Economics Model Answers Nine

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1. An oligopoly that illegally agrees to raise its prices is called a __________.

Cartel.

2. List three industries that are oligopolies and explain why.

EXAMPLE #1 – The Aircraft Industry. The aircraft industry is an oligopoly because the service is identical (you fly from point A to point B), and there are not very many competitors in the industry. Finally, these few competitors dominate the industry without fixing prices or outputs because the cost to entry is so great.

EXAMPLE #2 – The Computer Processor Industry. The computer processor industry is an oligopoly because although there are slight performance differences, the goods do virtually the same thing (process data), and there are only two main competitors (AMD and Intel). They dominate the industry without fixing prices or outputs.

EXAMPLE #3 – The Cigarette Industry. The cigarette industry is an oligopoly because all of their products are the same. There are less than two dozen competitors who dominate the industry, but those competitors do not fix prices or outputs. (thanks to Kevin)

3. As an industry becomes more competitive, what happens to price (P) compared to marginal cost (MC)? Explain.

The price P declines towards the marginal cost (MC). You can see this intuitively: as competition increases, firms must cut costs to stay up with the competition and still sell their product.

4. Suppose Daniel’s company sells goods in an industry having a demand curve with this set of Qs and Ps: (1,30), (2, 28), (3, 26), (4,24), (5, 14), (6, 8), (7,2). What type of industry is this, and what type of demand curve is this? If marginal cost equals $20 (MC=20), then what are the output and price in this industry?

Daniel’s company is in an industry that is an oligopoly and the demand curve for his goods is a kinked demand curve. The output would be 4 units at a price of $24, because this is the point right before the kink in the demand curve. It is the point at which the most money can be made. (Kevin)

5. Suppose you saw three different advertisements in three different industries: (1) “The lowest price in town is at Zack’s!”, (2) “Buy more channels from your cable service provider!”, and (3) “Matt is the smartest surveyor in town … call him to survey your property!” What type of industry would each ad likely represent?

The first ad is for a company in an industry with perfect competition. This is because it is advertising that Zack has the lowest prices which means that there is a perfect substitute for Zack’s goods. The reason that you should buy at Zack’s is because his prices are better.

The second ad is from an industry that is a monopoly. They are advertising that they want their customers to buy more, not because they want to win customers over from other companies. Also, cable companies generally have laws that there can be no competition in their territory.

The third ad would be in an industry of monopolistic competition because the advertisement says that Matt is the smartest surveyor, so there is no perfect substitute for his services if he is indeed the smartest surveyor. (Kevin)

6. What kind of industries are these: (1) one cleaners in town that sends the clothes out to be cleaned, (2) three car mechanics in town with hydraulic lifts and expensive electronic equipment, and (3) many apparel stores with distinctive fashions? Will consumers obtain the best prices?

EXAMPLE #1: The first industry is a monopoly because it is the only company in that market. Customers will not obtain the best prices because there is no alternative cleaner for their clothes.

EXAMPLE #2: The second industry is an oligopoly. It is an oligopoly because there aren’t very many companies, but there are high barriers to entry (expensive electronics, and hydraulic lifts) so competition cannot be easily created. Finally, the service of each company is exactly the same so they are all substitutes for each other. Customers will not obtain the best prices because there is not perfect competition; however, they will obtain good prices because there is still some competition.

EXAMPLE #3: The third industry is monopolistic competition because there are a lot of apparel stores, but none of the stores are substitutes for each other because they each have distinctive styles. Customers will not obtain the best prices because there is not perfect competition; however, they will still be able to obtain good prices because while there are no perfect substitutes, the substitutes are close enough that if one store raised its prices exorbitantly, they would lose business. (Kevin)

7. Suppose two students separately own the only widget companies in the entire world. They sell at the same price and have no plans to change that. But they might advertise. If both advertise, then they lost profits due to the advertising expenses. If neither advertises, then they make the largest profit by reducing expenses. But if one advertises and the other does not, then the one that advertised makes phenomenal profits. What happens?

The Nash Equilibrium is for both companies to advertise, because each individually can improve his own position by advertising. Note this is not the overall optimal result for the firms if they firms it were lawful for them to agree with each other not to advertise.

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