

firms frequently prefer nonprice competition to price competition. LO2

5. Critically evaluate and explain: LO2

a. In monopolistically competitive industries, economic profits are competed away in the long

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Answer:

a. The first part of the statement may well be true, but it does not lead logically to the

second part. The criticism of monopolistic competition is not related to the profit level

but to the fact that the firms do not produce at the point of minimum ATC and do not

equate price and MC. This is the inevitable consequence of imperfect competition and

its downward sloping demand curves. With P > minimum ATC, productive efficiency

is not attained. The firm is producing too little at too high a cost; it is wasting some of

its productive capacity. With P > MC, the firm is not allocating resources in

accordance with society’s desires; the value society sets on the product (P) is greater

than the cost of producing the last item (MC).

b. The statement is often true, since competition of close substitutes tends to compete

price of the average firm down to equality with ATC. Thus, there is no economic

profit. However, the firm is producing where its (moderately) monopolistically

downward-sloping demand curve is tangent to the ATC curve, short of the point of

minimum ATC and thus at a higher than purely competitive price. In other words, it is

at a “monopolistic” price.

6. LAST WORD What would you expect to happen to the proportion of big chain restaurants

relative to mom and pop restaurants in a town that lowered its minimum wage? Will the

proportion change due to exits or entrances? Which type of restaurant will see more in the way of

exits or entrances? Why? LO4

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REVIEW QUESTIONS

a. 10.

b. 100.

c. 1,000.

d. 10,000.

2. In the small town of Geneva, there are 5 firms that make watches. The firms’ respective output

b. 70.

d. 100.

3. Which of the following best describes the efficiency of monopolistically competitive firms?

Chapter 13 – Monopolistic Competition and Oligopoly

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Answer: D. Neither allocatively efficient nor productively efficient.

Monopolistically competitive firms are neither allocatively efficient nor productively

efficient. Both types of inefficiency have the same cause: product differentiation. That is

true because it is product differentiation that gives each firm in a monopolistically

competitive industry its small share of monopoly power. With that monopoly power

comes a downsloping MR curve that when intersected with the firm’s upsloping MC

curve results in a profit-maximizing output level that is inefficiently low. Productive

efficiency is when the firm produces where price = minimum ATC. Due to product

differentiation these firms produce at a lower quantity. Allocative efficiency is when the

firm produces where P = MC. Due to the downward sloping MC curve, price will be

higher than MC.

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PROBLEMS

1. Suppose that a small town has seven burger shops whose respective shares of the local

hamburger market are (as percentages of all hamburgers sold): 23%, 22%, 18%, 12%, 11%, 8%,

and 6%. What is the four‐firm concentration ratio of the hamburger industry in this town? What is

the Herfindahl index for the hamburger industry in this town? If the top three sellers combined to

form a single firm, what would happen to the four‐firm concentration ratio and to the Herfindahl

index? LO5

2. Suppose that the most popular car dealer in your area sells 10 percent of all vehicles. If all

other car dealers sell either the same number of vehicles or fewer, what is the largest value that

the Herfindahl index could possibly take for car dealers in your area? In that same situation, what

would the four‐firm concentration ratio be? LO5

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3. Suppose that a monopolistically competitive restaurant is currently serving 230 meals per day

(the output where MR = MC). At that output level, ATC per meal is $10 and consumers are

willing to pay $12 per meal. What is the size of this firm’s profit or loss? Will there be entry or

exit? Will this restaurant’s demand curve shift left or right? In long‐run equilibrium, suppose that

$8. What is the size of the firm’s profit? Suppose that the allocatively efficient output level in

long-run equilibrium is 200 meals. Is the deadweight loss for this firm greater than or less than

$60? LO5