Microeconomics: Market Structures Quiz

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Questions and Answers

What is a characteristic of a monopolistic competitive market?

Single seller

High barriers to entry

Perfect substitutes

Many sellers and many buyers (correct)

Which method helps a monopolistic competitive firm maintain market power?

Increasing entry barriers

Costly signaling through advertisement (correct)

Offering identical products

Lowering prices to match competitors

What distinguishes an oligopoly from a monopolistic competitive market?

Perfectly elastic demand

High barriers to entry (correct)

Absence of market power

A large number of small firms

In an oligopoly, why must a firm consider its rival's reactions?

Because firms are interdependent Signup and view all the answers

What is a dominant strategy in game theory?

A strategy that yields a higher payoff than other strategies regardless of rivals' actions Signup and view all the answers

What does overt collusion in an oligopoly result in?

Joint behavior similar to a monopolist Signup and view all the answers

What does a payoff matrix represent in game theory?

Possible outcomes based on players' actions Signup and view all the answers

Which of the following is NOT a characteristic of an oligopoly?

Firms act independently without considering rivals Signup and view all the answers

What indicates that a strategy is strictly dominant for player A?

Player A's outcomes are better when B chooses 'Confess'. Signup and view all the answers

Which scenario represents a Nash Equilibrium?

Both players choose 'Confess'. Signup and view all the answers

What is the payoff when both players achieve the Nash Equilibrium of (Confess, Confess)?

-2,-2 Signup and view all the answers

In the example provided, what happens to the sum of payoffs if both players choose 'Not Confess'?

-2 Signup and view all the answers

What is necessary to find the equilibrium outcome between two players?

Each player's strategy must be fixed and maximized based on the other's action. Signup and view all the answers

How can repeated plays restore the first-best solution in a game?

By removing incentives for players to deviate from the optimal strategy. Signup and view all the answers

What is an intertemporal trade-off in game theory?

Choosing a strategy that leads to a lower payoff now for a higher payoff later. Signup and view all the answers

When is a player's strategy considered best-responding?

When they maximize their payoff given the other player's action. Signup and view all the answers

Study Notes

Monopolistic Competition

A monopolistic competitive market, like soft drinks, has many sellers and buyers.
Products are differentiated—not perfect substitutes, like Coke vs. Pepsi
Barriers to entry are low.

Monopolist within Product Market

A monopolist in a product market can earn a profit.
The profit area is represented on a diagram, as is deadweight loss.
Diagrams show the relationship of Price (P) to quantity (Q) and other cost curves.

Perfectly Competitive Firm

Low barriers to entry lead to zero profit in the long run.
Firms will enter if profit exists
Demand shifts to the left.

Maintaining Product Differentiation

To maintain long-run profit, a monopolistic firm must maintain market power.
Innovation is one key method
Advertising is another method (costly signal)

Oligopoly Characteristics

An oligopoly has a small number of large firms.
Firms are interdependent.
Firms are strategic price makers.
High barriers to entry.

Firms are Interdependent

Oligopolists consider how rivals will react to their decisions.
Perfectly competitive firms are price takers
Monopolists have no rivals.
Monopolistic competitive firms have no direct rivals within their product market.

Overt Collusion

Oligopolists act together like a monopolist
There is a deadweight loss, which is visually depicted
OPEC countries are an example.

The Payoff Matrix

To understand a game, define players, their actions and payoffs.
An example presented is Prisoner's Dilemma.

Strategy

A plan of action in response to rival actions
Always confess and match rival's action are examples

Dominant Strategy

A strategy that’s best for a player, regardless of the other players’ choices
An example in a payoff matrix is always confess in Prisoner's Dilemma.

Nash Equilibrium

No player can unilaterally improve by changing strategy .
An example is given in a payoff matrix, where always confess is the equilibrium strategy
(-2,-2) is the equilibrium outcome in the example

How to Find Equilibrium

Determine the best action for each player, given the actions of others.

Second-Best Solution

The sum of payoffs in the equilibrium is -4
The sum of payoffs if players choose not to confess is -2,
The not confess option is often the first-best solution

Restoring First-Best through Repeated Plays

Repeated plays allow players to base strategies on action history.
Players can penalize each other for deviating from the first-best solution
Intertemporal trade-offs are a key consideration (current vs. future benefits)
Sufficiently patient players can sustain a monopoly outcome.
Game theory examines this relationship in detail.

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Description

Test your understanding of different market structures including monopolistic competition, monopolies, and oligopolies. Explore concepts like product differentiation, barriers to entry, and pricing strategies in various market scenarios.