?CFAInstitute.Forcandidateuseonly.Notfordistribution.

Reading12■TopicsinDemandandSupplyAnalysis

50

PRACTICEPROBLEMS

1

2

Ifthepriceelasticitycoe?cientofthedemandcurveforpaperclipsisequalto

–1,demandis:

A

B

C

elastic.

inelastic.

unitelastic.

edemandformembershipatalocalhealthclubisdeterminedbythefollow-

ingequation:

d

Q

=400?5P

hm

hm

whereQdisthenumberofhealthclubmembersandPisthepriceof

hm

hm

membership.Ifthepriceofhealthclubmembershipis$35,thepriceelasticity

ofdemandisclosestto:

A

B

C

–0.778.

–0.500.

–0.438.

3

4

5

Priceelasticityofdemandforagoodwillmostlikelybegreaterif:

A

B

C

therearenosubstitutesforthegood.

consumersconsiderthegoodasdiscretionary.

consumersspendasmallportionoftheirbudgetonthegood.

Iftheincomeelasticityofdemandforaproductis–0.6,a:

A

B

C

1%increaseinincomewillresultina0.6%increaseindemand.

1%increaseinincomewillresultina0.6%decreaseindemand.

0.6%increaseinincomewillresultina1%decreaseindemand.

Anindividual’sdemandforonionsisgivenbythefollowingequation:

d

Q=3?0.05P+0.009I?0.16P

o

o

t

d

whereQoisthenumberofonionsdemanded,Pisthepriceperpoundof

o

onions,Iisthehouseholdincome,andPisthepriceperpoundoftomatoes.

t

Ifthepriceofonionsis$1.25,householdincomeis$2,500,andthepriceof

tomatoesis$3.75,thecross-priceelasticityofdemandforonionswithrespect

tothepriceoftomatoesisclosestto:

A

B

C

–1.0597.

–0.0242.

–0.0081.

6

MovementalongthedemandcurveforgoodXoccursduetoachangein:

A

B

C

income.

thepriceofgoodX.

thepriceofasubstituteforgoodX.

?2017CFAInstitute.Allrightsreserved.

?CFAInstitute.Forcandidateuseonly.Notfordistribution.

PracticeProblems

51

7

Awirelessphonemanufacturerintroducedanext-generationphonethat

receivedahighlevelofpositivepublicity.Despiterunningseveralhigh-speed

productionassemblylines,themanufacturerisstillfallingshortinmeeting

demandforthephoneninemonthsafterintroduction.Whichofthefollowing

statementsisthemostplausibleexplanationforthedemand/supplyimbalance?

A

B

C

ephonepriceislowrelativetotheequilibriumprice.

Competitorsintroducednext-generationphonesatasimilarprice.

Consumerincomesgrewfasterthanthemanufactureranticipated.

ThefollowinginformationrelatestoQuestions

8–11

emarketdemandfunctionforfour-yearprivateuniversitiesisgivenbytheequation

d

Q

=84–3.1Ppr+0.8I+0.9Ppu

pr

whereQdisthenumberofapplicantstoprivateuniversitiesperyearinthousands,

pr

P

istheaveragepriceofprivateuniversities(inthousandsofUSD),Iisthehousehold

pr

monthlyincome(inthousandsofUSD),andPistheaveragepriceofpublic

pu

(government-supported)universities(inthousandsofUSD).AssumethatPisequal

to38,Iisequalto100,andPpuisequalto18.

pr

8

epriceelasticityofdemandforprivateuniversitiesisclosestto:

A

B

C

–3.1.

–1.9.

0.6.

9

eincomeelasticityofdemandforprivateuniversitiesisclosestto:

A

B

C

0.5.

0.8.

1.3.

10ecross-priceelasticityofdemandforprivateuniversitieswithrespecttothe

priceofpublicuniversitiesisclosestto:

A

B

C

0.3.

3.1.

3.9.

11Ifthecross-priceelasticitybetweentwogoodsisnegative,thetwogoodsare

classi?edas:

A

B

C

normal.

substitutes.

complements.

