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Chapter 11 The World of Imperfect Competition
Concept Problems
1. Monopolistic competition is characterized by many firms producing
differentiated products. The large number of firms means that each firm ignores
the actions of its rivals. In contrast, in oligopoly, the products may be either
homogeneous or differentiated. The fact that there are only a few dominant firms
in oligopolistic industries means that each must take account of the behavior of
its rivals. Thus, strategic behavior characterizes oligopoly but not monopolistic
competition.
2. A price taker has no ability to affect market price; the firm faces a horizontal
demand curve. A price setter chooses the price it charges because it faces a
downward-sloping demand curve.
3. Product differentiation means that consumers perceive the goods produced
by competing firms as different in quality, service associated with the product,
location of the store, or some other characteristic. The assumption of
homogeneous goods in perfect competition means that consumers perceive no
difference whatsoever in the goods produced by competing firms.
4.
a. Soft drinks are listed in the text as being produced by oligopolies.
b. The market for exercise drinks is fairly concentrated and would be categorized
as an oligopoly.
c. To an increasing degree, office supply stores are dominated by national chains
such as Staples and Kinko's, moving them in the direction of oligopoly.
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d. Massage therapy is an industry with easy entry that satisfies the conditions of
monopolistic competition.
e. Accountants compete in an industry in which entry is relatively easy, satisfying
the conditions of monopolistic competition.
f. Colleges and universities are increasingly characterized by easy entry,
particularly now that many offer degrees online. This is a monopolistically
competitive industry.
g. Astrologers compete in a monopolistically competitive industry.
5. Profits will rise in the short run. That will attract entry in the long run, driving
profits for a typical firm back down to zero.
6. Its possible that they trust their students not to cheat. Even a more
suspicious professor, though, could probably count on one or more students to
engage in strategic behavior and cheat on any agreements reached among
members of the class. Each student would have a strong incentive to try to
outperform the rest of the class.
7. Two-way trade occurs when products are differentiated.
8. The DRAM producers were engaging in collusive behavior to maximize
profits. While collusion is illegal, some firms merge with rivals to achieve the
same result.
9. The Case in Point essay argues that foreign visitors to Costa Rica have a
lower elasticity of demand for visits to national parks than do local citizens. The
estimate presented of their demand suggested that it was inelastic, so that an
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increase in price would increase Costa Rica's total revenue, while reducing costs
(because there would be fewer visitors).
10. Customers at lunch are likely to be business people who eat out often. Their
knowledge of the market is likely to make them more responsive to price
changes than dinner customers. Restaurants are engaging in price
discrimination.
11. Because many teens are influenced by their peers when choosing whether
or not to smoke cigarettes, the advertising may be effective in making smoking
less popular in teens. Adults, who may have been smoking longer and thus are
more likely to have problems of addiction, may be less responsive to advertising
designed to discourage smoking. Cigarette manufacturers may change their
marketing strategy to more clearly differentiate between their teen and adult
customers.
12. Shoppers at outlet malls are likely to be more price conscious than other
shoppers, giving them a greater elasticity of demand. In general, price
discriminating firms seek to charge lower prices to customers with greater price
elasticity of demand.
13. The evidence presented in the text suggests that such a ban would probably
tend to increase prices for the service.
14. While the long-run equilibrium in monopolistically competitive markets is one
of zero economic profits, this is achieved through easy entry. Monopolistically
competitive markets are generally characterized by frequent entry by firms
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hoping to earn a profit. They may earn positive economic profit in the short-run
and then be satisfied with zero economic profit in the long run.
15. Advertising by lawyers probably makes local markets more competitive,
putting downward pressure on price.

Numerical Problems
1.
a. The demand curve facing a typical firm increases, raising the price above $20
per haircut.
Increase in Demand under Monopolistic Competition
12
14
16
18
20
22
24
26
0 30 60 90
Q
Haircuts
/ period of time
P
r
i
c
e

/

h
a
i
r
c
u
t

(
$
)
MC
ATC
D
2
D
1
MR
2
MR
1
Q
1
Q
2





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b. The demand curve shifts back to the left until it is again tangent to the long-
run-average-total-cost curve. The price returns to $20 per haircut.
Decrease in Demand under Monopolistic Competition
12
14
16
18
20
22
24
26
0 30 60 90
Q
Haircuts
/ period of time
P
r
i
c
e

/

h
a
i
r
c
u
t

(
$
)
MC
ATC
D
1
D
2
MR
1
MR
2
Q
2
Q
1




c. A lower price for children's haircuts does not represent price discrimination if
the cost of those haircuts is lower. If the cost is the same, however, then this
price differential would represent price discrimination and may result from a
greater elasticity of demand on the part of parents for haircuts for their children.

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2.
a. The average total cost curve rises, but the marginal cost curve does not shift.
There is also no change in demand or marginal revenue. There is no change in
price or output in the short run.
Imposition of a Licence Fee
12
14
16
18
20
22
24
26
28
30
0 10 20 30 40 50 60
Q
Haircuts
/ period of time
P
r
i
c
e

/

h
a
i
r
c
u
t

(
$
)
MR D
ATC
1
ATC
2
MC



b. In the long-run, some firms will leave the industry. The demand curve facing a
typical firm that remains will shift to the right until it is tangent to the new, higher
average total cost curve.
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c. Consumers pay the fee in the long run, because easy entry assures that they
ultimately bear the effects of all cost changes. This is the same result as in
perfect competition.


3.
a. HHI = 4 (25
2
) = 625 x 4 = 2,500
b. HHI = 10 (10
2
) = 1,000. The industry in (a) is more concentrated than the
industry in (b).
c. HHI = 100 (1
2
) = 100.
d. The lower the value of the Herfindahl-Hirschman index, the greater the
competitiveness of the industry. A perfectly competitive industry would have an
HHI approaching zero.
4.
a. Firm A has a dominant strategy of expanding advertising. Its payoff from this
strategy is greater regardless of the strategy chosen by Firm B.
b. Firm B also has a dominant strategy of expanding advertising. Its payoff from
that strategy is greater regardless of the strategy chosen by Firm A.
c. Because both firms have a dominant strategy, there is a dominant strategy
equilibrium of expanding advertising.
5.
a. A 4-firm concentration ratio of 75 percent means that the four largest firms in
the industry account for 75 percent of total output.
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b. The lower the HHI the more competitive the industry. Thus, the second
industry is more competitive.
6.
a. (This problem can be done graphically or with calculus. For students who
have had calculus, we can write the demand equation in terms of price as:
(1/2) p = 60 - q.
p = 120 - 2q
Converting this to an equation for total revenue, we have:
pq = 120q- 2q
2

Taking the derivative of this with respect to q, we have:
(d (pq))/dq = MR = 120 - 4q
Setting MR equal to MC, we have:
120 - 4q = 60
15 per week = q
Alternatively, we can draw a graph of the demand curve and then draw the
marginal revenue curve.
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Graphical Representation of Such Firm
0
20
40
60
80
100
120
140
0 15 30 45 60 75 90 105 120 135
Q
Goods produced
/ period of time
P
r
i
c
e

/

g
o
o
d

(
$
)
MR D
MC


b. Because p = 120 -2q we have:
p = $90
c. We have already drawn the curves in part (a) of this problem. The firm's total
revenue is $90 x 15 = $1,350. Since marginal cost is a horizontal line at $60,
average total cost is $60 per unit and total cost equals $900 per week. The firm
is earning a profit. So that this is not a long-run equilibrium. New firms will enter
the industry.