CEA Market Structures and Competition 3 — Questions and Answers
Question 1: In a Stackelberg duopoly, the leader firm gains an advantage by:
- Setting price before the follower sets quantity
- Committing to an output level first, forcing the follower to react via its reaction function (Correct answer)
- Forming a cartel agreement with the follower
- Producing at its Bertrand equilibrium output
Correct answer: Committing to an output level first, forcing the follower to react via its reaction function
The Stackelberg leader commits to output first, knowing the follower will best-respond, allowing the leader to produce more and earn higher profit than in Cournot.
Question 2: Which of the following is NOT a barrier to entry in a monopoly market?
- Exclusive ownership of a key resource
- Economies of scale that favor the incumbent
- Inelastic market demand for the product (Correct answer)
- Government-granted exclusive franchise
Correct answer: Inelastic market demand for the product
Inelastic demand describes consumer sensitivity to price changes but does not itself prevent rivals from entering the market; the other options are classic entry barriers.
Question 3: Third-degree price discrimination requires that the seller:
- Know each individual buyer's exact willingness to pay
- Separate markets with different price elasticities and prevent resale (Correct answer)
- Sell identical units at declining prices to the same buyer
- Charge a two-part tariff consisting of a fixed fee plus a per-unit price
Correct answer: Separate markets with different price elasticities and prevent resale
Third-degree price discrimination splits customers into groups with different elasticities (e.g., students vs. adults) and prevents arbitrage between groups.
Question 4: The Lerner Index for a profit-maximizing firm equals:
- (TR − TC) / TR
- (P − MC) / P (Correct answer)
- MC / P
- 1 / |price elasticity of demand|
Correct answer: (P − MC) / P
The Lerner Index is (P − MC)/P and measures the percentage markup over marginal cost, ranging from 0 (perfect competition) toward 1 (pure monopoly).
Question 5: In a repeated game, cooperation in a cartel is most sustainable when:
- The discount rate is high, making future payoffs relatively unimportant
- Firms interact indefinitely and the discount rate is low (Correct answer)
- The number of cartel members is large
- Demand fluctuations make cheating easy to detect
Correct answer: Firms interact indefinitely and the discount rate is low
With an infinite horizon and patient firms (low discount rate), the future punishment for cheating outweighs the short-run gain, supporting cooperative equilibrium.
Question 6: A monopsony buyer in a labor market sets the wage:
- Equal to the marginal revenue product of labor
- Below the competitive wage, hiring fewer workers than the competitive outcome (Correct answer)
- Equal to the average cost of labor
- Where the supply curve intersects marginal revenue product
Correct answer: Below the competitive wage, hiring fewer workers than the competitive outcome
A monopsony faces an upward-sloping labor supply and sets the wage below MRP, resulting in both a lower wage and lower employment than under competition.
Question 7: What distinguishes an oligopoly from monopolistic competition primarily?
- Presence of differentiated products
- Strategic interdependence among a small number of firms (Correct answer)
- Existence of long-run economic profit
- Barriers that prevent any entry
Correct answer: Strategic interdependence among a small number of firms
Oligopoly is defined by strategic interdependence—each firm must consider rivals' reactions—while monopolistic competition involves many small firms with no such interdependence.
CEA Market Structures and Competition 3
In a Stackelberg duopoly, the leader firm gains an advantage by: