Download Monopoly Chapter

Chapter
Monopoly
CHAPTER IN PERSPECTIVE
11
In Chapter 11 we study how a monopoly chooses its price and quantity and discuss whether a monopoly is efficient or fair.
■ Explain how monopoly arises and distinguish between single-price monopoly
and price-discriminating monopoly.
A monopoly is a market with a single supplier of a good or service that has no close substitutes and in
which natural or legal barriers to entry prevent competition. A monopolist faces a tradeoff between price
and the quantity sold. A single-price monopoly is a monopoly that must sell each unit of its output for
the same price to all its customers. A price-discriminating monopoly is a monopoly that is able to sell
different units of a good or service for different prices.
■ Explain how a single-price monopoly determines its output and price.
The demand curve for a monopoly is the downward sloping market demand curve. For a single-price
monopoly, marginal revenue is less than price, so the marginal revenue curve lies below the demand
curve. A monopoly maximizes profit by producing the quantity at which marginal revenue equals
marginal cost and finding the highest price at which it can sell this output on the demand curve.
■ Compare the performance of a single-price monopoly with that of perfect
competition.
Compared to perfect competition, a single-price monopoly produces a smaller output and charges a
higher price. A monopoly is inefficient because it creates a deadweight loss. A monopoly redistributes
consumer surplus so that the producer gains and the consumers lose. Rent seeking is the act of obtaining special treatment by the government to create an economic profit or divert consumer surplus or
producer surplus away from others. Rent seeking restricts competition and can create a monopoly.
■ Explain how price discrimination increases profit.
To be able to price discriminate, a firm must be able to identify and separate different types of buyers
and sell a product that cannot be resold. Price discrimination converts consumer surplus into economic
profit. Perfect price discrimination charges every consumer the maximum price the consumer is willing to pay. Perfect price discrimination leaves no consumer surplus but is efficient.
■ Explain how monopoly regulation influences output, price, economic profit,
and efficiency.
Monopolies exist and have a potential advantage over a competitive alternative because of economies
of scale and incentives to innovate. Natural monopolies are regulated. Marginal cost pricing is a rule
that sets price equal to marginal cost. The monopoly produces the efficient quantity but incurs an economic loss. Average cost pricing is a rule that sets price equal to average cost. The monopoly produces
an inefficient quantity but earns a normal profit.
166
Part 3 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
EXPANDED CHAPTER CHECKLIST
•
When you have completed this chapter,
you will be able to:
•
1 Explain how monopoly arises and
distinguish between single-price
monopoly and price-discriminating
monopoly.
•
•
•
•
how
a
single-price
monopoly determines its output
and price.
•
•
•
Calculate marginal revenue and explain
why marginal revenue is less than price for
a single-price monopoly.
Explain the relationship between marginal
revenue and elasticity.
Use a total revenue curve and a total cost
curve to find the profit-maximizing level of
output for a single-price monopoly.
Use a marginal revenue curve, a marginal
cost curve, and a demand curve to find the
profit-maximizing level of output and price
for a single-price monopoly.
3 Compare the performance of a
single-price monopoly with that of
perfect competition.
•
•
•
Compare the output and price of perfect
competition and single-price monopoly.
Discuss the efficiency and fairness of monopoly.
Define rent seeking and discuss its effects.
4 Explain how price discrimination
increases profit.
•
5 Explain how monopoly regulation
influences output, price, economic
profit, and efficiency.
Define monopoly and state the two conditions under which monopoly arises.
Define natural barrier and natural monopoly.
Give examples of legal barriers that create
legal monopoly.
Describe how a price-discriminating monopoly differs from single-price monopoly.
2 Explain
•
•
State the two conditions necessary for price
discrimination.
Explain how a firm profits from price discrimination.
Define perfect price discrimination and explain how a perfectly price-discriminating
monopoly chooses its level of output.
Discuss the relationship between price discrimination and efficiency.
•
•
List two potential advantages of monopoly
over perfect competition.
Define and illustrate a marginal cost pricing
rule and average cost pricing rule.
KEY TERMS
•
•
•
•
•
•
•
•
•
Barrier to entry (page 272)
Natural monopoly (page 272)
Legal monopoly (page 273)
Single-price monopoly (page 274)
Price-discriminating monopoly (page 274)
Rent seeking (page 285)
Perfect price discrimination (page 288)
Marginal cost pricing rule (page 293)
Average cost pricing rule (page 293)
CHECKPOINT 11.1
■ Explain how monopoly arises and
distinguish between single-price
monopoly and price-discriminating
monopoly.
Practice Problems 11.1
1. Monopoly arises in which of the following
situations?
a. Coca-Cola cuts its price below that of
Pepsi-Cola in an attempt to increase its
market share.
b. A single firm, protected by a barrier to entry, produces a personal service that has
no close substitutes.
c. A barrier to entry exists, but some close
substitutes for the good exist.
