Economics. 13 question(s) in this unit's pool
(2 above the exam). Free up to ten a day; the coach picks which ones based on what you have
already answered and when each is next due.
Pick an answer, say how sure you are, then reveal. Every wrong choice gets its own
explanation. Questions you have already answered correctly and confidently stay out of the way until they
are due for review again.
Question 1Exam level
A firm in a perfectly competitive market is producing at a level where price equals $45, average total cost equals $50, and average variable cost equals $38. Which of the following actions is most appropriate in the short run?
How sure are you?
Correct: B. The shutdown rule states that a firm should cease production only if price falls below average variable cost (P < AVC). Here, P = $45 > AVC = $38, so the firm covers its variable costs and contributes to fixed costs by operating. Although the firm earns a short-run economic loss (P < ATC), shutting down would result in a larger loss equal to total fixed costs. In the long run, if price remains below ATC, the firm exits. Option A is the classic wrong answer. Candidates confuse the shutdown condition (P < AVC) with the breakeven condition (P = ATC).
A. Option A is the classic wrong answer. You might confuse the shutdown condition (P < AVC) with the breakeven condition (P = ATC).
C. You might be tempted to think that increasing output will help the firm reach a break-even point where price equals average total cost, but in a perfectly competitive market, expanding output does not influence the market price, and attempting to change the price by altering output violates the principle of price takers, where firms must accept the market price.
Unit: the-firm-and-market-structures
Question 2Exam level
In the long run, a firm in monopolistic competition will most likely:
How sure are you?
Correct: C. Monopolistic competition long-run equilibrium occurs where P = LRAC (zero economic profit, same as perfect competition) BUT the firm does NOT produce at minimum LRAC. The demand curve is tangent to LRAC to the left of the minimum point, creating excess capacity. This differs critically from perfect competition, where long-run equilibrium is at the minimum of LRAC (efficient scale). Option A is wrong: free entry eliminates positive economic profit in the long run. Option B describes perfect competition, not monopolistic competition.
A. Option A is wrong: free entry eliminates positive economic profit in the long run.
B. Option B describes perfect competition, not monopolistic competition.
Unit: the-firm-and-market-structures
Question 3Harder
A monopolist faces a demand curve P = 120 - 2Q. Its marginal cost is constant at $40. To maximize profit, the monopolist will set price and quantity at closest to:
How sure are you?
Correct: A. Marginal revenue MR = 120 - 4Q (twice the slope of the linear demand curve). Setting MR = MC: 120 - 4Q = 40, so Q = 20. Substituting into demand: P = 120 - 2(20) = $80. A monopolist never sets P = MC (that is the competitive outcome); it sets MR = MC and reads price off the demand curve.
B. Option B is a common arithmetic error.
C. Option C represents the competitive equilibrium (P = MC = $40), which is incorrect for a monopolist.
Unit: the-firm-and-market-structures
Question 4Exam level
An industry consists of four firms with market shares of 40%, 30%, 20%, and 10%. The Herfindahl-Hirschman Index (HHI) for this industry is closest to:
How sure are you?
Correct: B. HHI = sum of squared market shares (expressed as whole numbers, not decimals): HHI = 40² + 30² + 20² + 10² = 1,600 + 900 + 400 + 100 = 3,000. This exceeds the DOJ threshold of 2,500, classifying the market as highly concentrated. The four-firm concentration ratio (CR4) = 100% (all four firms). 40, 0.30, 0.20, 0.10), multiply the HHI result by 10,000 to get the standard value. Option A is the common error from squaring decimals without multiplying by 10,000.
A. Option A is the common error from squaring decimals without multiplying by 10,000.
C. Choosing 1,000 might tempt you if you mistakenly sum the market shares instead of squaring them, but the HHI calculation requires squaring each market share and then summing those values, leading to a much higher number like 3,000.
Unit: the-firm-and-market-structures
Question 5Exam level
The kinked demand curve model of oligopoly most likely predicts that:
How sure are you?
Correct: C. The kinked demand curve (Sweezy model) explains price rigidity in oligopoly. The kink arises because rivals match price decreases (to prevent losing market share) but do not match price increases (allowing the price-increasing firm to lose customers). This creates a discontinuous marginal revenue curve at the current price and output. As long as marginal cost shifts within the discontinuous range of MR, the profit-maximizing price and quantity remain unchanged. Hence price rigidity. Option A is the opposite of the model's prediction. Option B describes a cartel, not the kinked demand model.
A. Option A is the opposite of the model's prediction.
B. You might be tempted by the idea of collusion because it seems like a straightforward way for firms to maintain high profits, but this choice confuses the kinked demand curve model with the concept of cartels, where firms explicitly agree to set prices; the kinked demand curve model instead relies on implicit price leadership and the fear of competitive responses to price changes.
