AP_Krugman_Textbook

run, thanks to the lack of barriers to entry, it would be

impossible to maintain such a monopoly.

3. a.False. As illustrated in panel (b) of Figure 67.4, a monop-
   olistically competitive firm sells its output at a price that
   exceeds marginal cost—unlike a perfectly competitive
   firm, which sells at a price equal to marginal cost. Not
   only does a monopolistically competitive firm maximize
   profit by charging more than marginal cost, but in long-
   run equilibrium, a price equal to marginal cost would be
   below average total cost and cause the firm to incur a
   loss.
   b.True. Firms in a monopolistically competitive industry
   could achieve higher profit (monopoly profit) if they all
   joined together as a single firm with a single product.
   Because each of the smaller firms possesses excess capaci-
   ty, a single firm producing a larger quantity would have a
   lower average total cost. The effect on consumers, howev-
   er, is ambiguous. They would experience less choice. But
   if consolidation substantially reduced industry-wide aver-
   age total cost and increases industry-wide output, con-
   sumers could experience lower prices with the monopoly.
   c.True. Fads and fashions are promulgated by advertising
   and a desire for product differentiation, which are com-
   mon in oligopolies and monopolistically competitive
   industries, but not in monopolies or perfectly competitive
   industries.
   Tackle the Test:
   Multiple-Choice Questions


4. b


5. e


6. b


7. b


8. e
   Tackle the Test:
   Free-Response Questions


9. 
   

MC ATC

Quantity

Price,

cost,

marginal

revenue

PMC = ATCMC

MCMC

QMC

MRMC DMC

Minimum-cost output

Excess capacity

it. Because it could gain market share by doing so,

refusing to do so supports the conclusion that there is

tacit collusion.

Tackle the Test:

Multiple-Choice Questions

1. d


2. d


3. c


4. e


5. a

Tackle the Test:

Free-Response Questions

2. a.A large number of firms: having more firms means there
   is less incentive for any firm to behave cooperatively.
   b.Complex products/pricing schemes: keeping track of
   adherence to an agreement is more difficult.
   c.Differences in interests: firms often have different views
   of their own interests and of what a fair agreement would
   entail.
   d.Bargaining power of buyers: firms are less able to raise
   prices for buyers with significant bargaining power, which
   can result from size or access to many options.

Module 67

Check Your Understanding

1. a.An increase in fixed cost shifts the average total cost
   curve upward. In the short run, firms incur losses
   because price is below average total cost. In the long run,
   some firms will exit the industry, resulting in a rightward
   shift of the demand curves for those firms that remain,
   since each firm now serves a larger share of the market.
   Long-run equilibrium is reestablished when the demand
   curve for each remaining firm has shifted rightward to
   the point where it is tangent to the firm’s new, higher
   average total cost curve. At this point each firm’s price
   just equals its average total cost, and each firm makes
   zero profit.
   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-
   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
   profit.


2. If all the existing firms in the industry joined together to
   create a monopoly, they could achieve positive economic
   profit in the short run. But this would induce new firms
   to create new, differentiated products and then enter the
   industry and capture some of the profit. So, in the long

S-42 SOLUTIONS TO AP REVIEW QUESTIONS