Chapter 11 . Monopoly
d. A firm offers discounts to students and
seniors.
e. A firm can sell any quantity it chooses at
the going price.
f. The government issues Tiger Woods, Inc.
an exclusive license to produce golf balls.
g. A firm experiences economies of scale
even when it produces the quantity that
meets the entire market demand.
2. Which of the cases a to f in Problem 1 are natural monopolies and which are legal monopolies? Which can price discriminate, which cannot, and why?
Solution to Practice Problems 11.1
These Practice Problems focus on the definition
of monopoly. Remember that a monopoly arises
when there are no close substitutes for the good
or service and there are barriers to entry.
Quick Review
• Barrier to entry A natural or legal constraint
that protects a firm from competitors.
1. Monopoly arises in which of the following
situations?
1a. Coca-Cola cuts its price below that of
Pepsi-Cola in an attempt to increase its
market share.
A monopoly is a market with a single firm.
There is no monopoly in part (a) because there
is more than one firm.
1b. A single firm, protected by a barrier to
entry, produces a personal service that
has no close substitutes.
A monopoly is a market with a single supplier
of a good that has no close substitutes and in
which natural or legal barriers to entry prevent
competition. Part (b) describes a monopoly.
1c. A barrier to entry exists, but some close
substitutes for the good exist.
A monopoly does not arise because close substitutes for the good exist.
1d. A firm offers discounts to students and
seniors.
Firms other than a monopoly can price discriminate, so price discrimination by itself is not
proof of a monopoly.
167
1e. A firm can sell any quantity it chooses at
the going price.
When a firm can sell any quantity it chooses at
the going price, demand for the good that the
firm produces is perfectly elastic. This situation
occurs when the firm is in perfect competition.
1f. The government issues Tiger Woods, Inc.
an exclusive license to produce golf
balls.
This government license creates a legal monopoly in golf balls because a single firm is protected from competition and is supplying a
good without close substitutes.
1g. A firm experiences economies of scale
even when it produces the quantity that
meets the entire market demand.
When a firm experiences economies of scale
when it produces the quantity that meets the
entire market demand, it produces that quantity at a lower price than two or more firms
could. This firm is a natural monopoly.
2. Which of the cases a to f in Problem 1 are
natural monopolies and which are legal monopolies? Which can price discriminate,
which cannot, and why?
A natural monopoly is a monopoly that arises
because one firm can meet the entire market
demand at a lower price than two or more
firms. Part (g) describes a natural monopoly.
Part (b) could be a natural monopoly, but the
type of barrier to entry is not specified.
A legal monopoly is a market in which competition and entry are restricted by the concentration of ownership of a natural resource or by
the granting of a public franchise, government
license, patent, or copyright. Part (f) describes a
legal monopoly. Part (b) could be a legal monopoly, but the type of barrier to entry is not
specified.
Monopoly (b) can price discriminate because a
personal service cannot be resold. Monopoly (f)
cannot price discriminate because golf balls
could be resold. There is not enough information given about the type of good in monopoly
(g) to determine if monopoly (g) can price discriminate.
168
Part 3 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
Additional Practice Problem 11.1a
What is the source of the monopoly for the U.S.
Postal Service’s first class mail delivery and DeBeer’s diamond sales?
Solution to Additional Practice Problem 11.1a
The U.S. Post Service derives its monopoly
status by a government franchise to deliver first
class mail. Though it retains its franchise on
first class mail delivery, it faces competition
from the overnight services provided by FedEx,
United Parcel Service, and others.
DeBeers gained its monopoly power in diamond sales by buying up supplies of diamonds
from sources throughout the world.
3. A natural monopoly is one that arises from
a. patent law.
b. copyright law.
c. a firm buying up all of a natural resource.
d. economies of scale.
■ Self Test 11.1
5. Pizza producers charge one price for a single pizza and almost give away a second
one. This is an example of
a. monopoly.
b. a barrier to entry.
c. behavior that is not profit-maximizing.
d. price discrimination.
Fill in the blanks
One of the requirements for monopoly is that
there ____ (are; are no) close substitutes for the
good. A ____ (legal; natural) monopoly exists
when one firm can meet the entire market demand at a lower price than two or more firms
could. A monopoly that is able to sell different
units of a good or service for different prices is
a ____ (legal-price; natural-price; pricediscriminating) monopoly.
True or false
1. A legal barrier creates a natural monopoly.
2. A firm experiences economies of scale along
a downward-sloping long-run average total
cost curve.
3. A monopoly always charges all customers
the same price.
Multiple choice
1. A monopoly market has
a. a few firms.
b. a single firm.
c. two dominating firms in the market.
d. only two firms in it.
2. There are two types of barriers to entry:
a. legal and illegal.
b. natural and legal.
c. natural and illegal.
d. natural and unnatural.
