CHAPTER 7 Answer

Topics: Economics, Monopoly, Perfect competition Pages: 6 (1725 words) Published: March 4, 2015
Chapter 7

Competition and Policies towards
Monopolies and Oligopolies,
Privatization and Deregulation

Suggested Answers to the Review Questions

I.Questions

1. Pure monopoly refers to the case where:
a) there is a single firm selling the commodity,
b) there are no close substitutes for the commodity, and
c) entry into the industry is very difficult or impossible.

If we further assume that the monopolist has perfect knowledge of present and future prices and costs, we have perfect monopoly.

2. The firm may control the entire supply of raw materials required to produce the commodity. For example, up to World War II, Alcoa (a U.S. company) owned or controlled almost every source of bauxite – the raw material necessary to produce aluminum in the U.S. and thus had a complete monopoly over the production of aluminum in the U.S.

The firm may own a patent which precludes other firms from producing the same commodity. For example, when cellophane was first introduced, Dupont had monopoly power in its production based on patents.

A monopoly may be established by a government franchise. In this case, the firm is set up as the sole producer and distributor of a good or service but is subjected to governmental control in certain aspects of its operation.

In some industries, increasing returns to scale may operate over a sufficiently large range of outputs as to leave only one firm to produce the equilibrium industry output. These are called natural monopolies and are fairly common in the areas of public utilities and transportation. What the government usually does in these cases is to allow the monopolist to operate but subjects him to government control. 3. a.Monopolistic competition refers to the market organization in which there are many sellers of a differentiated product. Monopolistic competition is very common in the retail and service sectors of our economy. Examples of monopolistic competition are the numerous barber shops, gasoline stations, grocery stores, liquor stores, drug stores and so on located in close proximity to one another.

b.The competitive element results from the fact that in a monopolistically competitive industry (as in perfectly competitive industry) there are so many firms that the activities of each have no perceptible effect on the other firms in the industry. The monopoly element results because the many sellers in the industry sell a differentiated rather than a homogeneous product.

c.Technically speaking, we cannot define the industry under monopolistic competition because each firm produces a somewhat different product. All we can do is to group together firms producing closely related commodities and refer to them as a “product group”. However, because of the product differentiation, we cannot construct the “industry” D and S curves and we do not have a single equilibrium price but a cluster of prices. Thus, our graphical analysis must be confined to the typical or representative firm.
4. a.Oligopoly is the form of market organization in which there are few sellers of a commodity. If there are only two sellers, we have a duopoly. If the product is homogeneous (e.g., steel, cement and copper) we have a pure oligopoly. For simplicity, we deal mostly with a pure duopoly. Oligopoly is the most prevalent form of market organization in the manufacturing sector of modern economies and arises for the same general reasons as monopoly (i.e., economies of scale, control over an essential resource, government licensing and patents).

b.The interdependence among the firms in the industry is the single most important characteristic setting oligopoly apart from other market structures. This interdependence is the natural result of fewness. That is, since there are few firms in an oligopolistic industry, when one of them lowers its price, undertakes a successful advertising campaign, or introduces a better model, the demand curve faced by other...
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