Microeconomics Quiz Answers and Notes PDF

Microeconomics Quiz Answers and Notes **[Chapter One]** **[Economic Issues and Concepts]** **Notes:** **Economic Issues that are of pressing concern:** - Productivity growth - Population aging - Climate change - Global financing stability - Rising government debt - Globalizatio...

Microeconomics Quiz Answers and Notes **[Chapter One]** **[Economic Issues and Concepts]** **Notes:** **Economic Issues that are of pressing concern:** - Productivity growth - Population aging - Climate change - Global financing stability - Rising government debt - Globalization Many of the issues we face in Canada and around the world are primarily economic **What is Economics?** The study of the use of scarce resources to satisfy unlimited human wants **Resources:** Societies resources are usually divided into land, labor, and capital. Economists refer to resources as factors of production Outputs are goods (tangibles) or services (intangibles). Scarcity = need for choice Choices have an associated cost which is called **opportunity cost --** the benefit given up by not using resources in the best alternative way. A graph with a line and a line pointing to the top Description automatically generated with medium confidence All points within or on the line are attainable combinations, the negatively sloped line provides a boundary between attainable and unattainable combinations. The opportunity cost of getting 1 extra slice of pizza is half of a beer that must be given up. **Production Possibilities Boundary:**  The PPB illustrates scarcity, choice, and opportunity cost. Points e and f show scarcity; they are unattainable with current resources. Point a, b, c, and d show choice. They are all attainable. The negative slope shows opportunity cost. **Four Key Economic Problems:** - What is produced and how? - Resource allocation determines the quantities of various goods that are produced - In terms of the previous illustration, what combination of civilian and military goods will be chosen? - Will the economy be inside the production possibilities boundary -- inefficiently used resources? - What is consumed and by whom? - What determines how economies distribute total output? Why do some people get a lot while others get only a little? - Will the economy consume exactly what it produces? - Microeconomics is the study of the allocation of resources as it is affected by the workings of the price system. - Why are resources sometimes idle? - An economy is operating inside its production possibilities boundary if some resources are idle - Under what circumstances are workers seeking jobs unable to find them - Should governments worry about idle resources? Is there anything governments can do about it? - Is productive capacity growing? - Growth in productive capacity is shown by an outward shift of the PPB. - Point d was initially unattainable. But after sufficient growth, it becomes attainable. **Economics and Government Policy** The design and effectiveness of government policy is relevant to discussing all four problems. It can alter the allocation of the economy\'s resources, be used to improve the distribution of consumption across people, it is also part of the discussion of why economic resources are sometimes idle, and it can affect the overall output and income. **The Nature of Market Economies** Economists noticed that the interaction of self-interested people creates a spontaneous social order -- the economy is **self-organizing** **Efficiency** refers to organizing available resources to produce the goods and services that people most value, when the most want them, and by using the fewest possible resources to do so. Self interest guides individuals, individuals respond to incentives, prices and quantities are set in free markets, institutions created by the state protect private property and enforce contractual obligations. **The Decision Makers and Their Choices** Three broad groups of decision makers, are consumers, producers, and government. In order to achieve their objectives, maximizing consumers and producers make their marginal decisions. They decide whether they will be made better off by buying or selling a little less of any given product. **The Circular Flow of Income Expenditure** A diagram of a market Description automatically generated **The factor incomes of individuals:** Individuals own factors of production. They sell services of these factors to producers in **factor markets** and receive payment in return. **The incomes of producers:** Transform factor services into goods and services, which they then sell to individuals in good markets, receiving payment in return. Production and Trade: Production displays 2 characteristics noted by Adam Smith **Specialization**: the allocation of different jobs to different people. It is more efficient that self-sufficiency, because individual abilities differ - **comparative advantage**, and focusing on one activity leads to improvements -- **learning by doing** **Division of Labor**: extends the idea of specialization for the production of a single good or service. Production and Trade Specialization MUST be accompanied by trade. Money eliminates the cumbersome system of **barter** by separating the transactions involved in the exchange of products, thereby facilitating specialization trade. Underlying modern **globalization** is the rapid reduction of transportation and communication costs in the last half of the 20^th^ century. Today NO country can take an isolationist economic stance and hope to take part in the global economy. **Types of Economic Systems:** - Traditional - Command - Free-Market Every economy is a