Answers to Pause-for-Thought Questions

Chapter 4

p119  Give one more example in each of the four market categories in Table 4.1.
 Perfect competition: grains; foreign exchange.
 Monopolistic competition: taxis; van hire.
 Oligopoly: (homogeneous) white sugar; (differentiated) beer; banks.
 Monopoly: National Grid Company (electricity transmission); local bus company on specific
routes.

p122  Will the industry supply be zero below a price of P5 in Figure 4.2?
Once the price dips below a firm’s AVC curve, it will stop production. But only if all firms have the
same AVC curve will the entire industry stop production. If some firms have a lower AVC curve than
the firm illustrated in Figure 4.2 (b), then industry supply will not be zero at P5.

p130  If the shares in a monopoly (such as a water company) were very widely distributed among
the population, would the shareholders necessarily want the firm to use its monopoly power to
make larger profits?
If the water company raised its charges and thereby made a larger profit, shareholders would gain
from larger dividends, but as consumers of water would lose from having to pay the higher charges.
Except in the case of shareholders with only a few water shares, however, the gain is likely to
outweigh the loss. Nevertheless, with shares very widely distributed, the average net gain would be
only very small, and the wider the distribution, the more shareholders there would be who would suffer
a net loss from the higher charges.

p136  Think of two examples of highly contestable monopolies (or oligopolies). How well is the
consumer’s interest served?
 Bus company operating a particular route: the market may be large enough for only one
company, but the market is highly contestable, especially if other bus companies are already
established on other routes in the area. A reduction in fares may be the result of the threat of
competition.
 The deregulation of the UK Directory Enquires service in 2003 made the previous monopoly of
BT in this area contestable. This led to several new directory enquiry providers. The consumer
benefits in so far as the competition drives down call costs, although to make an informed choice
such call costs need to be transparent. The degree of contestability depends on the costs of
setting up such a service and the exit costs if the company fails to make sufficient profit. Both
these costs could be quite low for a company that already has a call-centre infrastructure and
could use such as centre for other purposes, or could hire it out to other companies.
Alternatively, the company could hire such services from a call-centre operator. Again, this could
keep entry and exit costs low.

p138  Which of these two items is a petrol station more likely to sell at a discount: (a) oil; (b)
sweets? Why?
Oil (especially in large cans). The reason is that demand is more price elastic. People will be tempted
to buy now, rather than waiting, if they see a reasonable discount (or a free gift). In the case of sweets,
these are often an impulse buy and the price is very low anyway relative to the amount already spent
 Answers to pause-for-thought questions in Essentials of Economics (3rd edition), John Sloman

on petrol. A penny or two price reduction will probably make very little difference to sales.

p139  Why will additional advertising lead to smaller and smaller increases in sales?
Because fewer and fewer additional people will see each extra advert (i.e. many of the people will have
seen the adverts already and thus there will be little additional effect on their demand).

p143  If this ‘fair’ solution were adopted, what effect would it have on the industry MC curve in
Figure 4.9?
It would be likely to shift it upwards, given that additional output would not merely come from the
most efficient producers, but rather from all producers in proportion to their market share. Also, over
time, by protecting companies’ market share in this way, there would be less competition to adopt new
more efficient techniques.

p147  If a firm has a typically shaped average cost curve and sets prices 10 per cent above average
cost, what will its supply curve look like?
It will be vertically above the AC curve by 10 per cent: i.e. it will get further apart from the AC curve,
the higher the AC curve is.

p153  Assume that there are two major oil companies operating filling stations in an area. The first
promises to match the other’s prices. The other promises to sell at 1p per litre cheaper than the
first. Describe the likely sequence of events in this ‘game’ and the likely eventual outcome. Could
the promise of the second company be seen as credible?
Prices would be driven down, and hence profits reduced, until one of the companies could no longer
stick to its promise – either the first accepting that its price will be 1p above the second, or the
second accepting the same price as the first. Alternatively both companies simultaneously may
decide to abandon their policy and collude to raise prices. This may involve a secret meeting
between them, or simply ‘letting it be known’ that they would be willing to raise prices, providing
that the other company did the same.
The promise of the second company could be seen as credible if it had lower costs or greater
financial backing than the first company. In such circumstances, the first company may be forced to
give up its policy first. If they have similar costs and financial strength, then the threat is not
credible.

p154  Give an example of decisions that two firms could make in sequence, each one affecting the
other’s next decision.
Two supermarket chains are thinking of expanding into the small ‘metro’ stores segment of the market
in a particular city that does not have any such stores. There is room in the market for only one in each
of three suburbs, with the third having little prospect of making a profit in the short run. The first
mover may succeed in gaining planning permission for the most profitable of the three. This will give
the second an advantage in gaining planning permission in the second most profitable, given than the
local authorities will want to maintain as much competition as possible. Both will have to consider,
however, what they do about the third, which is only marginally profitable, but could help to develop
the image of their other metro store in the city. They will also have to consider whether if the other
company opened the third store this would deny them an opportunity of ever having a second metro
store in the city: a store which could be profitable at some point in the future.
p156  Assume that two brewers announce that they are about to merge. What information would
you need to help you decide whether the merger would be in the consumer’s interests?
You would need information on the likely impact on costs, prices and choice. If there are substantial

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 Answers to pause-for-thought questions in Essentials of Economics (3rd edition), John Sloman

economies of scale to be gained, then that is an argument in favour. If, however, it meant that there
would be less choice for consumers in particular parts of the country, then the reduction in
competition may lead to an increase in profit margins, which might more than offset the economies
of scale and result in higher prices. A crucial question here is whether the two brewers were
competing previously, or whether they were operating on different parts of the market (in terms of
product or region). The more they were competing previously, the greater the potential gain in
market power and the greater the likelihood of an increase in prices.