4. A legal barrier is created when a firm
a. has economies of scale, which allow it to
produce at a lower cost than two or more
firms.
b. is granted a public franchise, government
license, patent, or copyright.
c. produces a unique product or service.
d. produces a standardized product or service.
Short answer and numeric questions
1. What conditions define monopoly?
2. What are the two types of barriers to entry?
3. What are the two pricing strategies a monopoly can use? Why don’t perfectly competitive firms have these same strategies?
CHECKPOINT 11.2
■ Explain
how
a
single-price
monopoly determines its output
and price.
Practice Problem 11.2
1. Minnie’s Mineral
Price
Total
Springs is a sin- (dollars Quantity
cost
gle-price
moper
(bottles (dollars
nopoly. The first bottle) per hour) per hour)
two columns of
10
0
1.0
9
1
1.5
the table show
8
2
2.5
the
demand
7
3
5.5
schedule
for
6
4
10.5
Minnie’s spring
5
5
17.5
water, and the
Chapter 11 . Monopoly
middle and third columns show the firm’s total
cost schedule.
a. Calculate Minnie’s total revenue schedule
and marginal revenue schedule.
b. Sketch Minnie’s demand curve and marginal revenue curve.
c. Calculate Minnie’s profit-maximizing
output, price, and economic profit.
d. If the owner of the water source that Minnie uses increases the fee that Minnie pays
by $15.50 an hour, what are Minnie’s new
profit-maximizing output, price, and economic profit?
e. If instead of increasing the fee that Minnie
pays by $15.50 an hour, the owner of the
water source increases the fee that Minnie
pays by $4 a bottle, what are Minnie’s new
profit-maximizing output, price, and economic profit?
Solution to Practice Problem 11.2
Both a monopoly and a perfectly competitive
firm maximize their profit by producing where
marginal revenue equals marginal cost.
Quick Review
• Marginal revenue The change in total
revenue resulting from a one-unit increase in the quantity sold.
• Maximize profit A single-price monopoly
maximizes its profit by producing where
MR = MC and then using the demand
curve to determine the price for this
quantity of output.
a. Calculate Minnie’s total revenue schedule and marginal revenue schedule.
Total
revenue
Total
Marginal
equals price times Quantity revenue revenue
quantity and is (bottles (dollars (dollars
reported in the per hour) per hour) per hour)
0
0
middle column of
9
the table. Mar1
9
7
ginal revenue is
2
16
5
equal
to
the
3
21
change in total
3
revenue
when
4
24
1
Minnie increases
5
25
her output by 1
169
bottle an hour and is reported in the third column in the table.
b. Sketch Minnie’s demand curve and marginal revenue curve.
The
demand
Price and marginal revenue
(dollars per bottle)
curve and the
marginal revenue 10
curve are in the
8
figure to the right.
6
The
marginal
D
revenue curve lies
4
below the demand
2
curve.
MR
0
1
2
3
4
5
Quantity (bottles per hour)
c. Calculate Minnie’s profit-maximizing
output, price, and economic profit.
Equate marginal revenue to marginal cost. The
marginal revenue of 3 bottles is $4.00 (the average of the marginal revenue from 2 to 3 and
from 3 to 4) and the marginal cost is $4.00, so
the profit-maximizing output is 3 bottles an
hour. The price is determined from the demand
curve above 3 bottles and is $7.00 per bottle.
Minnie’s economic profit is the total revenue
minus the total cost or $21.00 − $5.50 = $15.50
an hour.
d. If the owner of the water source that
Minnie uses increases the fee that Minnie pays by $15.50 an hour, what are
Minnie’s new profit-maximizing output,
price, and economic profit?
Minnie’s fixed cost increases when the fee increases but her marginal cost does not change.
The profit-maximizing output and price remain
the same. But the economic profit falls to $0.
e. If instead of increasing the fee that Minnie pays by $15.50 an hour, the owner of
the water source increases the fee that
Minnie pays by $4 a bottle, what are
Minnie’s new profit-maximizing output,
price, and economic profit?
Minnie’s marginal cost increases by $4 a bottle.
Marginal revenue now equals marginal cost
when Minnie produces 2 bottles. Minnie sells
both at a price of $8, so her total revenue is $16
Part 3 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
170
an hour. Total cost is $10.50 an hour. Minnie’s
economic profit is $16.00 − $10.50, which is
$5.50 an hour.
Additional Practice Problem 11.2a
1. The table gives part of Minnie’s total cost
schedule from Practice Problem 11.2.
Average
total cost
(dollars per
bottle)
Quantity
(bottles
per hour)
Total cost
(dollars per
hour)
0
1.0
1
1.50
____
2
2.50
____
3
5.50
____
4
10.50
____
a. Complete the table.
b. Using information in
the table and in
Practice
Problem
11.2, plot Minnie’s demand, marginal revenue, average total
cost, and marginal
cost curves. Indicate
the
equilibrium
quantity and price,
and show Minnie’s
economic profit.