12Inthecaseofanormalgoodwithadecreaseinownprice,whichofthefollow-

ingstatementsismostlikelytrue?

A

Boththesubstitutionandincomee?ectsleadtoanincreaseinthequantity

purchased.

?CFAInstitute.Forcandidateuseonly.Notfordistribution.

Reading12■TopicsinDemandandSupplyAnalysis

52

B

C

esubstitutione?ectleadstoanincreaseinthequantitypurchased,while

theincomee?ecthasnoimpact.

esubstitutione?ectleadstoanincreaseinthequantitypurchased,while

theincomee?ectleadstoadecrease.

13ForaGi?engood,the:

A

B

C

demandcurveispositivelysloped.

substitutione?ectoverwhelmstheincomee?ect.

incomeandsubstitutione?ectsareinthesamedirection.

14Normalpro?tisbestdescribedas:

A

B

C

zeroeconomicpro?t.

totalrevenueminusallexplicitcosts.

thesumofaccountingpro?tpluseconomicpro?t.

15Acompanyplanstohireadditionalfactoryemployees.Intheshortrun,mar-

ginalreturnsaremostlikelytodecreaseif:

A

B

C

thefactoryisoperatingatfullcapacity.

thefactoryisexperiencingalaborshortage.

workersarerequiredtomultitaskandshareduties.

16eproductionrelationshipbetweenthenumberofmachinehoursandtotal

productforacompanyispresentedbelow.

MachineHours

TotalProduct

AverageProduct

1

2

3

4

5

3

8

14

19

21

3.00

4.00

4.67

4.75

4.20

Diminishingmarginalreturns?rstoccurbeyondmachinehour:

A

B

C

3.

4.

5.

17emarketingdirectorforaSwissspecialtyequipmentmanufacturerestimates

the?rmcansell200unitsandearntotalrevenueofCHF500,000.However,if

250unitsaresold,revenuewilltotalCHF600,000.emarginalrevenueper

unitassociatedwithmarketing250unitsinsteadof200unitsisclosestto:

A

B

C

CHF2,000.

CHF2,400.

CHF2,500.

18Anagricultural?rmoperatinginaperfectlycompetitivemarketsupplieswheat

tomanufacturersofconsumerfoodproductsandanimalfeeds.Ifthe?rmwere

abletoexpanditsproductionandunitsalesby10%themostlikelyresultwould

be:

A

B

C

a10%increaseintotalrevenue.

a10%increaseinaveragerevenue.

anincreaseintotalrevenueoflessthan10%.

?CFAInstitute.Forcandidateuseonly.Notfordistribution.

PracticeProblems

53

19Anoperatorofaskiresortisconsideringo?eringpricereductionsonweekday

skipasses.Atthenormalpriceof€50perday,300customersareexpectedto

buypasseseachweekday.Atadiscountedpriceof€40perday450customers

areexpectedtobuypasseseachweekday.emarginalrevenuepercustomer

earnedfromo?eringthediscountedpriceisclosestto:

A

B

C

€20.

€40.

€50.

20emarginalrevenueperunitsoldfora?rmdoingbusinessunderconditions

ofperfectcompetitionwillmostlikelybe:

A

B

C

equaltoaveragerevenue.

lessthanaveragerevenue.

greaterthanaveragerevenue.

ThefollowinginformationrelatestoQuestions

21–23

A?rm’sdirectorofoperationsgathersthefollowinginformationaboutthe?rm’scost

structureatdi?erentlevelsofoutput:

Exhibit1

Quantity

TotalFixedCost

TotalVariableCost

(Q)

(TFC)

(TVC)

0

1

2

3

4

5

200

200

200

200

200

200

0

100

150

200

240

320

21RefertothedatainExhibit1.Whenquantityproducedisequalto4units,the

average?xedcost(AFC)isclosestto:

A

B

C

50.

60.

110.

