UNIVERSITY OF KWAZULU-NATAL

SCHOOL OF ACCOUNTING, ECONOMICS & FINANCE

ECON 202/204: INTERMEDIATE MICRO AND APPLICATIONS

Tutorial 2 of Micro 2: (Complete questions BEFORE you attend!)

Coverage: Perloff Chapters 13

A. MCQs

Ch 13
The following diagram shows a cartel in an industry where firms ordinarily have zero
market power.

1. Which of the following statements is/are correct?

i. The cartel will try to keep the market price at MCm.
ii. The cartel will try to keep industry output at Qc.
iii. Each member of the cartel has an individual incentive to produce more than qm.
iv. The cartel will try to keep the market price at pc.

a) (i) and (ii) are correct.

b) (iii) and (iv) are correct.
c) Only (ii) is correct.
d) (ii) and (iii) are correct.
e) only (iii) is correct.

1
 2. The cartel will be unstable because at the level of output allocated to each firm:

a) marginal revenue is greater than marginal cost.

b) marginal cost is greater than marginal revenue.
c) average cost is greater than marginal cost.
d) price equals marginal cost.
e) marginal revenue is zero.

For two firms (firm A and firm B) in a Cournot duopoly, the market demand curve is
described by the equation P=338-2Q, and the marginal costs of production are constant at
R50. Firm A’s MRR=338-4qA-2qB. Use this information to answer questions 3-5.

3. Firm A’s best-response function is:

a) qA=288- ½qB
b) qA=338- qB
c) qA=72- ½qB
d) qB=72- ½qA
e) qB=72- qA

4. What is the total output in the Cournot equilibrium?

a) 72
b) 48
c) 36
d) 96
e) 288

5. What is the Cournot equilibrium price?

a) R146
b) R242
c) R288
d) R338
e) Impossible to calculate.

6. Suppose a market with a Cournot structure has four firms and a market price
elasticity of demand equal to –1.5. What is a Cournot firm’s Lerner Index?

a) 0.1
b) 0.167
c) 0.25
d) 6
e) Impossible to calculate.

2
7. The diagram above shows the residual demand, marginal revenue and long-run cost
curves for a monopolistically competitive producer. In the long-run, the monopolistically
competitive firm will:
a) continue to earn economic profit.
b) earn normal profit like perfectly competitive firms.
c) operate at full capacity and produce Q2 units.
d) break even due to the existence of barriers to entry.
e) achieve productive efficiency.

8. Monopolistically competitive firms:

a) have market power because they can set price above marginal cost.
b) have no market power because they earn zero economic profit.
c) have no market power because of free entry.
d) have no market power because price equals marginal cost.
e) Always operate at full capacity, otherwise new entrants will erode their profits.

3
The diagram for question 9 below shows the best-response curves for Roman and Scoozi, two
identical pizza delivery firms operating in a small town where they have no other rivals. A unit of
output is 100 pizzas per week. Which of the following statements is correct?

9.

a) If Roman believes that Scoozi will produce 60 units, Roman’s best-response is to

produce 40 units.
b) If Roman believes that Scoozi will produce 30 units, Roman’s best-response is to
produce 60 units.
c) If Scoozi believes that Roman’s will produce 0 units, Scoozi’s best-response is to
produce 60 units.
d) If Scoozi believes Roman’s will produce 40 units, Scoozi’s best-response is to
produce 30 units.
e) A Cournot equilibrium exists when Roman produces 60 units and Scoozi produces
60 units.

10. Which of the following statements regarding the Bertrand Model is correct?

a) The Bertrand leader knows that the Bertrand follower will use its Cournot best-
response curve to determine its best-response price.
b) Firms make their output decisions simultaneously and the market determines the
price.
c) Bertrand best-response curves have a positive slope (i.e. slope upwards) because the
firms are price setting firms.
d) Bertrand best-response curves have a negative slope (i.e. slope downwards) because
the firms are quantity setting firms.
e) None of the above.

4
 11. The diagram below shows the short run position of a monopolistically competitive
firm. Which of the following would describe the transition to long-run equilibrium in
this market?

i. More firms would enter the market until all economic profits were competed
away.
ii. The firm’s demand curve and marginal revenue curve would shift to the left.
iii. The firm’s average and marginal cost curves would increase until all economic
profits were gone.

a) All of the above are true.

b) (i) and (ii) are true.
c) (ii) and (iii) are true.
d) (i) and (iii) are true.
e) None of the above is true.

Consider the statements that follow to answer question 12.

12. A market with no barriers to entry and exit, product differentiation and advertising:
(i) guarantees short-run profitability to a firm operating in it
(ii) gives the firm some measure of market power
(iii) does not enable firms to make economic profits in the long run

Which of the above statements is / are correct?

a) Only (i) and (ii) are correct.
b) Only (ii) and (iii) are correct.
c) Only (i) and (iii) are correct.
d) Only (iii) is correct.
e) All are correct.

5
Refer to the diagram below, which shows the position of a monopolistically competitive firm, in
order to answer question 13.

13. Which one of the following statements about the diagram above is correct?

a) Welfare is being sacrificed because of scale diseconomies.

b) Product differentiation has caused a welfare loss of abd.
c) The firm will make a profit of area abc.
d) New firms entering the industry will cause output to rise from Q1 to Q2.
e) The firm is producing Q1, its long-run equilibrium output.

B. Written questions (Mark guidelines are very approximate)

1. Read the following online article before attending your tutorial and before answering
the questions that follow:

https://mg.co.za/article/2008-07-07-busting-cartels-threatened-by-new-bill/

a) What is a cartel and why would firms enter into a cartel? Why does the Law
Society of South Africa suggest that the ability of the competition authorities to
bust cartels could be brought to a grinding halt by a new law considered by
Parliament? (15 marks)
b) Using an appropriate diagram, explain the incentive to form a cartel. (20 marks)

6
2. Using the diagram below (showing the reaction functions for the only two garages
selling fuel in a small isolated town):

i) Compare the Cournot, cartel, and competitive equilibria in terms of total output
and welfare (15 marks)

3. Read the article below before answering the questions that follow:

https://www.educba.com/monopolistic-competition-examples/

a) Does a monopolistically competitive firm have market power? Explain why this is
the case with reference to the examples given in the online article. (15 marks)
b) Is this firm likely to have market power in the long-run? Is the monopolistically
competitive firm able to make long-run profit? Explain with the aid of a diagram.
(20 marks)

4. Consider the three firms described below:

• Firm 1 operates in the cement industry and has two rivals. New firms can only enter
the market if the government grants the firm a license to enter the market.
• Firm 2 operates in the market for clothing and has over 80 rivals. Firm 2 advertises
its product and has succeeded in differentiating its product from its rivals’.
• Firm 3 is the only hairdresser in a small town.

i. Which type of market (perfect competition, monopoly, monopolistic competition,

and oligopoly) best characterises the three different cases described above? Briefly
explain your answer. (9 marks)

ii. Which firms would you expect to make economic profits in the long run? Briefly
explain your answer. (6 marks)