Marginal
cost
(dollars per
bottle)
____
____
____
____
Price and cost
(dollars per bottle)
mand, marginal revenue, average total
cost, and marginal cost curves. Indicate
the equilibrium quantity and price, and
show Minnie’s economic profit.
The completed figure
is to the right. The Price and cost
(dollars per bottle)
equilibrium quantity
is the quantity where 10
the MR and MC 8
curves
intersect,
which is 3 bottles an 6
D
MC
hour. The price is $7 a 4
bottle, from the deATC
2
mand curve. The
MR
economic profit is
0
1
2
3
4
5
equal to the area of
(bottles
per
hour)
Quantity
the rectangle.
■ Self Test 11.2
Fill in the blanks
For each level of output, marginal revenue for a
10
single-price monopoly is ____ (greater than;
8
equal to; less than) price. When demand is ine6
lastic, marginal revenue is ____ (positive; negative). A single-price monopoly maximizes profit
4
by producing the quantity at which marginal
2
revenue ____ (is greater than; equals; is less
than) marginal cost and then finds the highest
0
1 2 3 4 5
price for which it can sell that output by using
Quantity (bottles per hour)
the ____ (demand; marginal revenue; average
total cost) curve.
Solution to Additional Practice Problem 11.2a
True or false
a. Complete the table.
1. For a single-price monopoly, marginal reveAverage
Marginal
nue exceeds price.
Quantity
Total cost
total cost
cost
2. Marginal revenue is always positive for a
(bottles
(dollars per (dollars per (dollars per
per hour)
hour)
bottle)
bottle)
monopoly.
0
1.00
3. A single-price monopoly maximizes profit
0.50
by producing the quantity that makes mar1
1.50
1.50
1.00
ginal revenue equal to marginal cost.
2
2.50
1.25
3
5.50
1.83
4
10.50
2.63
3.00
5.00
The completed table is above.
b. Using information in the table and in
Practice Problem 11.2, plot Minnie’s de-
Multiple choice
1. For a single-price monopoly, price is ____
marginal revenue.
a. greater than
b. less than
c. equal to
d. unrelated to
Chapter 11 . Monopoly
2. A single-price monopoly can sell 1 unit for
$9.00. To sell 2 units, the price must be $8.50
per unit. The marginal revenue from selling
the second unit is
a. $17.50.
b. $17.00.
c. $8.50.
d. $8.00.
3. When demand is elastic, marginal revenue is
a. positive.
b. negative.
c. zero.
d. increasing as output increases.
4. To maximize profit, a single-price monopoly
produces where
a. the difference between marginal revenue
and marginal cost is as large as possible.
b. marginal revenue is equal to marginal
cost.
c. average total cost is at its minimum.
d. the marginal cost curve intersects the
demand curve.
5. Once a monopolist has determined its output level, it will charge a price that
a. is determined by the intersection of the
marginal revenue and marginal cost
curves.
b. minimizes marginal cost.
c. is determined by its demand curve.
d. is independent of the amount produced.
Complete the graph
Quantity
(hamburgers
per hour)
1
Price
(dollars)
8.00
2
7.00
3
6.00
4
5.00
5
4.00
Marginal
revenue
(dollars)
___
___
___
___
1. The table gives the demand schedule for a
monopoly seller of hamburgers. Complete
the table by calculating the marginal revenue and then draw the demand curve and
marginal revenue curve in Figure 11.1.
171
FIGURE 11.1
Price and marginal revenue (dollars per hamburger)
10
9
8
7
6
5
4
3
2
1
0
1
2
3
4
5
Quantity (hamburgers per hour)
FIGURE 11.2
Price and cost (dollars per unit)
0
Quantity (units per year)
2. Figure 11.2 shows a monopoly. Label the
curves. Identify the quantity produced by
labeling it Q and the price charged by labeling it P. Is the monopoly earning an economic profit or incurring an economic loss?
Darken the area that shows the economic
profit or economic loss.
Short answer and numeric questions
1. What is the relationship between the elasticity of demand and marginal revenue?
2. Both perfectly competitive and monopoly
firms maximize their profit by producing
where MR = MC. Why do both use the same
rule?
3. Why can a monopoly earn an economic
profit in the long run?
172
Part 3 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
CHECKPOINT 11.3
■ Compare the performance of a
single-price monopoly with that of
perfect competition.
Practice Problem 11.3
Township is a small isolated community
served by one newspaper that can meet the
market demand at a lower cost than two or
more newspapers could. There is no local radio
or TV station and no Internet access. The Township Gazette is the Price (cents per newspaper)
only source of news. 100
The figure shows
80
MC
the marginal cost of
60
printing the Township Gazette and the
40
demand for it. The
25
Township Gazette is a
D
profit-maximizing,
0 100 200 300 400 500
single-price
moQuantity (newspapers per day)
nopoly.
a. How many copies of the Township Gazette
are printed each day?
b. What is the price of the Township Gazette?
c. What is the efficient number of copies of
the Township Gazette?
d. What is the price at which the efficient
number of copies could be sold?
e. Is the number of copies printed the efficient quantity? Explain why or why not.
f. On a graph, show the consumer surplus
that is redistributed from consumers to
the Township Gazette.
g. On a graph, show the deadweight loss
that results from the monopoly of the
Township Gazette.