22RefertothedatainExhibit1.Whenthe?rmincreasesproductionfrom4to5

units,themarginalcost(MC)isclosestto:

A

B

C

40.

64.

80.

23RefertothedatainExhibit1.elevelofunitproductionresultinginthelow-

estaveragetotalcost(ATC)isclosestto:

A

3.

54

Reading12■TopicsinDemandandSupplyAnalysis

B

C

4.

5.

24eshort-termbreakevenpointofproductionfora?rmoperatingunderper-

fectcompetitionwillmostlikelyoccurwhen:

A

B

C

priceisequaltoaveragetotalcost.

marginalrevenueisequaltomarginalcost.

marginalrevenueisequaltoaveragevariablecosts.

25eshort-termshutdownpointofproductionfora?rmoperatingunderper-

fectcompetitionwillmostlikelyoccurwhen:

A

B

C

priceisequaltoaveragetotalcost.

marginalrevenueisequaltomarginalcost.

marginalrevenueisequaltoaveragevariablecosts.

26Underconditionsofperfectcompetition,acompanywillbreakevenwhenmar-

ketpriceisequaltotheminimumpointofthe:

A

B

C

averagetotalcostcurve.

averagevariablecostcurve.

short-runmarginalcostcurve.

27Acompanywillshutdownproductionintheshortruniftotalrevenueisless

thantotal:

A

B

C

?xedcosts.

variablecosts.

opportunitycosts.

28Acompanyhastotalvariablecostsof$4millionand?xedcostsof$3million.

Basedonthisinformation,thecompanywillstayinthemarketinthelongterm

iftotalrevenueisatleast:

A

B

C

$3.0million.

$4.5million.

$7.0million.

29Whentotalrevenueisgreaterthantotalvariablecostsbutlessthantotalcosts,

intheshortterma?rmwillmostlikely:

A

B

C

exitthemarket.

stayinthemarket.

shutdownproduction.

30Apro?tmaximumisleastlikelytooccurwhen:

A

B

C

averagetotalcostisminimized.

marginalrevenueequalsmarginalcost.

thedi?erencebetweentotalrevenueandtotalcostismaximized.

31A?rmthatincreasesitsquantityproducedwithoutanychangeinper-unitcost

isexperiencing:

A

B

C

economiesofscale.

diseconomiesofscale.

constantreturnstoscale.

32Acompanyisexperiencingeconomiesofscalewhen:

PracticeProblems

55

A

B

C

costperunitincreasesasoutputincreases.

itisoperatingatapointontheLRACcurvewheretheslopeisnegative.

Itisoperatingbeyondtheminimumpointonthelong-runaveragetotalcost

curve.

33Diseconomiesofscalemostlikelyresultfrom:

A

B

C

specializationinthelaborforce.

overlapofbusinessfunctionsandproductlines.

discountedpricesonresourceswhenbuyinginlargerquantities.

34A?rmisoperatingbeyondminimume?cientscaleinaperfectlycompetitive

industry.Tomaintainlong-termviabilitythemostlikelycourseofactionforthe

?rmisto:

A

B

C

operateatthecurrentlevelofproduction.

increaseitslevelofproductiontogaineconomiesofscale.

decreaseitslevelofproductiontotheminimumpointonthelong-runaver-

agetotalcostcurve.

35Underconditionsofperfectcompetition,inthelongrun?rmswillmostlikely

earn:

A

B

C

normalpro?ts.

positiveeconomicpro?ts.

negativeeconomicpro?ts.

ThefollowinginformationrelatestoQuestions36

and37

emanagerofasmallmanufacturing?rmgathersthefollowinginformationabout

the?rm’slaborutilizationandproduction:

Exhibit2

Labor(L)

TotalProduct(TP)

0

1

2

3

4

5

0

150

320

510

660

800

36RefertothedatainExhibit2.enumberofworkersresultinginthehighest

levelofaverageproductoflaborisclosestto:

A

B

C

3.

4.

5.

