CFA Level 1 - Economics Session 4 - Reading 15

CFA Level 1 - Economics Session 4 - Reading 16 (Notes, Practice Questions, Sample Questions) 1. Which of the following is a characteristic of perfect competition? A)There are no barriers to entry into the market. B)The products of different firms are sold at different prices.C)There are a few sellers <Explanation>: The only true statement listed in the question isthat, under perfect competition there are no barriers to entry intothe market. Each of the other possible answers is not acharacteristic of perfect competition. While the competitors canearn positive economic profits in the short-run, they cannot earnlong term economic profits due to ease of entry and exit 2. Which of the following is least likely a condition of a perfectly competitive market? A)Indistinguishable products. B)Sellers make economic profits. C)Firms face elastic demand curves. <Explanation>: The only item listed that is NOT a condition of aperfectly competitive market is that sellers make economic profits.

In fact, sellers do not make economic profit after taking intoaccount their opportunity costs 3. The demand curve for a firm in a perfectly competitive market is: A)horizontal. B)upward sloping.C)downward sloping. <Explanation>: In a market of perfect competition an individualfirm’s demand schedule is perfectly elastic (horizontal) 4. Which of the following is least likely a characteristic of perfect competition? A)The size of each firm is small relative to the size of the overall market.B)The products produced within a given market are homogenous. C)The demand curve for an individual firm is a vertical line <Explanation>: Under perfect competition individual firms have nocontrol over price resulting in a demand schedule that is perfectlyelastic or horizontal 5. A perfect competition has all of the following characteristics EXCEPT: A)a differentiated product. B)barriers to entry don't exist.C)a large number of independent firms <Explanation>: In a perfectly competitive market all the firmsproduce a homogeneous product

6. A firm operating as a price taker will: A)produce quantity where P = MR = MC. B)be a revenue maximizer.C)face an inelastic demand curve <Explanation>: A firm operating as a price taker will producequantity where MC = MR. It will maximize profit and not revenue. Inthe long run, it will make zero economic profits after taking intoaccount fair return on capital 7. Which of the following is least likely a barrier to entry? A)Resource controls. B)Price controls. C)Economies of scale. <Explanation>: Often barriers to entry are government licensingand legal barriers 8. Which one of the following is most likely to contribute to the presence of monopoly in an industry? A)Legal barriers to entry into the industry. B)Inefficiency attributable to bureaucratic decision-making proceduresin the industry.C)Diseconomies of scale

<Explanation>: An example of an industry with legal barriers isutility firms, which are granted exclusive rights to supply electricityin certain areas 9. Consider the following statements: Statement 1: “The sum of consumer and producer surpluses ismaximized under both monopoly and perfect competition.”Statement 2: “All else being equal, a monopolist that practices pricediscrimination will be more allocatively efficient than a single-pricemonopolist.”With respect to these statements: A)both of these statements are accurate.B)neither of these statements is accurate. C)only one of these statements is accurate. <Explanation>: Statement 1 is incorrect because the sum ofconsumer and producer surpluses is maximized under perfectcompetition when marginal benefit and marginal cost are equal, orequivalently, where the marginal cost curve intersects the demandcurve. Monopolies, however, produce a quantity that is less than thequantity where marginal cost equals marginal benefit, so the sumof producer and consumer surpluses is not maximized 10. Which of the following is least likely a barrier to entry? A)Few sellers. B)Economies of scale.C)Government licensing and legal barriers

<Explanation>: Few sellers are a characteristic, not a barrier, of aprice-searcher market where there are high barriers to entry. Otherbarriers are patents or exclusive rights of production 11. Which of the following situations is least likely to lead to high barriers to entry and monopoly supply? A)Natural resources are spread among many firms. B)Economies of scale are present.C)Governmental licensing and regulations are present <Explanation>: All cases except wide distribution of a naturalresource facilitate a monopoly. If natural resource ownership isconcentrated in one firm a monopoly would result 12. In a natural monopoly: A)the average total cost of production continually declines withincreased output. B)one firm controls all natural resources.C)the price charged by a monopolist is determined by the intersectionof the demand curve with the marginal cost curve <Explanation>: A monopoly situation in which the average totalcost of production continually declines with increased output iscalled a natural monopoly 13. Natural monopolies exist because they can produce at lower costs with greater output, which means there are economies of scale. Whichof the following industries is typically a natural monopoly?