Solution to Practice Problem 11.3
Single-price monopolies create a deadweight
loss because a monopoly produces where MR =
MC but efficiency requires production where
MB = MC.
Quick Review
• Monopoly and competition compared Compared to perfect competition, a single-
price monopoly produces a smaller output and charges a higher price.
a. How many copies of the Township Gazette are printed each day?
To maximize profit, the firm produces 150 papers because in the figure below, 150 papers a
day is the quantity at which marginal revenue
equals marginal cost.
b. What is the price of the Township Gazette?
Using the demand Price (cents per newspaper)
curve, in the fig- 100
ure, the price that
80
MC
corresponds to the
70
60
quantity of 150
50
newspapers a day
40
is 70¢ a newspa25
per.
D
MR
0 100 200 300 400 500
c. What is the
Quantity (newspapers per day)
efficient number of copies of the Township Gazette?
The efficient quantity is the quantity where
marginal benefit equals marginal cost. The demand curve is the marginal benefit curve, so the
figure shows that the efficient quantity is 250
newspapers a day.
d. What is the price at which the efficient
number of copies could be sold?
From the demand curve, 250 newspapers a day
will be purchased at 50¢ each.
e. Is the number of copies printed the efficient quantity? Explain why or why not.
The Township Gazette is not printing the efficient
quantity. The marginal benefit of the 150th
newspaper exceeds the marginal cost.
f. On a graph, show the consumer surplus
that is redistributed from consumers to
the Township Gazette.
The redistributed consumer surplus is the light
rectangle in the figure.
g. On a graph, show the deadweight loss
that results from the monopoly of the
Township Gazette.
The dark triangular area is the deadweight loss
from the monopoly.
Chapter 11 . Monopoly
Additional Practice Problem 11.3a
The Township Gazette is put up for sale. Suppose that looking at the entire future, the Township Gazette’s total economic profit is $2 million.
If the bidding for the Township Gazette is a
competitive process, what do you expect will be
the price for which the newspaper is sold? What
result are you illustrating?
Solution to Additional Practice Problem 11.3a
Bidders will be willing to pay up to $2 million
for the Township Gazette because if they can buy
it for any price less than $2 million, they will receive an economic profit. Because the bidding is
competitive, the price the Township Gazette will
be bid up to $2 million, so that the winning
bidder will earn a normal profit. This result
demonstrates rent-seeking equilibrium in
which the rent-seeking costs exhaust the economic profit.
■ Self Test 11.3
Fill in the blanks
Compared to perfect competition, a single-price
monopoly produces a ____ (larger; smaller)
output and charges a ____ (higher; lower) price.
A single-price monopoly ____ (creates; does not
create) a deadweight loss. The act of obtaining
special treatment by the government to create
an economic profit is called ____ (government
surplus; rent seeking). Rent seeking ____ (decreases; increases) the amount of deadweight
loss.
True or false
1. A monopoly charges a higher price than a
perfectly competitive industry would
charge.
2. A monopoly redistributes consumer surplus
so that the consumers gain and the producer
loses.
3. The buyer of a monopoly always makes an
economic profit.
173
Multiple choice
1. If a perfectly competitive industry is taken
over by a single firm that operates as a singleprice monopoly, the price will ____ and the
quantity will ____.
a. fall, decrease
b. fall, increase
c. rise, decrease
d. rise, increase
2. Comparing single-price monopoly to perfect
competition, we see that
a. monopoly increases the amount of consumer surplus.
b. monopoly has the same amount of consumer surplus.
c. perfect competition has no consumer
surplus.
d. monopoly decreases the amount of consumer surplus.
3. Is a single-price monopoly efficient?
a. Yes, because it creates a deadweight loss.
b. No, because it creates a deadweight loss.
c. Yes, because consumers gain and producers lose some of their surpluses.
d. Yes, because consumers lose and producers gain some of their surpluses.
4. Monopolies are
a. always fair but not efficient.
b. efficient but might or might not be fair.
c. inefficient and might or might not be fair.
d. both fair and efficient.
5. In equilibrium, rent seeking eliminates the
a. deadweight loss.
b. economic profit.
c. consumer surplus.
d. demand for the product.
