The document discusses markets for various goods and classifies them as perfectly competitive, monopolistically competitive, or monopolistic. It then analyzes the characteristics of firms in these different market structures and how they determine profit maximizing price and output. The document also provides examples of how individual firms might behave in these market contexts.

2. Tayyab Ismat

4. QUESTION:1
Classify the following markets as perfectly competitive,
monopolistic, or monopolistically competitive, and explain
your answers?
a. wooden #2 pencils
b. bottled water
c. copper
d. local telephone service
e. peanut butter
f. lipstick

5. A:
 Wooden 2 pencils:
• The market for 2 pencils is perfectly competitive since
pencils by any manufacturer are identical and there
are a large number of manufacturers.

6. B:
Bottled water:
• The market for bottled water is monopolistically
competitive because of consumers' concerns about
quality As a result, each producer has a slightly
different product.

7. C:
 copper:
• The market for copper is perfectly competitive, since all
copper is identical and there are a large number of
producers.

8. D:
 local telephone service:
• The market for local telephone service is monopolistic
because it is a natural monopoly—it is cheaper for one firm
to supply all the output.

9. E:
peanut butter:
• The market for peanut butter is monopolistically competitive
because different brand names exist with different quality
characteristics

10. F:
Lipstick:
• The market for lipstick is monopolistically competitive
because lipstick from different firms differs slightly, but there
are a large number of firms who can enter or exit without
restriction.

11. QUESTION:2
For each of the following, say whether it describes a
perfectly competitive firm, a monopolistically competitive
firm, both, or neither.
• Charges a price equal to marginal cost.
• Has marginal revenue equal to price.
• Faces barriers to entry.
• Produces a product that is identical to that of its competitors.
• Earns zero economic profit in the long run.
• Produces where marginal revenue is greater than marginal cost.

12. 1:
Charges a price equal to marginal
cost?
 A firm in perfect competition charges a price equal to
marginal cost.

13. 2:
 Has marginal revenue equal to price?
 A firm in perfect competition has marginal revenue
Equal to price.

14. 3:
 Faces barriers to entry?
 Neither a firm in monopolistic competition nor in perfect
competition faces barriers to entry.

15. 4:
 Produces a product that is identical to
that of its competitors?
 A firm in perfect competition produces a product that is
identical to that of its competitors.

16. 5:
 Earns zero economic profit in the long
run?
 Both a firm in monopolistic competition and a firm in
perfect competition earn zero economic profit in the long
run.

17. 6:
 Produces where marginal revenue is
greater than marginal cost?
 Neither a firm in monopolistic competition nor in perfect
competition produces where marginal revenue is greater than
marginal cost.

18. QUESTION:3
For each of the following characteristics, say
whether it describes a monopoly firm, a
monopolistically competitive firm, both, or neither.
• Faces a downward-sloping demand curve.
• Has marginal revenue less than price.
• Faces the entry of new firms selling similar products.
• Earns economic profit in the long run.
• Equates marginal revenue and marginal cost.
• Produces the socially efficient quantity of output.

19. 1:
 Faces a downward-sloping demand
curve?
 Both a firm in monopolistic competition and a monopoly
firm face a downward-sloping demand curve.

20. 2:
 Has marginal revenue less than price
 Both a firm in monopolistic competition and a
monopoly firm have marginal revenue that is less
than price.

21. 3:
 Faces the entry of new firms selling
similar products?
 A firm in monopolistic competition faces the entry
of new firms selling similar products.

22. 4:
Earns economic profit in the long
run?
A monopoly firm earns economic profit in the
long run

23. 5:
Equates marginal revenue and
marginal cost?
Both a firm in monopolistic competition and a
monopoly firm equate marginal revenue and
marginal cost.

24. 6:
Produces the socially efficient quantity
of output?
 Neither a firm in monopolistic competition nor a monopoly
firm produce the socially efficient quantity of output.

25. QUESTION:4
You are hired as the consultant to a monopolistically
competitive firm. The firm reports the following
information about its price, marginal cost, and
average total cost. Can the firm possibly be
maximizing profit? If the firm is profit maximizing, is
the firm in a long-run equilibrium? If not, what will
happen to restore long-run equilibrium?

26. A: P < MC, P > ATC
I would think that the firm can’t possible be maximizing profit. The firm should raise price, so that
price is greater than MC.Since the firm isn’t profit maximizing the firm should raise price, so that
price is equal to ATC but greater than MC.
B: P > MC, P < ATC
The firm is maximizing profit. The firm is not in long-run equilibrium since the price is less than ATC.
C: P = MC, P > ATC
The firm is maximizing profit. The firm is not in long-run equilibrium since the price is greater than
ATC.
D: P > MC, P = ATC
The firm is maximizing profit. The firm is in long-run equilibrium since the price is equal to ATC.

27. A:
• The profit maximizing point is determined by the
quantity at which marginal cost and marginal revenue
are equal. Take that quantity and see what consumers
are willing to pay for it (follow a vertical line to the
demand curve.) That is the profit maximizing price,
which will be higher than marginal cost.

28. B:
•That shows P (price) > (is
greater than) MC (marginal
cost)
It always will be.

29. C:
• If that price happens to be higher then the ATC (average total cost)
then the firm is making an economic profit. If this happens, then
other firms will begin to offer substitutes to attempt to capture part
of that profit. As this competition increases market supply will
increase and the equilibrium price will fall until none of the firms
are making economic profit. They will probably be making
accounting profit but when you factor in opportunity cost into the
equation then they could do no better elsewhere.