mixed economy, in the sense that it combines significant elements of all three. Government in the Modern Mixed Economy Key government-provided institutions in market economies are **private property** and **freedom of contract**. Governments also intervene to, correct market failures, provide public goods, and offset the effects of externalities. **[Chapter Two]** **[Economic Theories, Data, and Graphs]** **Notes:** **Normative Statements:** depend on value judgments and opinions, they cannot be settled by recourse to facts. **Positive Statements:** Do not involve value judgments. They are statements about what is, was, or will be. Theories: - A set of definitions about **variables** - A set of **assumptions** - A set of **predictions** (or **hypotheses**) **Testing Theories** A theory is tested by confronting its predictions with evidence. If a theory conflicts with facts, it will usually be amended to make it consistent with those facts, or it will be discarded to be replaced by a superior theory. The **scientific approach** is central to economics. **Rejection Vs. Confirmation** A hypothesis can be tested and may be rejected by the data. This rejection brings the value of the theory into question. An alternative is to search for confirming evidence for a theory. But no matter how unlikely the theory is, some confirming evidence can generally be found. **Statistical Analysis** Used to test a hypothesis Can be observed and recorded continuously, producing a mass of data. **Correlation Vs. Causation** **Positive correlation** = X and Y move together **Negative correlation** = X and Y move in opposite directions Index Numbers Used to compare changes in some variables relative to some **base period**. Value of index in given period = absolute value in given period/absolute value in base period X 100 **Graphing Economic Data, Theories, and Functional Relations** Variables come in two forms: - Cross-sectional data - Time-series data A scatter diagram is a useful and common way of looking at the relationship between two variables. A functional relation can be expressed: - In a verbal statement - In a numerical statement - In a mathematical equation - In a graph The relationship between two variables can be positive or negative. If the graphs of these relationships are straight lines, they are linearly related to each other. If not, they are non-linearly related. **Linear** **Non-Linear** In general, non-linear relations are more common than linear ones. **[Chapter Three]** **[Demand, Supply, and Price]** **Notes:** **Quantity Demanded** The total amount that consumers desire to purchase in a time period is called the quantity demanded of a product. The quantity bought refers to actual purchases. The quantity demanded is a flow as opposed to a stock. **Quantity Demanded and Price** A basic hypothesis is that - ceteris paribus - the price of a product and the quantity demanded are negatively related. The law of demand as called by Alfred Marshall A reduction in the price of a product means that the specific desire can now be satisfied more cheaply by buying more of that product. **Demand Schedules and Demand Curves**  Shifts in Demand Curves A change in variables other than price will shift the demand curve to a new position. - Average household income -- normal and inferior goods - Tastes - Prices of other products -- substitutes and complements - Distribution of income or population - Expectations about the future A rightward shift indicates an increase in demand, whereas a leftward shift indicates a decrease in demand. A diagram of a price and quantity demand Description automatically generated A change in demand is a change in quantity demanded at every price -- a shift of entire curve. A change in quantity demanded refers to a movement from one point on a demand curve to another point, either on the same demand curve or on a new one. **Supply** The amount of a product that firms desire to sell in a period of time is called quantity supplied of that product. Which is the amount that firms are willing to offer for sale and not necessarily the quantity actually sold. Quantity supplied is a flow as opposed to a stock. **Quantity Supplied and Price** Another basic economic hypothesis is that -- ceteris paribus -- the price of the product and the quantity supplied are positively related. This is because producers are interested in making profits. If the price of a particular product rises, then the production and sale of this product is more profitable. **Supply Schedules and Supply Curves**  A change in any variable other than price will shift the supply curve to a new position - Changes in these variables will shift the supply curve:\ prices of inputs - Technology - Government taxes/subsidies - Prices of other products - Number of suppliers A change in supply is a change in the quantity that will be supplied at every price -- a shift of the entire curve. A change in quantity supplied refers to a movement from one point on a supply curve to another, either on the same supply curve or on a new one. A graph of numbers and letters Description automatically generated **The Concept of a Market** A market may be defined as any situation in which buyers and sellers negotiate the transaction of goods or services. They may differ in the degree of competition among various buyers and sellers. In a perfectly competitive market buyers and sellers are price takers. Graphical analysis of a market The equilibrium price, every buyer finds a seller and every seller finds a buyer -- the market "clears".  **Changes in Market Prices** The four laws of supply and demand 1. An increase in demand causes an increase in both the equilibrium price and the equilibrium quantity 2. A decrease in demand causes a decrease in both equilibrium price and equilibrium quantity. 3. An increase in supply causes a decrease in the equilibrium price and an increase in the equilibrium quantity. 4. A decrease in supply causes an increase in the equilibrium price and a decrease in the equilibrium quantity. **Relative Prices and Inflation** The absolute price of a product is the amount of money that must be spent to acquire one unit of that product. A relative price is the price of a good in terms of another. Demand and supply curves are drawn in terms of relative prices, not absolute prices. **[Chapter Four]** **[Elasticity]** **Notes:** **Price Elasticity of Demand** Demand is said to be elastic when quantity demanded is very responsive to a change in the products own price. Demand is inelastic if the quantity demanded is very unresponsive to changes in its price. Elasticity is related to the slope of the demand curve, but it is not exactly the same. A diagram of a price and quantity Description automatically generated  The measurement of price elasticity Elasticity = n N= percentage change in quantity demanded / percentage change in price A black and white image of letters Description automatically generated Demand elasticity is negative, but economists usually emphasize the absolute value Elasticity usually measures the change in p and Q relative to some "base" values of p and Q. Demand elasticity between point "0" and point "1" on a demand curve is: N= (Q1-Q0)/Q **** (p1-p0)/(p1+p0)/2  A graph of elasticity and inelasticity Description automatically generated What Determines Elasticity of Demand Demand elasticity tends to be high when there are many close substitutes. The availability of substitutes is determined by: The length of time interval considered whether the good is a necessity or a luxury, and how specifically the product is defined. Three demand curves with constant elasticity: D1 is perfectly inelastic D2 is perfectly elastic at P0 D3 is unit elastic Short-run and long-run changes following an increase in supply: The changes depend on the time that consumers have to respond In the long run, demand is more elastic. When demand is elastic, total expenditure increases when the price falls When demand is inelastic, total expenditure decreases when the price falls. Total expenditure reaches a maximum when demand is unit-elastic. **Price Elasticity of Supply** Price elasticity of supply measures the responsiveness of the quantity supplied to a change in the products own price. It is denoted by ns and is defined as: Ns = Percentage change in quantity supplied / percentage change in price A black text with black letters Description automatically generated with medium confidence Determinants of Supply Elasticity The elasticity of supply depends on how easily firms can increase output in response to an increase in the products price. This depends on: - The technical ease of substitution in production - The time span under consideration - The nature of production costs For a linear supply curve from the origin, p/Q = \^p/\^Q. it follows that supply elasticity equals one at every point.  **An important example of when elasticity matters!** An excise tax raises the price paid by consumers but reduces the price received by producers. A diagram of a price chart Description automatically generated The burden of an excise tax is independent of who actually remits the tax to the government -- it depends only on the relative elasticities of demand and supply. **Income Elasticity of Demand** Ny = percentage change in quantity demanded / percentage change in income If ny \> 0, the good is said to be normal. If Ny \< 0, the good is said to be inferior. **Luxuries Vs. Necessities** The more necessary an item is in the consumption patten of consumers, the lower its income elasticity Income elasticities for any one product also vary with the level of a consumers income The distinction between luxuries and necessities also helps to explain differences in income elasticities between countries. Cross Elasticity of Demand Nxy = percentage change in quantity demanded of good X / percentage change in price of good Y If Nxy \> 0 then they are substitutes If Nxy \< 0 then they are compliments **[Chapter Five]** **[Markets in Action]** **Notes:** **The interaction among markets** Partial-equilibrium analysis examines a single market in isolation and ignores feedback effects from other markets. In general, this is appropriate when the specific market is quite small relative to the entire economy. Most of microeconomics uses partial-equilibrium analysis. When economists study all markets together, they use general-equilibrium analysis. General equilibrium analysis is more complicated because it involves the analysis of all the economy\'s markets simultaneously. Economists must consider how all the markets function together, taking into account the feedback effects between individual markets. **Government Controlled Prices** **Disequilibrium Prices** If the price is set above equilibrium, some sellers will be unable to find buyers. Conversely, if the price is set below equilibrium, some buyers will be unable to find sellers. With administered prices, the quantity is determined by the lesser of quantity demanded or supplied. **Price Floor** When binding, leads to excess supply Minimum but above the equilibrium (ex. minimum wage and alcohol) This makes it illegal to sell the product below the controlled price **Price Ceiling** When binding, leads to excess demand Maximum but below the equilibrium A price ceiling is the maximum price at which a product may be exchanged/purchased. Typically, a