Part 3 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
174
Complete the graph
FIGURE 11.3
Price and costs (dollars per ostrich)
50
40
30
20
10
0
5 10 15 20 25 30 35 40 45 50
Quantity (thousands of ostriches per year)
1. Figure 11.3 shows the market for ostrich
farming, an industry that is initially perfectly competitive. Then one farmer buys all
the other farms and operates as a singleprice monopoly. In the figure, label the
curves. What was the competitive price and
quantity? What is the monopoly price and
quantity? Darken the deadweight loss area.
Short answer and numeric questions
1. How does the quantity produced and the
price set by a single-price monopoly compare to those in a perfectly competitive
market?
2. What happens to consumer surplus with a
single-price monopoly?
3. What is rent seeking? How does rent seeking affect society?
CHECKPOINT 11.4
■ Explain how price discrimination
increases profit.
Practice Problem 11.4
Village, a small isolated town, has one doctor.
For a 30-minute consultation, the doctor
charges a rich person twice as much as a poor
person.
a. Does the doctor practice price discrimination?
b. Does the doctor’s pricing system redistribute consumer surplus? If so, explain
how.
c. Is the doctor using resources efficiently?
Explain your answer.
d. If the doctor decided to charge everyone
the maximum price that he or she would
be willing to pay, what would be the consumer surplus?
e. In part (d), is the market for medical service in Village efficient?
Solution to Practice Problem 11.4
This Practice Problem helps you understand
who truly gains from price discrimination. Remember that the key idea behind price discrimination is to convert consumer surplus into
economic profit.
Quick Review
• Price discrimination Price discrimination
is selling a good at a number of different
prices.
• Consumer surplus The consumer surplus
of a good is its marginal benefit, which
equals the maximum price the consumer
is willing to pay, minus the price paid for
it.
a. Does the doctor practice price discrimination?
Yes, charging different prices to rich people and
poor people for the same service is price discrimination.
b. Does the doctor’s pricing system redistribute consumer surplus? If so, explain
how.
Yes. Because the doctor is setting the price
closer to the maximum the consumer is willing
to pay, each consumer receives less consumer
surplus. The doctor is converting consumer
surplus into economic profit.
c. Is the doctor using resources efficiently?
Explain your answer.
The doctor is not using resources efficiently.
Price discrimination creates a deadweight loss
Chapter 11 . Monopoly
unless the producer can practice perfect price
discrimination.
d. If the doctor decided to charge everyone
the maximum price that he or she would
be willing to pay, what would be the
consumer surplus?
The doctor is practicing perfect price discrimination. All of the consumer surplus would be
converted into economic profit and so consumer surplus would be zero.
e. In part (d), is the market for medical service in Village efficient?
Yes, because the demand curve becomes the
marginal revenue curve in perfect price discrimination. The demand curve is also the marginal benefit curve. So the doctor will continue
services until marginal revenue equals marginal
cost, which is the quantity where marginal
benefit equals marginal cost. And when marginal benefit equals marginal cost there is an efficient use of resources.
Additional Practice Problem 11.4a
Why is the price to attend a movie less on a
weekday afternoon than on a weekend evening?
Solution to Additional Practice Problem 11.4a
When the price to attend a movie is less on a
weekday afternoon than on a weekend evening,
the movie theater is practicing price discrimination among two groups of buyers. Each group
has a different average willingness to pay to see
a movie. By having two different prices, the
movie theater maximizes profit by converting
consumer surplus into economic profit.
■ Self Test 11.4
Fill in the blanks
It is ____ (sometimes; never) possible for a monopoly to charge different customers different
prices. The key idea behind price discrimination
is to convert ____ (consumer surplus; producer
surplus) into economic profit. Price discrimination results in consumers with a higher willingness to pay paying a ____ (higher; lower) price
than consumers with a lower willingness to
pay. Perfect price discrimination results in ____
175
(the maximum; zero) consumer surplus and
____ (creates; does not create) a deadweight
loss.
True or false
1. Price discrimination lowers a firm’s profit.
2. Price discrimination converts producer surplus into consumer surplus.
3. With perfect price discrimination, the demand curve becomes the marginal revenue
curve.
Multiple choice
1. Which of the following must a firm do to
successfully price discriminate?
a. divide buyers into different groups according to their willingness to pay
b. prevent resale of the good or service
c. identify into which group a buyer falls
d. All of the above answers are correct.
2. Which of the following is NOT price discrimination?
a. different prices based on differences in
production cost
b. charging business flyers a higher airfare
than tourists
c. charging consumers who buy a larger
quantity a lower price
d. pricing on the basis of some easily distinguishing characteristic of buyers that
identifies some buyers as having higher
willingness to pay
3. When a monopolist price discriminates, it
a. increases the amount of consumer surplus.
b. decreases the monopolist’s economic
profit.
c. converts consumer surplus into economic
profit.
d. converts economic profit into consumer
surplus.
Part 3 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
176
4. If a monopolist is able to perfectly price discriminate, then consumer surplus is
a. equal to zero.
b. maximized.
c. unchanged from what it is with a singleprice monopoly.
d. unchanged from what it is in a perfectly
competitive industry.