56

Reading12■TopicsinDemandandSupplyAnalysis

37RefertothedatainExhibit2.emarginalproductoflabordemonstrates

increasingreturnsforthe?rmifthenumberofworkersisclosesttobutnot

morethan:

A

B

C

2.

3.

4.

Solutions

57

SOLUTIONS

1

2

Ciscorrect.Whenthepriceelasticityofdemandcoe?cientis–1,demandis

saidtobeunitelastic,orunitaryelastic.

Aiscorrect.Insertingthepriceof$35intothedemandfunction,quantity

demandediscalculatedas

d

Q

=400?5(35)=225

hm

Atapriceof$35perhealthclubmembership,theelasticityofdemandis

(

d

)(

d

)

Q

hm

Priceelasticityofdemand=?Q

?P×P

hm

hm

hm

Priceelasticityofdemand=–5×(35/225)=–0.778

3

4

Biscorrect.Priceelasticityofdemandislikelytobegreaterforitemsthatare

seenasoptionalordiscretionary.

Biscorrect.Incomeelasticityisameasureofhowsensitivequantitydemanded

istoachangeinincome.Iftheincomeelasticityofdemandfortheproductis

–0.6,wheneverincomeincreasesby1%,thequantitydemandedoftheproduct

ateachpricedecreasesby0.6%.Consequently,asincomerises,consumerswill

purchaselessoftheproduct.

5

Biscorrect.ecross-priceelasticityofdemandmeasurestheresponsiveness

ofthedemandforonionsinresponsetoachangeinthepriceoftomatoes.

Fromthedemandfunctionequation:

d

Q

=3–0.05P+0.009I–0.16P

ot

o

d

Q

=3–0.05(1.25)+0.009(2,500)–0.16(3.75)=24.8375

o

Atapriceofonionsof$1.25andapriceoftomatoesof$3.75,thecross-price

elasticityofdemandiscalculatedasfollows:

(

d

)(

d

)

Cross-priceelasticityofdemand=?Q?P×PQ

o

o

t

t

Cross-priceelasticityofdemand=–0.16×(3.75/24.8375)=–0.0242

6

7

Biscorrect.edemandcurveshowsquantitydemandedasafunctionofown

priceonly.

Aiscorrect.esituationdescribedisoneofexcessdemandbecause,inorder

formarketstoclearatthegivenlevelofquantitysupplied,thecompanywould

needtoraiseprices.

8

Biscorrect.Fromthedemandfunction:

SolveforQd

:

pr

d

?Q?Ppr=–3.1(thecoe?cientinfrontofownprice)

pr

d

Q

=84–3.1Ppr+0.8I+0.9Ppu

pr

=84–3.1(38)+0.8(100)+0.9(18)

=62.4

58

Reading12■TopicsinDemandandSupplyAnalysis

AtPpr=38,

priceelasticityofdemand=?Q

(

d

?Ppr)(Ppr

d

)

Q

pr

pr

=(–3.1)(38/62.4)

=–1.9

9

Ciscorrect.Fromthedemandfunction:

SolveforQd

:

pr

d

?Q?I=0.8(coe?cientinfrontoftheincomevariable)

pr

d

Q

=84–3.1Ppr+0.8I+0.9Ppu

pr

=84–3.1(38)+0.8(100)+0.9(18)

=62.4

AtI=100,

(

d

)(

d

)

theincomeelasticityofdemand=?Q?IIQ

pr

pr

=(0.8)(100/62.4)

=1.3

10Aiscorrect.Fromthedemandfunction:

SolveforQd

:

pr

d

?Q?Ppu=0.9(thecoe?cientinfrontofPpu

)

pr

d

Q

=84–3.1Ppr+0.8I+0.9Ppu

pr

=84–3.1(38)+0.8(100)+0.9(18)

=62.4

AtP=38,andPpu=18,

thecross-priceelasticityofdemand=?Q

(

d

?Ppu)(Ppu

d

)

Q

pr

pr

=(0.9)(18/62.4)

=0.3

11Ciscorrect.Withcomplements,consumptiongoesupordowntogether.With

anegativecross-priceelasticity,asthepriceofonegoodgoesup,thedemand

forbothfalls.

