Page 888 - Krugmans Economics for AP Text Book_Neat

S-42 SOLUTIONS TO AP REVIEW QUESTIONS

it. Because it could gain market share by doing so, run, thanks to the lack of barriers to entry, it would be
refusing to do so supports the conclusion that there is impossible to maintain such a monopoly.
tacit collusion.
3. a. False. As illustrated in panel (b) of Figure 67.4, a monop-
Tackle the Test: olistically competitive firm sells its output at a price that
Multiple-Choice Questions exceeds marginal cost—unlike a perfectly competitive
firm, which sells at a price equal to marginal cost. Not
1. d only does a monopolistically competitive firm maximize
2. d profit by charging more than marginal cost, but in long-
3. c run equilibrium, a price equal to marginal cost would be
below average total cost and cause the firm to incur a
4. e loss.
5. a b. True. Firms in a monopolistically competitive industry
could achieve higher profit (monopoly profit) if they all
Tackle the Test: joined together as a single firm with a single product.
Free-Response Questions Because each of the smaller firms possesses excess capaci-
ty, a single firm producing a larger quantity would have a
2. a. A large number of firms: having more firms means there lower average total cost. The effect on consumers, howev-
is less incentive for any firm to behave cooperatively. er, is ambiguous. They would experience less choice. But
b. Complex products/pricing schemes: keeping track of if consolidation substantially reduced industry-wide aver-
adherence to an agreement is more difficult. age total cost and increases industry-wide output, con-
c. Differences in interests: firms often have different views sumers could experience lower prices with the monopoly.
of their own interests and of what a fair agreement would c. True. Fads and fashions are promulgated by advertising
entail. and a desire for product differentiation, which are com-
d. Bargaining power of buyers: firms are less able to raise mon in oligopolies and monopolistically competitive
prices for buyers with significant bargaining power, which industries, but not in monopolies or perfectly competitive
can result from size or access to many options. industries.
Tackle the Test:
Module 67 Multiple-Choice Questions

Check Your Understanding 1. b
1. a. An increase in fixed cost shifts the average total cost 2. e
curve upward. In the short run, firms incur losses 3. b
because price is below average total cost. In the long run, 4.
some firms will exit the industry, resulting in a rightward b
shift of the demand curves for those firms that remain, 5. e
since each firm now serves a larger share of the market.
Long-run equilibrium is reestablished when the demand Tackle the Test:
curve for each remaining firm has shifted rightward to Free-Response Questions
the point where it is tangent to the firm’s new, higher 2. Price,
average total cost curve. At this point each firm’s price cost,
just equals its average total cost, and each firm makes marginal
revenue
zero profit. MC ATC
b. A decrease in marginal cost shifts the average total cost
curve and the marginal cost curve downward. In the
short run, firms earn positive economic profit. In the
long run new entrants are attracted into the industry by
the profit. This results in a leftward shift of each existing
firm’s demand curve because each firm now has a small-
er share of the market. Long-run equilibrium is reestab-
P MC = ATC MC
lished when each firm’s demand curve has shifted left-
ward to the point where it is tangent to the new, lower
average total cost curve. At this point each firm’s price
just equals average total cost, and each firm makes zero MC MC
profit. D MC
MR MC
2. If all the existing firms in the industry joined together to Q MC Quantity
create a monopoly, they could achieve positive economic Minimum-cost output
profit in the short run. But this would induce new firms
to create new, differentiated products and then enter the
Excess capacity
industry and capture some of the profit. So, in the long