THE UNIVERSITY OF ZAMBIA

SCHOOL OF HUMANITIES AND SOCIAL SCIENCES

DEPARTMENT OF ECONOMICS
QUIZ 2 13th May, 2018
ECN 9125: INDUSTRIAL ORGANISATION
TIME: 50 Minutes
INSTRUCTIONS:
ANSWER ALL QUESTIONS [30 Marks]

Indicate whether the following are TRUE, FALSE or UNCERTIAN. Correct answers without
corresponding JUSTIFICATIONS will NOT be rewarded.

1. The strategy of advertising is more prominent in monopolistic competition than in oligopolistic

markets.
(TRUE)
Advertising is one of the key characteristics of monopolistic competition due to product
differentiation.
2. According to positive models of advertising, the effect of advertising in profit maximizing
equilibrium is to shift the demand curve.
(FALSE)
It is normative models which postulate that advertising influences tastes and preferences and
thus shifts the demand curve.
3. In quality-based differentiated markets, the price of a commodity is not always a good measure
of quality but consumers may still want to pay more for a commodity.
(TRUE)
 Selling costs can mislead consumers about the nature and quality of the product. Consumers my
however pay more for a commodity because a higher prices is assumed to be linked to higher-
perceived quality and utility.
4. When two goods are close substitutes and have more or less the same prices, consumers usually
employ preference-based differentiation.
(TRUE)
Preference-based or horizontal differentiation occurs when products are close substitutes and
prices are almost identical. The goods must be at the same quality scale.
5. The goods approach to modeling preference assumes that products can be imperfect substitutes
but yet be close substitutes.
(TRUE)
The assumptions of the goods approach are: products are imperfect substitutes, products are
close substitutes, preferences can be aggregated, and economies of scale in technology.
6. Under brand proliferation strategy, the incumbent firm can only make credible threats to
deter entry if it has incurred sunk fixed costs in a location.
(TRUE)
Even if the incumbent firm earns losses due to the entrant, there is no incentive to
accommodate or relocate because of fixed costs (sunk expenditures) already incurred.
7. A monopolistic firm will have a demand curve which is less elastic than a competitive firm
because of product differentiation.
(TRUE)
The monopolistic firm’s demand curve is lese elastic than pure competition because the seller’s
product is differentiated from its rivals.
8. Under horizontally differentiated markets, the higher quality producer will earn greater profits
and charge a higher price.
(FALSE)
This is true only under vertically differentiated markets which is quality based.
9. The oligopolistic profit-maximizing level of advertising is at a point where from society’s
perspective, advertising is already excessive.
(TRUE)
 Though this directly applies to monopoly, the findings can be extended to all imperfect markets
such as oligopoly and monopolistic competition.
10. Monopolistic markets can sustain situations where some firm are earning supernormal profits
while others are making losses in the long run.
(FALSE)
Whether the losses are economic or accounting losses, the firms will need to exit the industry.
Thus monopolistic markets only sustain supernormal profits and zero economic profits in the
long-run.
11. The principle of maximal differentiation implies that there is positive proportionality between
the level of product differentiation and a firm’s equilibrium profits.
(TRUE)
The principle of maximal differentiation states that equilibrium profits are increasing in quality
gap and if there is no gap in quality, profit are Zero. This does imply the more a firm
differentiated its product, the greater the equilibrium profits.
12. If the total cost is K200,000 , the average costs is K2,500 and given that the average physical
product is K2,000 , the firm’s level of advertising is not less than K40,000.
(TRUE)
200,000
𝑞= = 80
2,500
𝑇𝐶 = 𝑎 + 𝑇𝑃𝐶
𝑎 = 200,000 − (2,000)(80) = 40,000
The firms level of advertising is equal to K40,000. This is indeed not less than K40,000 (
implying it is either 40,000 or more)
13. Economies of advertising scale can prolong the level of economies of scale in an industry and
generate excess capacity.
(TRUE)
Economies of advertising scale increase the level of total economies of scale and thus increase
the MES this would generate excess capacity.
14. Most adverts for novice products in monopolistic markets are persuasive as opposed to being
informative.
(TRUE)
 Advertising can be more informative for new (novice) products and more persuasive for known
products.
15. Given that selling costs are K30,000 and total fixed costs are K50,000 , total fixed production
costs must be K10,000.
(FALSE)
𝑇𝐹𝐶 = 𝑇𝐹𝑃𝐶 + 𝑎
𝑇𝐹𝑃𝐶 = 𝑇𝐹𝐶 − 𝑎 = (50,000 − 30,000) = 20,000
Since advertising costs are either K30,000 or less, total fixed production costs must be K20,000
or more.
16. When advertising is assumed to be exogenously imposed on a firm, incumbent firms can use
advertising as a strategic weapon to deter entry.
(FALSE)
Only true if advertising is endogenously imposed on a firm. If it is exogenously imposed it
becomes a barrier to entry and not a strategic weapon to deter entry.
17. If a firm’s marketing and distribution costs are K150,000 while advertising costs are zero,
selling costs are equal to K150,000.
(TURE)
In this case, the firm only has other marketing costs other than advertising (advertising is a
component of marketing costs) and distribution costs. This implies that selling costs are equal
to K150,000 due to the existence of marketing costs.
18. Selling costs may be considered an item of possible wastage because their influence on the
demand curve has no proportionality.
(TRUE)
Increasing selling costs may not proportionately increase demand or profits, thus they may be
considered to be an item of possible wastage.
19. If the additional advertising expenditure increase demand such that the additional revenue is
less than the additional cost, profits would decreases.
(TRUE)
Note that advertising costs are a component of selling costs. If the increase in revenue is less
than the increase in costs, profits would decrease since PROFIT = Revenue - Cost.
20. “Jane decided to purchase a low-quality dress as opposed to purchasing a high-quality one
simply because she wanted variety and change.” This behavior is consistent with the goods
approach to modeling preference.
(FALSE)
The goods approach to modeling preference only applies to horizontal (preference-based)
differentiation. (There are two common approaches to modeling consumer preferences when
products are HORIZONTALLY DIFFERENTIATED: the goods approach and address
approach).

All the Best

Chizonde. B