12Aiscorrect.Inthecaseofnormalgoods,theincomeandsubstitutione?ects

arereinforcing,leadingtoanincreaseintheamountpurchasedafteradropin

price.

13Aiscorrect.eincomee?ectoverwhelmsthesubstitutione?ectsuchthatan

increaseinthepriceofthegoodresultsingreaterdemandforthegood,result-

inginapositivelyslopeddemandcurve.

14Aiscorrect.Normalpro?tisthelevelofaccountingpro?tsuchthatimplicit

opportunitycostsarejustcovered;thus,itisequaltoalevelofaccounting

pro?tsuchthateconomicpro?tiszero.

15Aiscorrect.elawofdiminishingreturnsoccursintheshortrunwhenaddi-

tionaloutputfallsasmoreandmorelaborisaddedtoa?xedamountofcapital.

Whenafactoryisoperatingatfullcapacity,addingadditionalemployeeswill

Solutions

59

notincreaseproductionbecausethephysicalplantisalready100%employed.

Morelaborhourswilladdtocostswithoutaddingtooutput,thusresultingin

diminishingmarginalreturns.

16Aiscorrect.Diminishingmarginalreturnsoccurwhenthemarginalproductof

aresourcedecreasesasadditionalunitsofthatinputareemployed.Marginal

product,whichistheadditionaloutputresultingfromusingonemoreunitof

input,ispresentedbelow.

MachineHours

TotalProduct

AverageProduct

MarginalProduct

1

2

3

4

5

3

8

14

19

21

3.00

4.00

4.67

4.75

4.20

3

5

6

5

2

emarginalproductofthethirdmachinehouris6anddeclinesthereafter.

Consequently,diminishingmarginalreturnsare?rstevidentbeyondthree

machinehours.

17Aiscorrect.Marginalrevenueperunitisde?nedasthechangeintotalrevenue

dividedbythechangeinquantitysold.MR=?TR÷?Q.Inthiscase,change

intotalrevenueequalsCHF100,000,andchangeintotalunitssoldequals50.

CHF100,000÷50=CHF2,000.

18Aiscorrect.Inaperfectlycompetitivemarket,anincreaseinsupplybyasingle

?rmwillnota?ectprice.erefore,anincreaseinunitssoldbythe?rmwillbe

matchedproportionatelybyanincreaseinrevenue.

19Aiscorrect.Marginalrevenueperunitisde?nedasthechangeintotalrev-

enuesdividedbythechangeinquantitysold.MR=?TR÷?Q.Inthiscase,

changeintotalrevenueperdayequals€3,000[(450×€40)–(300×€50)],and

changeinunitssoldequals150(450–300).€3,000÷150=€20.

20Aiscorrect.Underperfectcompetition,a?rmisapricetakeratanyquantity

suppliedtothemarket,andAR=MR=Price.

21Aiscorrect.Average?xedcostisequaltototal?xedcostdividedbyquantity

produced:AFC=TFC/Q=200/4=50.

22Ciscorrect.Marginalcostisequaltothechangeintotalcostdividedbythe

changeinquantityproduced.MC=?TC/?Q=80/1=80.

23Ciscorrect.Averagetotalcostisequaltototalcostdividedbyquantitypro-

duced.At5unitsproducedtheaveragetotalcostis104.ATC=TC/Q=520/5=

104.

24Aiscorrect.Underperfectcompetition,priceequalsmarginalrevenue.A?rm

breaksevenwhenmarginalrevenueequalsaveragetotalcost.

25Ciscorrect.e?rmshouldshutdownproductionwhenmarginalrevenueis

lessthanaveragevariablecost.

26Aiscorrect.Acompanyissaidtobreakevenifitstotalrevenueisequaltoits

totalcost.Underconditionsofperfectcompetition,acompanywillbreakeven

whenmarketpriceisequaltotheminimumpointoftheaveragetotalcost

curve.