government has one (or more) of three main objectives in imposing a price ceiling: restrict production, to keep specific prices down, satisfy normative notions of social equity **Black Market** Any market in which goods are sold at illegal prices **The Prediction Effects of Rent Controls** Binding rent controls are a specific form of a price ceiling. We can use the diagram to predict the effects: - Housing shortage - Alternative allocation schemes in black markets - Illegal schemes like "key money" or "under the table"  Who Gains and Who Loses? Existing tenants in rent-controlled apartments win, landlords lose, potential tenants also suffer. Housing shortages can be reduced if the government (at taxpayers' expense) either subsidizes housing production or produces public housing directly. The government may also provide lower-income households with income assistance, however, no policy is "free" -- every policy involves a resource cost. **An Introductory to Market Efficiency** Economists use the concept of market efficiency to measure the overall effect on society. Demand as "value" and supply as "cost" Price corresponding to a specific quantity demanded is the highest price consumers are willing to pay Price corresponding to a specific quantity supplied is the lowest price producers are willing to accept. **What is Economic Surplus** A diagram of a price Description automatically generated **Economic Surplus and Market Efficiency**  **Market Efficiency and Price Controls** **Price Floor** Change is CS= -(B+D) Change in PS= B-E Change in Total Surplus = -(D+E) This is the "deadweight loss" of the price floor **Price Ceiling** Change in CS= C-D Change in PS= -(C+E) Change in Total Surplus= -(D+E) This is the "deadweight loss" of the price ceiling. **Output Quotas** Change in CS = -(B+D) Change in PS = B-E Change in Total Surplus = -(D+E) This is the "deadweight loss" of the output quota **A Cautionary Word** Government intervention is competitive markets redistribute surplus between buyers and sellers, but often creates overall losses. Government policy is often motivated by a desire to help a specific group (ex. increase number of farmers) Economists must carefully analyze the effects of such policies to determine the actual effects rather than what is desirable for political reasons. **[Chapter Six]** **[Consumer Behavior]** **Notes:** **Diminishing Marginal Utility** Ceteris paribus, the utility that any consumer derives from successive units of a particular product is assumed to diminish as total consumption of the product increases. Therefore, marginal utility falls as the level of consumption rises. **Utility Schedules and Graphs** A graph of utility and quantity Description automatically generated **Maximizing Utility** Consumers must decide how to adjust their expenditures to maximize total utility. A utility-maximizing consumer allocates expenditures so that the utility obtained from the last dollar spent on each product is equal. Consider a consumer whose utility from the last dollar spent on Coke is more than from the last dollar spent on burritos, she could increase her total utility by switching a dollar of expenditure from burritos to coke and continuing until the marginal utility per dollar spent on Coke equals the marginal utility per dollar spent on burritos. For two products X and Y, the utility-maximizing condition is: MUx/Px = Muy/Py OR MUx/MUy = Px/Py In the second equation, we see the consumer adjusting her consumption in response to changes in relative prices. **The Consumer Demand Curve** What happens when there is a change in the productivity-maximizing its price? If the price of Coke (X) rises, then at the previous utility maximizing consumption bundle, we have: MUx/MUy\ATC, the firm makes positive economic profits equal to the blue area. Positive profits means that this firm is earning more than it could in its next best alternative venture. 3. Negative Profits (Losses) -- the typical firm maximizes its profits by producing at q\*. but if p\>ATC, the firm suffers losses equal to the blue surface area. 1.A diagram of a function Description automatically generated 2.  3. A diagram of a function Description automatically generated **Long-Run Decisions** **Entry and Exit** If existing firms have positive economic profits, new firms have an incentive to enter the industry. If existing firms have zero profits, there are no incentives for the firms to enter, and no incentives for new firms to enter, and no incentives for existing firms to exit. If existing firms have economic losses, there is an incentive for existing firms to exit the industry. 1. Positive profits attract new firms 2. Entry leads to an increase in supply and a decline in price 3. Positive profits are eroded. SR & LR Effects of an Increase in Demand A firms starts in long run equilibrium, but then an increase in demand raises P leading to SR profits for the firm. Over time, profits induce entry shifting S to the right reducing P, driving profits to zero and restoring long-run equilibrium. **Long-Run Equilibrium** The LR industry equilibrium occurs when there is no longer any incentive for entry or exit. In long-run equilibrium, all existing firms: - Must be maximizing their profits. - Are earning zero economic profits. - Are not able to increase their profits by changing the size of their production facilities. In LR equilibrium, competitives firms produce at the minimum point on their LRAC curves. At q0, the firm is maximizing short-run profits but not its long-run profits. A diagram of a function Description automatically generated In LR competitive equilibrium, each firm's average cost of production is the