Unit: the-firm-and-market-structures
Question 6Exam level
Which of the following market structures is most likely characterized by a large number of sellers offering differentiated products with low barriers to entry?
How sure are you?
Correct: B. Monopolistic competition features: (1) many sellers, (2) differentiated products (not identical/homogeneous), (3) relatively low barriers to entry, (4) some pricing power due to differentiation, (5) zero economic profit in long run. Perfect competition has identical products (not differentiated). Oligopoly has few sellers (not many) and high barriers to entry. The most common exam trap here is confusing monopolistic competition with perfect competition. Both have many sellers and low barriers, but the product differentiation is the key distinguishing feature.
A. You might be tempted by perfect competition because it also involves many sellers and low barriers to entry, but remember, perfect competition assumes homogeneous products, which contrasts with the differentiated products in monopolistic competition.
C. You might be tempted by oligopoly because it also involves product differentiation, but remember, oligopoly is defined by having only a few sellers with high barriers to entry, which contrasts with the many sellers and low barriers to entry characteristic of monopolistic competition.
Unit: the-firm-and-market-structures
Question 7Harder
A price-discriminating monopolist sells to two customer groups: Group A (elastic demand) and Group B (inelastic demand). To maximize profit, the monopolist should most likely charge:
How sure are you?
Correct: C. Third-degree price discrimination charges different prices to different customer segments based on demand elasticity. The profit-maximizing rule for a price discriminator: charge a higher price to the group with more inelastic demand and a lower price to the group with more elastic demand. Group B (inelastic) is less price-sensitive. They will not significantly reduce quantity demanded when price rises, so the monopolist extracts more surplus from them. Group A (elastic) is more price-sensitive. A lower price serves them while still covering marginal cost. Real-world examples: airline business class vs economy, student/senior discounts, pharmaceutical pricing by country.
A. Choosing the same price for both groups overlooks the fundamental principle of price discrimination, which relies on charging different prices based on elasticity; by not adjusting prices according to demand elasticity, you fail to maximize profit as effectively as you would by charging a higher price to the less price-sensitive Group B.
B. Choosing a higher price for Group A (elastic demand) might seem logical if you assume higher prices always lead to higher profits, but this violates the principle of price discrimination where you charge a higher price to the group with inelastic demand because they are less sensitive to price changes.
Unit: the-firm-and-market-structures
Question 8Exam level
Which of the following best describes the long-run equilibrium in a perfectly competitive industry?
How sure are you?
Correct: B. Perfect competition long-run equilibrium occurs at: P = MR = MC = minimum LRAC. This means: (1) allocative efficiency: P = MC, no deadweight loss; (2) productive efficiency: production at minimum LRAC; (3) zero economic profit: P = LRAC. Free entry eliminates positive economic profits (new firms enter, supply rises, price falls). Free exit eliminates losses (firms exit, supply falls, price rises). Normal accounting profit is still earned. 'zero economic profit' means the firm earns exactly enough to cover all opportunity costs including normal return on capital. Option C describes monopoly, not perfect competition.
A. You might be thinking that positive economic profits attract new firms, which is true in the short run, but in the long-run equilibrium of perfect competition, this positive profit scenario is unsustainable as it attracts new entrants until economic profits are driven to zero, contrasting with the long-run equilibrium where firms only earn zero economic profit.
C. You might be thinking that higher prices above marginal cost indicate inefficiency, but in perfect competition, market price equals marginal cost, ensuring allocative efficiency, unlike in a monopoly where price exceeds marginal cost, creating deadweight loss.
Unit: the-firm-and-market-structures
Question 9Exam level
Compared to a monopolist, a perfectly competitive industry most likely produces:
How sure are you?
Correct: B. Perfect competition equilibrium: P = MC (allocatively efficient). Monopoly equilibrium: P > MR = MC (price is above competitive level). A monopolist restricts output to the point where MR = MC, then charges the demand-curve price. Which is above MC. The welfare loss from monopoly (deadweight loss) represents output that would be produced under competition but is not produced under monopoly. Therefore: competitive industry output > monopoly output, and competitive price < monopoly price. This is the fundamental welfare argument for antitrust regulation.
A. You might be thinking that a monopolist produces less and charges more, which is true, but choice A confuses the price-output relationship; in a perfectly competitive market, firms produce where P = MC leading to higher output and lower prices compared to a monopolist where P > MC.
C. You might be tempted by choice C if you think that monopolists and competitive markets produce the same output but differ only in pricing, but this overlooks the fundamental difference that monopolists restrict output to increase prices, leading to lower output compared to competitive markets where output is maximized at the point where price equals marginal cost.
