Practice Questions: Monopoly, Competition, Oligopoly
Davidson spring 2007
Question # 1. Monopoly vs Competition
You are given the following information about an industry consisting of 100 identical firms who all make standard
12 inch black shoelaces:
The demand curve facing the industry is:
P = 75 - 0.10 Qd
The marginal revenue curve facing the industry is:
MR = 75 - 0.20 Qd
The marginal cost curve for an individual firm is:
MC = 15 +10 qf
The horizontal sum of the marginal cost curves of all the firms in the industry is: MC = 15 +0.10 Qd
(this is really the industry supply curve)
Use this information to answer the following questions:
A
Suppose the 100 firms operate in a perfectly competitive industry.
I
Graph a two panel diagram of this industry.
(HINT: graph industry demand and supply in one frame, determine the market price and
then graph the picture facing a single firm in another graph directly next to it.)
II
Calculate the short run equilibrium price and quantity for the industry. Is the industry in
Long run equilibrium ? Why or why not? How much is each of the 100 firms producing?
B
Suppose all 100 firms form a cartel and act like a monopoly.
I
Draw a graph of this monopoly .
(HINT: graph industry demand, MR and supply in one frame. Where industry supply is
the horizontal sum of the individual MC curves)
II
Calculate the short run equilibrium price and quantity for the industry. Is the industry in
Long run equilibrium ? Why or why not?
C.
Compare the Cartel price and quantity outcomes with the Perfectly competitive Market price and quantity
outcomes. Calculate the Consumer Surplus and Producer Surplus under competition and the cartel. Why is
the total surplus lower with the cartel?
D
Is there an incentive for a firm to cheat in the cartel? Why?
Question # 2
Consider a single firm in a monopolistically competitive industry in the short run. Draw a new graph for each of the
following situations.
A.
B.
C.
D.
The firm is making economic profit.
The firm is making a loss which will cause shutdown.
The firm is making a loss but still producing.
Starting from the situation in part c, explain what will happen in this industry and how your graph in part c
will be affected? ( no new graph required)
E. The firm is in long run equilibrium.
Question # 3
This exercise applies game theory to a firm’s choice of an advertising budget. Suppose two competitors,
Pepsi and Coke, must each select its advertising expenditure. For simplicity, assume there are only two
sizes of advertising budgets: moderate and large. The relationship between advertising and profits for each
firm is presented in the following payoff matrix which gives each firm’s profits under each of its own
budgets as well as that of the competitor’s. Note that there are four possible combinations of budgets in the
market; these are represented by the four cells in the diagram. Coke’s profits are presented on the left side
of each cell, while Pepsi’s are on the right side.
Pepsi’s
Advertising Budget
Large
Coke’s
Advertising
Budget
A.
Moderate
Large
60
60
90
50
Moderate
50
90
80
80
If Pepsi and Coke colluded on their choices of advertising budgets, which would they select? Explain.
B. Is the cooperative outcome in A. likely to be stable? Explain.
C. What is the noncooperative (ie NASH) Equilibrium in this game? Explain.