lowest attainable, given the limits of known technology and factor prices. Consider a competitive industry that is in long-run equilibrium. Now suppose that the market demand for the industry's product increases The price will rise, and profits will rise, entry will then occur, and price will eventually fall **Changes in Technology** Suppose technological development reduces the cost for newly built plants. New plants will earn economic profits, expand industry output and drive down price. The price will fall until it is equal to the SRATC of the new plants. Old plants may continue, but will earn losses. They will eventually exit. Declining Industries What happens when a competitive industry in LR equilibrium experiences a continual decrease in demand? The efficient response is to continue operating with existing equipment as long as variable costs of production can be covered. As demand shrinks, so will capacity. Antiquated equipment in a declining industry is often the effect rather than the cause of the industry's decline. **[Chapter Ten]** **[Monopoly, Cartels, and Price Discrimination]** **Notes:** Revenue concepts for a monopolist: A monopolist faces the (downward-sloping) market demand curve. If the monopolist charges the same price for all units sold, its total revenue is TR=p x Q. Average revenue is total revenue divided by quantity: AR=TR/Q = (p x Q)/Q=p Marginal revenue is the revenue resulting from the sale of an additional unity of production: MR = ∆TR / ∆Q The monopolist must reduce the price to increase its sales -- therefore the MR curve is below the demand curve.  Short-run profit maximization: The profit-maximizing level of output is where MC = MR A profit-maximizing monopolist has p\>MC The position of ATC curve will determine whether a monopolist earns economic profits. If above ATC its positive, if below ATC its negative. Unlike a competitive firm, the monopolist does not have a supply curve because it chooses its price. Can we compare the monopoly outcome to the competitive outcome?\ in a perfecr competitive industry price equals MC. But a monopolist produces at a lower level of output, with price exceeding MC. Ehtry barriers and long0run equilibrium: Despite incentives to enter, effective entry abrriers allow monopoly profits to persist in the long run. Entry barriers are of two types: Naural -- such as economies of scale Created -- by advertisting campaigns, government regulation, or patents. The very long run and creative destruction: In the very long run, technological changes and innovations can circumvent effective entry barriers. Joseph Schumpeter defended monopoly on the basis that the pursuit of monopoly profits provides incentives to innovate. Schumpter called the replacements of one monopolist by another through innovation the process of creative destruction. **Cartels as Monopolies** Several firms in an industry may form a cartel to maximize joint profits. The effects of cartelization: Cartelization will reduce output and raise price from the perfectly competitive levels. Problems that cartels face: Cartels tend to be unstable because members have an incentive to cheat A diagram of a business graph Description automatically generated with medium confidence Any one firm within the cartel has an incentive to cheat. But if all firms cheat, the price will fall back toward the competitive level, and joint profits will not be maximized. Enforcing output restrictions and preventing entry are difficult. This cartels rarely last for long. **Price Discrimination** A producer practices price discrimination by charging different prices for the same product that have the same cost. Central to this is that different consumers value the product by different amounts. Any firm facing a downward-sloping demand curve can increase profits if it is able to price discriminate. When is price discrimination possible?: - When firms have market power - When consumers differ in their valuations of the product - When firms can prevent arbitrage Different forms of price discrimination: Price discrimination among units of output A firm captures consumer surplus by charging different prices for different units sold. "perfect" price discrimination transfers all consumer surplus to the seller. The consequences of price discrimination: Price discrimination increases firm's profits (otherwise they wouldn't do it!) For price discrimination by the unit will often increase their output and overall efficiency will increase. The effect on consumers is unclear -- they may lose consumer surplus, but they could also gain surplus (if output increases as a result) **[Chapter Eleven]** **[Imperfect Competition and Strategic Behavior]** **Notes:** **The structure of the Canadian economy:** Industries with many small firms: The perfectly competitive model does not adequately explain many industries that have a large number of relativelt small firms Industries with a few large firms: Most modern industries that are dominated by large firms contain several firms. These are not competitive markets. Industrial concentration: The concentration ratio measures the economic power in an industry and shows the market shares of the largest 4 or 8 producers Defining a market with responsible accuracy is difficult. Sometimes the market is much smaller than the whole country. other times, it is much larger than the whole country. other times, it is much larger than the entire country. Due to globalization, a lone firm in one Canadian industry may be competing with foreign firms operating in Canada. **What is imperfect competition?