Unit: the-firm-and-market-structures
Question 10Exam level
Which market structure is most likely to exhibit Nash equilibrium behavior?
How sure are you?
Correct: C. Nash equilibrium is most relevant to oligopoly because oligopolists are interdependent. Each firm's optimal strategy depends on what it expects rivals to do. In a Nash equilibrium, no firm can improve its payoff by unilaterally changing its strategy, given the strategies of its rivals. The classic example is the prisoner's dilemma: two competing firms in an oligopoly would both be better off colluding (high price), but the Nash equilibrium is mutual competition (lower price) because each firm has an incentive to defect regardless of what the rival does. Perfect competition firms are price-takers with no strategic interdependence. Monopolistic competition firms have some pricing power but no strategic interdependence.
A. You might think perfect competition fits because firms in this market structure are numerous, but in perfect competition, firms are price takers with no strategic interaction, unlike in oligopoly where firms' strategies directly influence each other, making Nash equilibrium applicable.
B. You might be tempted by monopolistic competition because firms in this market do have some market power and product differentiation, but remember, monopolistic competition lacks the strategic interdependence seen in oligopolies where firms must consider rivals' actions to determine their own strategies.
Unit: the-firm-and-market-structures
Question 11Exam level
A firm that is the sole seller in a market with no close substitutes and significant barriers to entry is most likely described as a:
How sure are you?
Correct: C. Pure monopoly characteristics: (1) single seller, (2) no close substitutes for the product, (3) significant barriers to entry preventing competition (patents, government licenses, control of key resources, natural monopoly economics). A pure monopolist is a price-maker. It faces the entire market demand curve and can choose any price-quantity combination on that curve (subject to maximizing profit at MR = MC). Monopolistic competition (Option A) has many sellers, not one. A price-taker (Option B) is a perfectly competitive firm with no pricing power. The exam often confuses candidates with the word 'monopolistic'. Monopolistic competition is not a monopoly.
A. You might be tempted by monopolistic competition because it sounds similar to monopoly, but remember that monopolistic competition involves many sellers and differentiated products, which directly contrasts with the single seller characteristic of a pure monopolist.
B. Option B) is a perfectly competitive firm with no pricing power.
Unit: the-firm-and-market-structures
Question 12Above the exam
A monopolistically competitive firm is currently earning positive economic profit selling a differentiated product. An analyst predicts this profit will persist unchanged over the long run because the firm's product differentiation gives it some pricing power, similar to a monopolist. Combining the concept of long-run equilibrium with the effect of free entry in monopolistic competition, this prediction is most likely:
How sure are you?
Correct: B. Monopolistic competition combines two features: differentiated products (giving each firm some pricing power, like a monopolist, over its own variant) AND free entry (like perfect competition). In the long run, positive economic profits attract new entrants offering similar differentiated products, shifting demand for the incumbent's product down until price equals average total cost and economic profit falls to zero, even though the firm still retains some pricing power at that point (it is not a price taker).
A. Pricing power in monopolistic competition is limited and does not prevent entry; unlike a true monopoly (protected by barriers to entry), monopolistic competition has FREE entry, which competes away economic profit over the long run even as some product differentiation survives.
C. Monopolistically competitive firms do not always earn losses in the long run either; the long-run equilibrium outcome is economic profit converging toward ZERO (normal profit), not toward negative economic profit as a rule.
Unit: the-firm-and-market-structures
Question 13Above the exam
A firm operating in a perfectly competitive market currently has a market price below its average variable cost but above its average fixed cost is not relevant to the shutdown decision. Combining the short-run shutdown rule with the definition of relevant costs, the firm's most likely profit-maximizing action in the short run is to:
How sure are you?
Correct: B. The short-run shutdown rule compares price only to AVERAGE VARIABLE COST, because fixed costs are sunk in the short run and must be paid whether or not the firm produces. If price is below average variable cost, every unit produced adds more to variable cost than it brings in revenue, so producing anything makes the firm's losses WORSE than simply shutting down and losing only the fixed costs. Here price is below AVC, so shutting down in the short run minimizes the loss.
A. Continuing to produce when price is below average variable cost means every additional unit loses money on its variable costs alone, on top of the fixed costs already sunk; 'some revenue' is not better than none in this case; it actively deepens the loss beyond the fixed-cost baseline.
C. The short-run shutdown decision (stop producing this period) is different from the long-run EXIT decision (leave the industry permanently), which compares price to average TOTAL cost, not average variable cost; the question only establishes that price is below AVC, which triggers shutdown, not necessarily permanent exit.