5. With perfect price discrimination, the quantity of output produced by the monopolist is
____ the quantity produced by a perfectly
competitive industry.
a. greater than
b. less than
c. equal to
d. almost always greater than
Complete the graph
1. Figure 11.4 shows the cost and demand
curves for a dry-cleaner that has a monopoly in a small town.
FIGURE 11.4
Price and cost (dollars per article of clothing)
10
9
8
7
6
5
4
3
2
1
0
MC
MR
10
ATC
D
20
30
40
50
Quantity (articles of clothing per day)
a. In the figure, lightly darken the area of the
economic profit for a single-price monopoly. What is the amount of economic
profit this firm earns?
b. Suppose the firm is able to perfectly price
discriminate. More heavily darken the additional economic profit the firm now
earns. What is the amount of the firm’s
economic profit now?
Short answer and numeric questions
1. Explain the effect of price discrimination on
consumer surplus and economic profit.
2. When does a price discriminating monopoly
produce the efficient quantity of output?
CHECKPOINT 11.5
■ Explain how monopoly regulation
influences output, price, economic
profit, and efficiency.
Practice Problem 11.5
The local water Price and cost
company is a natural monopoly. The 10
8
figure shows the
demand for water
6
and the water com4
pany’s cost of proLRAC
viding water.
2
MC
D
a. If the com0
pany is an un1 2 3 4 5
Quantity
regulated
(thousands of gallons per day)
profitmaximizer:
i. What is the price of water?
ii. What quantity of water would be supplied?
iii. What would be the deadweight loss?
b. If the company is regulated to make normal profit:
i. What is the price of water?
ii. What quantity of water would be supplied?
iii. What would be the deadweight loss?
c. If the company is regulated to be efficient:
i. What is the price of water?
ii. What quantity of water would be supplied?
iii. What would be the deadweight loss?
Solution to Practice Problem 11.5
This Practice Problem studies the implications
of monopoly regulations that affect all our lives
through prices we pay.
Chapter 11 . Monopoly
Quick Review
• Marginal cost pricing rule Set the price
equal to the marginal cost.
• Average cost pricing rule Set the price
equal to the average total cost.
a. If the company is an unregulated profitmaximizer:
i. What is the price of water?
ii. What quantity of water would be
supplied?
iii. What would be the deadweight loss?
The firm produces
where
marginal Price and cost
revenue
equals 10
marginal cost. As
8
the figure shows,
6
the firm supplies
4
2,000 gallons of waLRAC
ter and the price is
2
MC
$6. The deadweight
D
MR
loss is the large tri0
1 2 3 4 5
angular area made
Quantity
(thousands of gallons per day)
up of the lightly
shaded gray area
plus the (small) darker grey triangle and equals
$4,000 a day.
b. If the company is regulated to make
normal profit:
i. What is the price of water?
ii. What quantity of water would be
supplied?
iii. What would be the deadweight loss?
If the company is regulated using an average
cost pricing rule, it makes a normal profit. As
the figure shows, the company will charge $4
and will supply 3,000 gallons. The deadweight
loss is the area of the (small) darker grey triangle and is $1,000 a day.
c. If the company is regulated to be efficient:
i. What is the price of water?
ii. What quantity of water would be
supplied?
iii. What would be the deadweight loss?
If the company is regulated to be efficient, it is
regulated using a marginal cost pricing rule. As
the figure shows, the company charges $2 and
177
supplies 4,000 gallons. Because the company is
producing the efficient quantity, there is no
deadweight loss.
Additional Practice Problem 11.5a
Suppose you are the owner of the natural monopoly in the previous Practice Problem. Would
you want to be regulated or unregulated? If you
were regulated, would you prefer an average
cost pricing rule or a marginal cost pricing rule?
Solution to Additional Practice Problem 11.5a
You would prefer not to be regulated. If you are
not regulated, as in part (a) of the Practice Problem, price is greater than average total cost and
you earn an economic profit. If you are regulated, you would prefer the average cost pricing
rule. With this rule you earn a normal profit. If
a marginal cost pricing rule is imposed, you
will incur an economic loss.
■ Self Test 11.5
Fill in the blanks
____ (Economies of scale; Incentives to innovate) can lead to natural monopoly. Efficiency
is attained if a natural monopoly is regulated
using ____ (a marginal; an average) cost pricing
rule. ____ (A marginal; An average) cost pricing
rule allows a natural monopoly to earn a normal profit.
True or false
1. Large firms with monopoly power innovate
more than smaller competitive firms which
lack monopoly power.
2. A natural monopoly regulated using a marginal cost pricing rule incurs an economic
loss.
3. A natural monopoly that is regulated using
an average cost pricing rule incurs an economic loss.
178
Part 3 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
Multiple choice
1. If a single firm can meet the entire market
demand at a lower price than a larger number of smaller firms can, the single firm is
a. price discriminating.
b. a natural monopoly.
c. a legal monopoly.
d. efficient when profit maximizing.