27Biscorrect.Acompanywillshutdownproductionintheshortrunwhentotal

revenueisbelowtotalvariablecosts.

60

Reading12■TopicsinDemandandSupplyAnalysis

28Ciscorrect.Acompanywillstayinthemarketinthelongtermiftotalrevenue

isequaltoorgreaterthantotalcost.Becausetotalcostsare$7million($4mil-

lionvariablecostsand$3million?xedcosts),thecompanywillstayinthe

marketinthelongtermiftotalrevenueequalsatleast$7million.

29Biscorrect.Whentotalrevenueisenoughtocovervariablecostsbutnottotal

?xedcostsinfull,the?rmcansurviveintheshortrunbutwouldbeunableto

maintain?nancialsolvencyinthelongrun.

30Aiscorrect.equantityatwhichaveragetotalcostisminimizeddoesnot

necessarilycorrespondtoapro?tmaximum.

31Ciscorrect.Outputincreasesinthesameproportionasinputincreasesoccur

atconstantreturnstoscale.

32Biscorrect.Economiesofscaleoccurif,asthe?rmincreasesoutput,costper

unitofproductionfalls.Graphically,thisde?nitiontranslatesintoalong-run

averagecostcurve(LRAC)withanegativeslope.

33Biscorrect.Asthe?rmincreasesoutput,diseconomiesofscaleandhigher

averagetotalcostscanresultwhenthereisoverlapandduplicationofbusiness

functionsandproductlines.

34Ciscorrect.e?rmoperatingatgreaterthanlong-rune?cientscaleissub-

jecttodiseconomiesofscale.Itshouldplantodecreaseitslevelofproduction.

35Aiscorrect.Competitionshoulddrivepricesdowntolong-runmarginalcost,

resultinginonlynormalpro?tsbeingearned.

36Aiscorrect.reeworkersproducethehighestaverageproductequalto170.

AP=510/3=170.

37Biscorrect.Marginalproductisequaltothechangeintotalproductdivided

bythechangeinlabor.eincreaseinMPfrom2to3workersis190:MP=

?TP/?L=(510–320)/(3–2)=190/1=190.

108

Reading13■TheFirmandMarketStructures

PRACTICEPROBLEMS

1

2

3

4

Amarketstructurecharacterizedbymanysellerswitheachhavingsomepric-

ingpowerandproductdi?erentiationisbestdescribedas:

A

B

C

oligopoly.

perfectcompetition.

monopolisticcompetition.

Amarketstructurewithrelativelyfewsellersofahomogeneousorstandardized

productisbestdescribedas:

A

B

C

oligopoly.

monopoly.

perfectcompetition.

Marketcompetitorsareleastlikelytouseadvertisingasatoolofdi?erentiation

inanindustrystructureidenti?edas:

A

B

C

monopoly.

perfectcompetition.

monopolisticcompetition.

UpsilonNaturalGas,Inc.isamonopolyenjoyingveryhighbarrierstoentry.

Itsmarginalcostis$40anditsaveragecostis$70.Arecentmarketstudyhas

determinedthepriceelasticityofdemandis1.5.ecompanywillmostlikely

setitspriceat:

A

B

C

$40.

$70.

$120.

5

edemandscheduleinaperfectlycompetitivemarketisgivenbyP=93–

1.5Q(forQ≤62)andthelong-runcoststructureofeachcompanyis:

Totalcost:

Averagecost:

Marginalcost:

256+2Q+4Q2

256/Q+2+4Q

2+8Q

Newcompanieswillenterthemarketatanypricegreaterthan:

A

B

C

8.

66.

81.

6

7

Companiesmostlikelyhaveawell-de?nedsupplyfunctionwhenthemarket

structureis:

A

B

C

oligopoly.

perfectcompetition.

monopolisticcompetition.

Aquarius,Inc.isthedominantcompanyandthepriceleaderinitsmarket.One

oftheothercompaniesinthemarketattemptstogainmarketsharebyunder-

cuttingthepricesetbyAquarius.emarketshareofAquariuswillmostlikely:

A

increase.

decrease.