30. D:
•In D P (price) = ATC (average total cost). This
means that the amount of market supply
makes the price too low for new competitors to
be falling all over themselves to get in. The
company is making zero economic profit also
known as normal economic profit.

31. So this shows they are in
the long term equilibrium

32. QUESTION:5
Sparkle is one firm of many in the market for toothpaste,
which is in long-run equilibrium.
 Draw a diagram showing Sparkle’s demand curve, marginal-revenue curve, average-
total-cost curve, and marginal-cost curve. Label Sparkle’s profit maximizing output
and price.
 What is Sparkle’s profit? Explain.
 On your diagram, show the consumer surplus derived from the purchase of Sparkle
toothpaste. Also show the deadweight loss relative to the efficient level of output.
 If the government forced Sparkle to produce the efficient level of output, what
would happen to the firm? What would happen to Sparkle’s customers?

33. A:
•Draw a diagram showing Sparkle’s demand
curve, marginal-revenue curve, average-
total-cost curve, and marginal-cost curve.
Label Sparkle’s profit maximizing output and
price.

34. Figure 1 illustrates the market for Sparkle toothpaste in long-run equilibrium. The
profit-maximizing level of output is QM and the price is PM.

35. B:
 What is Sparkle’s profit? Explain.
•Sparkle’s profit is zero, because at
quantity QM, price equals average total
cost.

36. C:
On your diagram, show the consumer
surplus derived from the purchase of
Sparkle toothpaste. Also show the
deadweight loss relative to the efficient
level of output?

37. The consumer surplus from the purchase of
Sparkle toothpaste is areas A + B. The efficient
level of output occurs where the demand curve
intersects the marginal-cost curve, at QC. The
deadweight loss is area C, the area above
marginal cost and below demand, from QM to
QC.

38. D:
 If the government forced Sparkle
to produce the efficient level of
output, what would happen to the
firm? What would happen to
Sparkle’s customers?

39. If the government forced Sparkle to produce
the efficient level of output, the firm would lose
money because average total cost would exceed
price, so the firm would shut down. If that
happened, Sparkle’s customers would earn no
consumer surplus

40. QUESTION:6
•The chapter states that monopolistically
competitive firms send Christmas cards to
their coustomers, what do they accomplish
by this? Explain in words and with a
diagram?

41. By sending Christmas cards to their customers,
monopolistically competitive firms are advertising
themselves. Since they are in a position in which price
exceeds marginal cost, they would like more customers to
come in, as shown in Figure 5. Since the price, PM, exceeds
marginal cost, MCM, any additional customer who pays the
existing price increases the firm's profits.

43. QUESTION:7
For each of the following pairs of firms, explain
explain which firm would be more likely to engage in
advertising:
• a A family owned farm or a family owned restaurant.
• b A manufacturer of forklifts or a manufacturer of cars.
• c A company that invented a very reliable watch or a company that
invented a less reliable watch that costs the same amount to make.

45. PART:A
• A family owned restaurant would be more likely to
advertise than a family owned farm because the
output of the farm is sold in a perfectly competitive
market, in which there is no reason to advertise,
while the output of the restaurant is sold in a
monopolistically competitive market.

46. PART:B
• A manufacturer of cars is more likely to advertise than
a manufacturer of forklifts because there is little
difference between different brands of industrial
products like forklifts, while there are greater
perceived differences between consumer products
like cars. The possible return to advertising is greater
in the case of cars than in the case of forklifts.

47. PART:C
• A company that invented a reliable watch is likely to
advertise more than a company that invented a less
reliable watch that costs the same amount to make
because the company with the reliable watch will get
many repeat sales over time to cover the cost of the
advertising, while the company with the less reliable
watch will not.

48. QUESTION:8
Thirty years ago, the market for chicken was
perfectly competitive. Then Frank Perdue began
marketing chicken under his name.
• How do you suppose Perdue created a brand name for chicken? What
did he gain from doing so?
• What did society gain from having brand-name chicken? What did
society lose?

49. A:How do you suppose Perdue created a brand
name for chicken? What did he gain from doing so?
• As I recall he fed them food that made them have a slightly
yellow color, then advertised heavily claiming yellow
chickens were "better" than pasty white ones. At some
point Purdue chickens lost their color and are now pasty
white like other chickens

50. B:What did society gain from having brand-
name chicken? What did society lose?
•Some people find utility in thinking they
are buying a superior product. Since
generic chickens are still available at a
lower price, I can't see much loss.

51. QUESTION:9
The makers of Tylenol pain reliever do a lot of
advertising and have loyal customers. In contrast,
the makers of generic acetaminophen do no
advertising, and their customers shop only for the
lowest price. Assume that the marginal costs of
Tylenol and generic acetaminophen are the same
and constant?

52. A:Draw a diagram showing Tylenol’s demand, marginal-revenue, and
marginal-cost curves. Label Tylenol’s price and markup over marginal
cost.

53. B:Repeat part a) for the producer of generic acetaminophen. How do the
diagrams differ? Which company has the bigger markup? Explain
• DIAGRAM shows the demand, marginal revenue, and
marginal cost curves for a maker of acetaminophen. The
diagrams differ in that the acetaminophen maker faces a
horizontal demand curve, while the maker of Tylenol faces
a downward-sloping demand curve. The acetaminophen
maker has no markup of price over marginal cost, while the
maker of Tylenol has a positive markup, because it has
some market power.

54. Acetaminophen:

55. C: Which company has the bigger incentive for
careful quality control? Why?
• The maker of Tylenol has a bigger incentive for careful
quality control, because if quality were poor, the value
of its brand name would deteriorate, sales would
decline, and its advertising would be worthless.