A)Utilities. B)Technology.C)Oil. <Explanation>: With a natural monopoly average costs ofproduction will be lowest when a single large firm produces theentire output demanded such as a utility 14. Which of the following is least likely a barrier to entry? A)Allocative Efficiency. B)Patents.C)Economies of Scale <Explanation>: The other barriers to entry are government licensingand legal barriers such as utilities are given the exclusive right tosupply electricity in certain areas 15. An oligopolistic firm: A)will consider the potential response of its rivals when makingbusiness decisions. B)is likely to be formed when the minimum-cost output is only a smallportion of the market output.C)will seldom use product quality as a competitive weapon <Explanation>: Oligopolists are highly dependent upon the actionsof their rivals when making business decisions. Price determinationin the auto industry is a good example. Automakers tend to play"follow the leader" and announce price increases in closesynchronization. They are not working explicitly together, but the

actions of one producer have a large impact on the others whenproducts are differentiated, quality may be a competitive strategy 16. Firms in perfectly competitive markets and firms operating in a market characterized by monopolistic competition have several thingsin common. Which of the following is least likely one of them? Both: A)operate in markets that have low or no barriers to entry. B)face perfectly elastic demand curves. C)maximize economic profit <Explanation>: The only item listed in the question thatmonopolistic competition and pure competition do not have incommon is a perfectly elastic demand curve. Under purecompetition, producers face a perfectly elastic demand curve,whereas price searchers face downward sloping demand curves 17. Characteristics of an oligopoly least likely include: A)interdependence among competitors.B)significant barriers to entry. C)identical products <Explanation>: In an oligopoly, a small number of producers sellproducts that can be similar or differentiated. An oligopoly typicallyfeatures significant barriers to entry including economies of scale.Pricing and output decisions by each firm directly influence thedecisions of competing firms

18. A market that is characterized by monopolistic competition is least likely to feature: A)low barriers to entry. B)a small number of independent sellers. C)sellers that produce a differentiated product <Explanation>: In monopolistic competition, there is a large, notsmall, number of independent sellers 19. Which of the following is most likely to be considered a characteristic of monopolistic competition? A)Inelastic demand curves.B)High barriers to entry and exit. C)Differentiated products. <Explanation>: Differentiated products are a key characteristic ofmonopolistic competition. Although producers have downwardsloping demand curves, they are typically elastic 20. Which of the following is least likely to be considered a feature that is common to both monopolistic competition and perfect competition? A)Extensive advertising to differentiate products. B)Low or no barriers to entry.C)Zero economic profits in the long run. <Explanation>: The only item listed in the question thatmonopolistic competition and perfect competition do not have incommon is the use of advertising to differentiate their products.Extensive advertising is a key feature of monopolistic competition

21. An oligopoly is characterized by all of the following EXCEPT: A)a large number of sellers. B)large economies of scale.C)significant barriers to entry <Explanation>: Oligopolies consist of a small number of sellers.Their products may be either similar or differentiated 22. Which one of the following is least likely a characteristic of monopolistic competition? A)Low barriers to entry and exit. B)A single seller. C)Differentiated products <Explanation>: There are many sellers or producers who selldifferentiated products that permit firms to attract customerswithout reducing price; and there are low barriers to entry 23. Characteristics of monopolistic competition include all of the following EXCEPT: A)large numbers of independent sellers. B)high barriers to entry. C)differentiated products <Explanation>: Monopolistic competition has low barriers to entry

24. An oligopolistic industry least likely has: A)many sellers. B)high barriers to entry.C)large economies of scale <Explanation>: An oligopolistic industry has a few sellers with largeeconomies of scale, a great deal of interdependence among firms,and high barriers to entry 25. Which of the following is least likely a characteristic of an oligopoly? A)Relatively small economies of scale. B)Products can either be similar or differentiated.C)There are few sellers <Explanation>: Oligopolies have large economies of scale andinterdependence among competitors 26. Which of the following is most likely to be considered a characteristic of an oligopolistic industry? A)Few barriers to entry. B)A great deal of interdependence among firms. C)Many sellers <Explanation>: An oligopolistic industry has a great deal ofinterdependence among firms. One firm’s pricing decisions oradvertising activities will affect the other firms' demand curves

27. The demand curves faced by monopolistic competitors is: A)not sensitive to price due to absence of close substitutes. B)elastic due to the availability of many close substitutes. C)inelastic due to the availability of many complementary goods <Explanation>: The demand for products from monopolisticcompetitors is elastic due to the availability of many closesubstitutes. If a firm increases its product price, it will losecustomers to firms selling substitute products 28. Monopolistic competition differs from pure monopoly in that: A)monopolists maximize profit; monopolistic competitors do not. B)barriers to entry are high under monopoly, but low undermonopolistic competition. C)monopolistic competitors are price takers, monopolists are not <Explanation>: Monopolistic competition is characterized by thelow barriers to enter its competitive markets. In contrast, amonopoly exists only where there are high barriers to market entry 29. One way in which monopolistic competition can be distinguished from perfect competition is that in monopolistic competition: A)price is greater than marginal cost. B)each firm faces a perfectly elastic demand curve.C)marginal revenue is greater than marginal cost at the quantityproduced <Explanation>: In monopolistic competition, price is greater thanmarginal cost (i.e., firms can realize a markup). In perfect

