CEA Market Structures and Competition 2 — Questions and Answers
Question 1: In a Cournot oligopoly with two identical firms, each firm's equilibrium output equals what fraction of the competitive output?
- One-half
- One-third (Correct answer)
- Two-thirds
- Three-quarters
Correct answer: One-third
In Cournot duopoly each firm produces 1/3 of the competitive quantity, yielding a combined industry output of 2/3 of the competitive level.
Question 2: Which condition best describes the Bertrand paradox in oligopoly theory?
- Two firms collude to set the monopoly price
- Two price-setting firms with identical costs drive price to marginal cost (Correct answer)
- Quantity-setting firms earn zero profit in the long run
- Price leadership eliminates strategic interaction
Correct answer: Two price-setting firms with identical costs drive price to marginal cost
The Bertrand paradox shows that just two identical firms competing on price undercut each other until price equals marginal cost, replicating perfect competition.
Question 3: A 'natural monopoly' arises when:
- A single firm holds a government-granted patent
- Average cost declines over the entire relevant range of market output (Correct answer)
- Network externalities make the product worthless without many users
- Entry barriers are created by aggressive advertising
Correct answer: Average cost declines over the entire relevant range of market output
Natural monopoly exists when economies of scale are so extensive that one firm can serve the entire market at lower average cost than multiple firms could.
Question 4: Which market structure is characterized by a kinked demand curve model used to explain price rigidity?
- Monopolistic competition
- Oligopoly (Correct answer)
- Perfect competition
- Monopsony
Correct answer: Oligopoly
The kinked demand curve model (Sweezy) applies to oligopoly, arguing rivals match price cuts but not price increases, creating a kink that leads to stable prices.
Question 5: A firm practicing first-degree price discrimination extracts:
- Only consumer surplus from high-income buyers
- All consumer surplus, converting it to producer surplus (Correct answer)
- A uniform price above marginal cost
- Zero economic profit because prices equal willingness to pay
Correct answer: All consumer surplus, converting it to producer surplus
Perfect (first-degree) price discrimination charges every consumer their maximum willingness to pay, capturing the entire consumer surplus as producer surplus.
Question 6: The Herfindahl-Hirschman Index (HHI) is calculated by:
- Summing each firm's market share
- Summing the squares of each firm's percentage market share (Correct answer)
- Dividing the largest firm's share by the number of firms
- Averaging the top four firms' market shares
Correct answer: Summing the squares of each firm's percentage market share
The HHI equals the sum of squared market share percentages; a higher HHI signals greater market concentration and potential monopoly power.
Question 7: Under monopolistic competition in long-run equilibrium, a firm produces:
- At the minimum of its average cost curve
- To the left of minimum average cost, resulting in excess capacity (Correct answer)
- Where price equals marginal cost
- Where economic profit is maximized above zero
Correct answer: To the left of minimum average cost, resulting in excess capacity
Free entry in monopolistic competition drives economic profit to zero but leaves firms on the downward-sloping portion of their AC curve, creating excess capacity.
CEA Market Structures and Competition 2
In a Cournot oligopoly with two identical firms, each firm's equilibrium output equals what fraction of the competitive output?