B

?2011CFAInstitute.Allrightsreserved.

PracticeProblems

109

C

staythesame.

8

SigmaSoftandetaTecharethedominantmakersofcomputersystemsoft-

ware.emarkethastwocomponents:alargemass-marketcomponentin

whichdemandispricesensitive,andasmallerperformance-orientedcom-

ponentinwhichdemandismuchlesspricesensitive.SigmaSoft’sproductis

consideredtobetechnicallysuperior.Eachcompanycanchooseoneoftwo

strategies:

Openarchitecture(Open):Massmarketfocusallowingothersoftwarevend-

erstodevelopproductsforitsplatform.

●■

Proprietary(Prop):Allowonlyitsownsoftwareapplicationstorunonits

platform.

●■

Dependinguponthestrategyeachcompanyselects,theirpro?tswouldbe:

SigmaSoft–Open

SigmaSoft–Prop

400

650

600

700

ThetaTech–Open

ThetaTech–Open

SigmaSoft–Open

SigmaSoft–Prop

800

600

300

400

ThetaTech–Prop

ThetaTech–Prop

eNashequilibriumforthesecompaniesis:

A

B

C

proprietaryforSigmaSoftandproprietaryforetaTech.

openarchitectureforSigmaSoftandproprietaryforetaTech.

proprietaryforSigmaSoftandopenarchitectureforetaTech.

9

Acompanydoingbusinessinamonopolisticallycompetitivemarketwillmost

likelymaximizepro?tswhenitsoutputquantityissetsuchthat:

A

B

C

averagecostisminimized.

marginalrevenueequalsaveragecost.

marginalrevenueequalsmarginalcost.

10Oligopolisticpricingstrategymostlikelyresultsinademandcurvethatis:

A

B

C

kinked.

vertical.

horizontal.

11Collusionislesslikelyinamarketwhen:

A

B

C

theproductishomogeneous.

companieshavesimilarmarketshares.

thecoststructuresofcompaniesaresimilar.

12Ifcompaniesearneconomicpro?tsinaperfectlycompetitivemarket,overthe

longrunthesupplycurvewillmostlikely:

A

B

C

shifttotheleft.

shifttotheright.

remainunchanged.

110

Reading13■TheFirmandMarketStructures

13Overtime,themarketshareofthedominantcompanyinanoligopolisticmar-

ketwillmostlikely:

A

B

C

increase.

decrease.

remainthesame.

14Agovernmententitythatregulatesanauthorizedmonopolywillmostlikely

baseregulatedpriceson:

A

B

C

marginalcost.

longrunaveragecost.

?rstdegreepricediscrimination.

15Ananalystgathersthefollowingmarketsharedataforanindustry:

Sales

Company

(inmillionsof€)

ABC

300

250

200

150

100

50

Brown

Coral

Delta

Erie

Allothers

eindustry’sfour-companyconcentrationratioisclosestto:

A

B

C

71%.

86%.

95%.

16Ananalystgatheredthefollowingmarketsharedataforanindustrycomprised

of?vecompanies:

Company

MarketShare(%)

Zeta

Yusef

Xenon

Waters

Vlastos

35

25

20

10

10

eindustry’sthree-?rmHer?ndahl–HirschmannIndexisclosestto:

A

B

C

0.185.

0.225.

0.235.

17OnedisadvantageoftheHer?ndahl–HirschmannIndexisthattheindex:

A

B

C

isdi?culttocompute.

failstore?ectlowbarrierstoentry.

failstore?ectthee?ectofmergersintheindustry.

18Inanindustrycomprisedofthreecompanies,whicharesmall-scalemanu-

facturersofaneasilyreplicableproductunprotectedbybrandrecognitionor

patents,themostrepresentativemodelofcompanybehavioris:

A

oligopoly.

PracticeProblems

111

B

C

perfectcompetition.

monopolisticcompetition.