competition, P = MC. Firms in monopolistic competition are pricesearchers, i.e., each firm faces a downward sloping demand curve.Regardless of the market structure, all firms produce the quantityat which marginal revenue equals marginal cost 30. Which of the following is least accurate regarding product development and marketing for firms under monopolistic competition? A)Firms that bring new and innovative products to the market facerelatively more elastic demand curves than their competitors. B)Relative to other types of competition, product innovation is critical tothe pursuit of economic profits.C)Brand names can provide consumers with information regarding thequality of firm’s products <Explanation>: Firms under monopolistic competition face lesselastic demand curves when they introduce new and innovativeproducts. This enables them to increase price and earn economicprofits. However, close substitutes and imitations will eventuallyerode the economic profit from a new product. So, firms mustconstantly seek innovative product features that make theirproducts relatively more desirable than their competitors 31. Under which type of market structure are the production and pricing alternatives of a firm most affected by the decisions of its competitors? A)Oligopoly. B)Monopolistic competition.C)Perfect competition. <Explanation>: An oligopoly market structure is characterized by asmall number of firms producing similar or differentiated products,

with a high degree of interdependence among competitors. Eachfirm’s optimal price and output are strongly affected by the pricingand output decisions of its competitors 32. Monopolistic competition differs from pure monopoly in that: A)monopolistic competitors are price takers and monopolists are not. B)monopolistic competitors have low barriers to entry andmonopolists do not. C)monopolists maximize profits and monopolistic competitors do not. <Explanation>: Another name for monopolistic competition is acompetitive price searcher market. Monopolistic competition refersto a large number of independent sellers, each produces adifferentiated product, each market has a low barrier to entry, andeach producer faces a downward sloping demand curve 33. Which of the following regarding monopolistic competition is most accurate? A)Zero barriers to entry and exit exist. B)Each firm produces a differentiated product. C)There are very few independent sellers <Explanation>: Other characteristics of monopolistic competition(also known as competitive price searcher markets) are: a largenumber of independent sellers, low barriers to entry, and an elasticdownward sloping demand curve 34. Which of the following is most accurate for a price-taker firm in long-run equilibrium when there are no barriers to entry?

A)P = MC = ATC = MR. B)P = AVC = MR.C)TC = TR = MC. <Explanation>: For a price-taker firm, long-run equilibrium is whereP = MC = ATC. For price taking firms, P = MC. Competition eliminateseconomic profits in the long run so that P = ATC 35. Assume that a perfectly competitive firm produces 10 units of a good and sells them each for a price (P) equal to $15. If the marginal cost (MC)of the 10th unit is $15 and the average total cost (ATC) is $13, economicprofit for the firm is closest to: A)$0.B)$120. C)$20. <Explanation>: When MR = MC = P, economic profit equals TR – TC.In this case, TR = $150 = 10 × $15 and TC = $130 = 10 × ATC = 10 × $13.So, economic profit is $20 = $150 − $130 36. A competitive firm will tend to expand its output as long as marginal: A)revenue is greater than marginal cost. B)revenue is greater than the average cost.C)cost is less than average cost <Explanation>: All firms will continue to expand production untilmarginal revenue = marginal cost

37. The short-run supply curve for a firm in a perfectly competitive market is equal to the firm's: A)MC curve. B)AVC curve.C)ATC curve. <Explanation>: The short-run supply curve for a firm in a perfectlycompetitive market is equal to the firm's MC curve. A price takerwill maximize profits when it produces the output level where P =MC. As price rises, its point of intersection with the MC curveindicates optimal production 38. Under perfect competition, the short-run market supply curve is most accurately described by which of the following statements? Themarket short-run supply curve is the: A)sum of the quantities at each price along the marginal cost curvesfor all firms in a given industry. B)sum of the quantities at each price along the average total cost curvefor all firms in a given industry.C)average of the quantities at each price along the marginal cost curvefor all firms in a given industry. <Explanation>: The short-run market supply curve is the horizontalsum of the marginal cost curves for all firms in a given industry. It isthe sum of all quantities from all firms at each price along eachfirm’s marginal cost curve 39. The short-run supply curve to a firm operating under perfect competition is most accurately described as the segment of the:

