MEcon Master of Economics Microeconomics and Market Structure 2 — Questions and Answers
Question 1: Which market structure is characterized by many firms selling differentiated products with free entry and exit?
- Perfect competition
- Oligopoly
- Monopolistic competition (Correct answer)
- Monopsony
Correct answer: Monopolistic competition
Monopolistic competition combines many competing firms (like perfect competition) with product differentiation giving each firm some pricing power (like monopoly).
Question 2: A natural monopoly arises when:
- The government grants exclusive rights to one firm
- A single firm can supply the entire market at lower average cost than multiple firms (Correct answer)
- One firm has superior technology that cannot be copied
- Network effects make smaller firms unviable
Correct answer: A single firm can supply the entire market at lower average cost than multiple firms
Natural monopoly occurs when economies of scale are so large relative to market demand that one firm's average cost keeps falling throughout the market, making duplication wasteful.
Question 3: The Lerner Index measures a firm's market power as:
- (P – MC) / P (Correct answer)
- (MR – MC) / P
- (TR – TC) / TR
- (P – ATC) / ATC
Correct answer: (P – MC) / P
The Lerner Index = (P − MC)/P ranges from 0 (perfect competition) to 1 (pure monopoly), measuring the markup over marginal cost as a share of price.
Question 4: In a Cournot duopoly, each firm chooses its output assuming the rival's:
- Price remains constant
- Output remains constant (Correct answer)
- Profit remains constant
- Market share remains constant
Correct answer: Output remains constant
Cournot competition has each firm selecting quantity as its best response to the other firm's fixed output, with equilibrium at the intersection of reaction functions.
Question 5: The concept of 'adverse selection' in insurance markets occurs because:
- Insurers deliberately select bad risks
- High-risk individuals are more likely to purchase insurance than low-risk individuals (Correct answer)
- Moral hazard raises claim rates
- Regulation forces premiums above costs
Correct answer: High-risk individuals are more likely to purchase insurance than low-risk individuals
Adverse selection arises from asymmetric information — those who know they are higher risk seek insurance more eagerly, skewing the insured pool toward bad risks.
Question 6: A Giffen good is one for which:
- Demand rises as quality improves
- Demand increases as price rises, violating the law of demand (Correct answer)
- Supply decreases as price rises
- Elasticity is exactly −1
Correct answer: Demand increases as price rises, violating the law of demand
A Giffen good is an inferior good whose income effect so dominates the substitution effect that a price rise causes consumers to buy more of it.
MEcon Master of Economics Microeconomics and Market Structure 2
Which market structure is characterized by many firms selling differentiated products with free entry and exit?