19DeepRiverManufacturingisoneofmanycompaniesinanindustrythatmake

afoodproduct.DeepRiverunitsareidenticaluptothepointtheyarelabeled.

DeepRiverproducesitslabeledbrand,whichsellsfor$2.20perunit,and

“housebrands”forsevendi?erentgrocerychainswhichsellfor$2.00perunit.

EachgrocerychainsellsboththeDeepRiverbrandanditshousebrand.e

bestcharacterizationofDeepRiver’smarketis:

A

B

C

oligopoly.

perfectcompetition.

monopolisticcompetition.

112

Reading13■TheFirmandMarketStructures

SOLUTIONS

1

2

3

4

Ciscorrect.Monopolisticcompetitionischaracterizedbymanysellers,di?er-

entiatedproducts,andsomepricingpower.

Aiscorrect.Fewsellersofahomogeneousorstandardizedproductcharacter-

izesanoligopoly.

Biscorrect.eproductproducedinaperfectlycompetitivemarketcannotbe

di?erentiatedbyadvertisingoranyothermeans.

Ciscorrect.Pro?tsaremaximizedwhenMR=MC.Foramonopoly,MR=P[1

–1/E].SettingthisequaltoMCandsolvingforP:

p

$40=P[1–(1/1.5)]=P×0.333

P=$120

5

Biscorrect.elong-runcompetitiveequilibriumoccurswhereMC=AC=P

foreachcompany.EquatingMCandACimplies2+8Q=256/Q+2+4Q.

SolvingforQgivesQ=8.EquatingMCwithpricegivesP=2+8Q=66.Any

priceabove66yieldsaneconomicpro?tbecauseP=MC>AC,sonewcompa-

nieswillenterthemarket.

6

7

8

Biscorrect.Acompanyinaperfectlycompetitivemarketmustacceptwhatever

pricethemarketdictates.emarginalcostscheduleofacompanyinaper-

fectlycompetitivemarketdeterminesitssupplyfunction.

Aiscorrect.Aspricesdecrease,smallercompanieswillleavethemarket

ratherthansellbelowcost.emarketshareofAquarius,thepriceleader,will

increase.

Ciscorrect.IntheNashmodel,eachcompanyconsiderstheother’sreaction

inselectingitsstrategy.Inequilibrium,neithercompanyhasanincentiveto

changeitsstrategy.etaTechisbettero?withopenarchitectureregardlessof

whatSigmaSoftdecides.Giventhischoice,SigmaSoftisbettero?withapro-

prietaryplatform.Neithercompanywillchangeitsdecisionunilaterally.

9

Ciscorrect.epro?tmaximizingchoiceisthelevelofoutputwheremarginal

revenueequalsmarginalcost.

10Aiscorrect.eoligopolistfacestwodi?erentdemandstructures,onefor

priceincreasesandanotherforpricedecreases.Competitorswilllowerprices

tomatchapricereduction,butwillnotmatchapriceincrease.eresultisa

kinkeddemandcurve.

11Biscorrect.Whencompanieshavesimilarmarketshares,competitiveforces

tendtooutweighthebene?tsofcollusion.

12Biscorrect.eeconomicpro?twillattractnewentrantstothemarketand

encourageexistingcompaniestoexpandcapacity.

13Biscorrect.edominantcompany’smarketsharetendstodecreaseaspro?ts

attractentrybyothercompanies.

14Biscorrect.isallowstheinvestorstoreceiveanormalreturnfortherisk

theyaretakinginthemarket.

15Biscorrect.etopfourcompaniesintheindustrycomprise86percentof

industrysales:(300+250+200+150)/(300+250+200+150+100+50)=

900/1050=86%.

16Biscorrect.ethree-?rmHer?ndahl–HirschmannIndexis0.352+0.252+

0.202=0.225.

Solutions

113

17Biscorrect.eHer?ndahl–HirschmannIndexdoesnotre?ectlowbarriersto

entrythatmayrestrictthemarketpowerofcompaniescurrentlyinthemarket.

18Biscorrect.ecr