A)marginal cost (MC) curve below the average total cost (ATC) curve. B)marginal cost (MC) curve above the average variable cost (AVC)curve. C)average total cost (ATC) curve above the average variable cost (AVC)curve <Explanation>: The short-run supply curve for a firm under perfectcompetition is the segment of its MC curve above the AVC curve 40. In a perfectly competitive industry, the short-run supply curve for the market is the: A)marginal cost curve above the average total cost curve.B)marginal cost curve above the average variable cost curve. C)sum of the individual supply curves for all firms in the industry <Explanation>: The short-run supply curve for a firm is its marginalcost curve above the average variable cost curve. The short-runsupply curve of the market is the sum of the supply curves for allfirms in the industry 41. The short-run supply curve for a purely competitive market: A)is a horizontal line.B)slopes downward to the right. C)slopes upward to the right. <Explanation>: The short-run supply curve for a purely competitivemarket slopes upward to the right. This reflects the fact that firmsin the industry will produce more when the price rises

42. Firms in a perfectly competitive industry will increase their output until which of the following conditions is met? A)Marginal cost equals price. B)Marginal revenue equals average total cost.C)Total revenue equals price <Explanation>: When a firm operates under conditions of perfectcompetition, marginal revenue always equals price. Under perfectcompetition, price is constant (a horizontal line) so marginalrevenue is constant. Therefore a firm will increase output untilmarginal cost equals price 43. Which of the following is the most likely result of a technological improvement in a perfectly competitive industry? A)The costs for individual firms increase. B)The industry supply curve shifts to the right. C)Individual firms’ supply curves shift to the left <Explanation>: When individual firms implement technologicalchange, their costs decline and their supply (cost) curve shifts to theright. At the lower costs, firms are willing to supply a given quantityat a reduced price. The lower cost structure for the individual firmsshifts the industry supply curve to the right 44. Concentration measures are most likely to be used to: A)measure elasticity of demand facing an industry.B)analyze barriers to entry into an industry. C)identify the market structure of an industry

<Explanation>: Concentration measures are used to identify themarket structure of an industry (perfect competition, monopolisticcompetition, oligopoly, or monopoly). Concentration measures donot directly indicate an industry’s barriers to entry or elasticity ofdemand 45. The most effective way to assess the impact of a potential merger on the market structure of an industry is to: A)calculate the n-firm concentration ratio.B)analyze barriers to entry. C)calculate the Hirfindahl-Hirschman Index <Explanation>: The Hirfindahl-Hirschman Index is more sensitive tomergers than the n-firm concentration ratio. Although barriers toentry for an industry are important in assessing market structure,they are not necessarily related to the impact of a merger 46. A firm has the following characteristics: relatively small in size.marginal revenue is equal to the selling price.economic profits will not be earned for any significant period of time.The firm is best described as existing in a(n): A)price searcher market.B)monopolistic market structure. C)purely competitive market <Explanation>: The firm being described is a price taker firm in apurely competitive market. These firms must sell their product at

the going market price, there are no barriers to entry, and there area large number of firms that produce a homogeneous product 47. An economic market characterized by a large number of independent firms all producing identical products is best described as: A)monopolistic competition.B)monopoly. C)perfect competition <Explanation>: In a perfectly competitive economic market, thereare many independent firms, each seller is small relative to thetotal market, and there are no barriers to entry or exit 48. Which of the following most accurately describes the competitive structure that is characterized by a firm that operates with the lowestaverage total cost and has the capacity to produce all of an industry’soutput? A)Natural monopoly. B)Competitive monopoly.C)Oligopoly <Explanation>: A natural monopoly is characterized by a single firmwithin the industry that has sufficient capacity to meet the entiredemand of an industry because at that scale the lowest averagetotal cost is achieved

49. Which of the following most accurately describes a market structure that has one seller of a specific, well-defined product that has no goodsubstitutes? A)Monopoly. B)Perfect competition.C)Oligopoly <Explanation>: A monopoly is characterized by one seller, a specificand well-defined product for which there is no good substitutes,and high barriers to entry 50. Which one of the following structures is characterized by free entry and exit, a differentiated product, and price searcher behavior? A)Monopolistic competition. B)Oligopoly.C)Pure competition. <Explanation>: Monopolistic competition is another name forcompetitive price-searcher markets. There are a large number ofindependent sellers, each produces a differentiated product, eachmarket has a low barrier to entry, and each producer faces adownward sloping demand curve 51. The type of economic market that features a large number of competitors offering differentiated products is best characterized as: A)perfect competition. B)monopolistic competition. C)oligopoly.

<Explanation>: Monopolistic competition is used to describemarkets where there are a large number of competitors producingdifferentiated products.In perfect competition all firms produce identical products. In anoligopoly there is a small number of firms