AP Microeconomics › Unit 4
Unit 4 studies firms with some power over price: monopolies, monopolistically competitive firms, and oligopolies. You will find a monopolist's output where marginal revenue equals marginal cost, then read the price from the demand curve. Questions ask you to compare efficiency, show deadweight loss, analyze price discrimination, and find dominant strategies and Nash equilibria in payoff matrices. A classic error is reading price off the marginal revenue curve. In game theory, students often call the best joint outcome the Nash equilibrium without checking that neither player wants to switch.
These are taken from the Regular set, with the answer and explanation shown.
1. Restaurants in a monopolistically competitive market are in long-run equilibrium when the wages of cooks rise. In the long run,
Answer: C. Higher wages raise each restaurant's marginal cost and average total cost (ATC), so in the short run price is below ATC and restaurants lose money. The losses lead some to exit. Their diners move to the remaining restaurants, whose demand shifts right until price again equals ATC and economic profit is zero.
Common trap: Choosing 'every restaurant keeps earning an economic loss'. Losses do not last in the long run, because exit shifts the remaining firms' demand right until they break even.
2. An imperfectly competitive firm raises its price by 10 percent and its total revenue falls. Which of the following must be true at the original price?
Answer: E. Revenue fell when price rose, so demand was elastic. With elastic demand, MR is positive.
Common trap: Concluding demand was inelastic.
3. In a two-firm game, Firm A's best choice is to cut its price whatever Firm B does. Firm B's best choice is to cut its price if A cuts and to keep its price if A keeps its price. What is the Nash equilibrium?
Answer: D. Cutting is dominant for A, so A cuts. B's best response to a cut is to cut. At (Cut, Cut), neither firm can gain by switching alone, so it is the Nash equilibrium, even though B has no dominant strategy.
Common trap: Choosing 'There is none, because B has no dominant strategy'. A Nash equilibrium only needs each player to make its best response to the other. Dominant strategies are not required.