** Firms choose their products: A differentiated product: a group of products that are similar enough to be called the same product but different enough that they can have different prices Most firms in imperfectly competitive markets sell differeentitated products: Ex: laundry soaps, beer, cars, shoes, etc. Firms choose their prices: Typically, firms are price setters Often, these prices vary only slowly over time. Firms often let output vary in response to demand shocks to avoid costs of changing prices (unless the shock is long-lasting) Non-price competition: Imperfectly competitive firms typically engage in behavior that is absent in either monopoly or perfect competition: - Firms often spend large sums of money on advertising - Firms often engage in non-price competition - Firms may create entry barriers to prevent erosion of current pure profits Two market structures: The preceding discussion applies in general to imperfectly competitive market structures. Industries with a large number of small firms -- the theory of **monopolistic competition.** Industries with a small number of large firms -- the theory of **oligopoly** (which involves game theory). A key difference: strategic behavior displayed by firms. **Monopolistic Competition** The assumptions of monopolistic competition 1. Each firm produces one variety of the differentiated product. Thus, it faces a negatively sloped and highly elastic demand curve 2. All firms have access to the sa,e technology and thus have the same cost curves 3. The industry contains so many firms that each one ignores competitors when making price and output decisions. 4. Firms are free to enter and exit the industry Predictions of the theory: In the short run, a monopolistically competitive firm faces a downward sloping demand curve and maximizes profits by equating MR and MC  This firm is earning positive profits. An incentive for new firms to enter the industry The existing market demand must be shared among a larger number of firms. As new firms enter, profitd per film are reduces and eventually eliminated. In the LR equilibrium, each firm has excess capacity. This result is often called the excess-capacity theorem of monopolistic competition. In contrast to perfect competition, the LR equilibrium in monopolistic competition does not minimize ATC -- there is excess capacity. This excess capacity may not be wasteful if consumers value product variety. Society faces a trade-off between product variety and lower cost per unity. Empirical relevance of monopolistic competition: The theory of monopolistic competition is useful for analyzing industries with low concentration ratios and differentiated products: - Restaurants - Clothes - Hair stylists - Mechanics **Oligopoly and Game Theory** Oligopoly: and industry containing two or more firms, at least one of which produces a significant portion of the industry's total output. An oligopolistic film faces only a few competitors. Strategic behavior is central to their actions. The basic dilemma of oligopoly: Oligopolistic firms will make more joint profits if they cooperate, or collude. But each individual firm may make more profits if it "cheats". How could firms reach a cooperative outcome to maximize their joint profits? Game theory is used to study decision making in such situations -- each player takes account of the others' expected reactions when making a move. The players are firms, their strategies are the price or output decisions, and their payoffs are profits. Consider a simplified duopoly in which two firms choose to cooperate or complete:\ cooperate: produce ½ of the monopoly output -- yields high output and low price. A diagram of a game Description automatically generated **Oligopoly in practice** Types of cooperative behavior: When firms agree to cooperate in order to restrict output and raise prices, their behavior is called collusion. Explicit collusion occurs when firms formally agree -- DeBeers and OPEC Cooperation without explicit agreement is called tacit collusion. Types of competitive behavior Firms may complete for market share Firms may offer secret discounts to increase sales firms may use innovation and attempt to gain advantage over rivals in the very long run. The importance of entry barriers: In the absence of natural entry barriers, oligopolistic firms must create entry barriers if they eare to earn profits in the long run. Brand proliferation as an entry barrier: A large number of differentiated products leaves a small market share available to a new firm. Advertising as an entry barrier: Heavy advertising can force an "outside" firm to spend heavily on its own advertising. If the outside firm had a low MES, the new advertising costs may result in a much higher MES deters enrey. Predatory pricing: A firm will not enter a market if it expects continued losses after entry. Existing firms can create such an expectation by keeping prices below their own costs until entrant goes bankrupt. The existing firm loses profits, but it also discourages potential future rivals. Oligopoly and the economy: Temporary changes in demand lead to more price volatility in competitive markets than in oligopoly markets. Permanents changes in demand, however, leave to similar adjustments in both market structures. Oligopoly is an important market structure in modern economies because there are many industries in which the MES is simply too large to support many competing firms. Oligopolists often grow through mergers or by dividing rivals into bankruptcy. This process increases the size and market share of survivors, and possibly reduces the extent of competition in the market. The calllenge for public policy is to keep oligopolies competing and using their competitive energies to improve products and resuce costs.