Unit 4: Imperfect Competition

Original practice questions written to the published framework for this section. No expert has reviewed them, and they are not taken from any official exam. Try each one before you open the answer.

1. Question 1Foundational

   For a single-price monopolist, how does marginal revenue compare with the price charged?

   1. AMarginal revenue is less than price
   2. BMarginal revenue equals price
   3. CMarginal revenue is greater than price
   4. DMarginal revenue equals average total cost

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   Answer: A. Marginal revenue is less than price

   To sell one more unit the monopolist must lower the price on every unit it sells, so the revenue gained from the extra unit is offset by the revenue lost on all the previous ones. Marginal revenue equal to price is the tempting distractor, but that holds only in perfect competition, where the firm can sell any quantity at the going market price.

   Key insight: Any firm facing a downward-sloping demand curve has marginal revenue below price, which is exactly why it produces less than the competitive quantity.

2. Question 2Foundational

   What level of economic profit does a monopolistically competitive firm earn in long-run equilibrium?

   1. AZero economic profit
   2. BPositive economic profit sustained indefinitely
   3. CNegative economic profit sustained indefinitely
   4. DThe same economic profit as an unregulated monopoly

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   Answer: A. Zero economic profit

   Low barriers to entry let new differentiated competitors enter whenever profits exist, shrinking each firm's demand until price just equals average total cost. Sustained positive profit is the tempting distractor, because it does occur in the short run and disappears only once entry has run its course.

   Key insight: Monopolistic competition ends with zero profit like perfect competition, but at a price above marginal cost and with excess capacity.

3. Question 3Intermediate

   True or False: A monopolist can select any price it wishes and still sell whatever quantity it wants at that price.

   1. ATrue
   2. BFalse

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   Answer: B. False

   A monopolist is constrained by the market demand curve, so it may choose a price or a quantity but not both independently: setting a higher price necessarily means selling fewer units. That constraint is why a monopolist maximizes profit by producing where marginal revenue equals marginal cost and then charging the highest price demand will bear for that quantity.

   Key insight: Price-making power means choosing a point on the demand curve, never escaping it.

4. Question 4Intermediate

   In a game theory payoff matrix, what makes one of a player's options a dominant strategy?

   1. AIt gives that player a better payoff no matter what the rival chooses
   2. BIt gives both players their highest combined payoff
   3. CIt is the option the player selects after seeing the rival's move
   4. DIt is the option both players choose in every Nash equilibrium

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   Answer: A. It gives that player a better payoff no matter what the rival chooses

   A dominant strategy is best against every possible rival action, which is why you find it by comparing a single player's payoffs row by row or column by column. Maximizing the combined payoff is the tempting distractor, but the prisoner's dilemma exists precisely because both players following their dominant strategies produces an outcome worse for both than cooperating would.

   Key insight: Check one player at a time and hold the rival's choice fixed; dominance is about a single player's own payoffs.

5. Question 5Advanced

   Why does an unregulated single-price monopoly generate deadweight loss even when it is maximizing its own profit?

   1. AIt restricts output below the quantity where price equals marginal cost, so valuable units go unproduced
   2. BIt earns positive economic profit, and that profit is itself the deadweight loss
   3. CIts average total cost is necessarily higher than a competitive firm's
   4. DIt produces a quantity at which price lies below marginal cost

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   Answer: A. It restricts output below the quantity where price equals marginal cost, so valuable units go unproduced

   Because marginal revenue lies below price, the monopolist stops producing while price still exceeds marginal cost, so every unit between that output and the efficient output represents a mutually beneficial trade that never happens. Treating the monopolist's profit as the deadweight loss is the tempting distractor, but profit is a transfer of surplus from consumers to the firm, and only the surplus destroyed by the unproduced units is truly lost.

   Key insight: Deadweight loss comes from output restriction, not from high profit; a transfer moves surplus while deadweight loss destroys it.