2. What are the potential advantages of monopoly over competition for the economy?
a. There are none.
b. Monopolists earn more profit.
c. Monopolies have a higher rate of productivity growth.
d. Economies of scale and incentives to innovate are potential advantages.
3. When the government regulates a natural
monopoly, the government
a. can determine the price the monopoly
charges.
b. insures that there is enough competition
because the government operates competing firms.
c. almost always uses the marginal cost
pricing rule.
d. All of the above answers are correct.
4. With a marginal cost pricing rule, a natural
monopoly produces an ____ amount of output and ____.
a. efficient; earns an economic profit
b. efficient; incurs an economic loss
c. inefficient; earns an economic profit
d. inefficient; incurs an economic loss
5. With an average cost pricing rule, a natural
monopoly produces an ____ amount of output and ____.
a. efficient; earns an economic profit
b. efficient; incurs an economic loss
c. inefficient; earns a normal profit
d. inefficient; earns an economic profit
Short answer and numeric questions
1. Why is creating competition in a market
with a natural monopoly wasteful from society’s vantage?
2. Describe the slope of a natural monopoly’s
long-run average cost curve at the point
where it intersects the demand curve.
3. What are the two ways to regulate a natural
monopoly? What are their advantages and
disadvantages?
Chapter 11 . Monopoly
179
SELF TEST ANSWERS
■ CHECKPOINT 11.1
Fill in the blanks
One of the requirements for monopoly is that
there are no close substitutes for the good. A
natural monopoly exists when one firm can
meet the entire market demand at a lower price
than two or more firms could. A monopoly that
is able to sell different units of a good or service
for different prices is a price-discriminating
monopoly.
True or false
1. False; page 272
2. True; page 272
3. False; page 274
Multiple choice
1. b; page 272
2. b; page 272
3. d; page 272
4. b; page 273
5. d; page 274
Short answer and numeric questions
1. Monopoly occurs when there is a market
with a single firm selling a good or service
that has no close substitutes and in which
the firm is protected by either a natural or a
legal barrier to entry; page 272.
2. Barriers to entry are anything that protects a
firm from the entry of new competitors. Barriers to entry are either natural barriers or
legal barriers; page 272.
3. A monopoly can sell each unit of its output
for the same price to all its customers or it
can price discriminate by selling different
units of its good or service at different
prices. A perfectly competitive firm cannot
affect the price so it must charge a single
price determined by market demand and
market supply; page 274.
■ CHECKPOINT 11.2
Fill in the blanks
For each level of output, marginal revenue for a
single-price monopoly is less than price. When
demand is inelastic, marginal revenue is nega-
tive. A single-price monopoly maximizes profit
by producing the quantity at which marginal
revenue equals marginal cost and then finds
the highest price for which it can sell that output by using the demand curve.
True or false
1. False; page 276
2. False; page 276
3. True; page 278
Multiple choice
1. a; page 276
2. d; page 276
3. a; page 277
4. b; page 278
5. c; page 278
Complete the graph
Quantity
(hamburgers
per hour)
1
Price
(dollars)
8.00
2
7.00
3
6.00
4
5.00
5
4.00
Marginal
revenue
(dollars)
6.00
4.00
2.00
0.00
1. The completed table is above and Figure
11.5 plots the demand and marginal revenue curves; page 278.
FIGURE 11.5
Price and marginal revenue (dollars per hamburger)
10
9
8
7
6
5
4
3
2
1
0
D
MR
1
2
3
4
5
Quantity (hamburgers per hour)
Part 3 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
180
Rent seeking increases the amount of deadweight loss.
FIGURE 11.6
Price and cost (dollars per unit)
MC
ATC
P
MR
0
Q
D
Quantity (units per year)
2. The curves, quantity, price, and economic
profit are labeled and illustrated in Figure
11.6; page 279.
Short answer and numeric questions
1. If demand is elastic, marginal revenue is
positive; if demand is unit elastic, marginal
revenue is zero; and if demand is inelastic,
marginal revenue is negative; page 277.
2. Both competitive and monopoly firms
maximize profit by producing where MR =
MC because for any firm, a unit of output is
produced if MR > MC and is not produced
if MR < MC. As long as MR > MC, any firm
continues to produce additional output until
it reaches the point at which MR = MC;
page 278.
3. A monopoly can earn an economic profit in
the long run because it is protected by a barrier to entry. Other firms might want to enter the market in order to earn an economic
profit, but they cannot do so; page 279.
■ CHECKPOINT 11.3
Fill in the blanks
Compared to perfect competition, a single-price
monopoly produces a smaller output and
charges a higher price. A single-price monopoly creates a deadweight loss. The act of obtaining special treatment by the government to create an economic profit is called rent seeking.
True or false
1. True; page 281
2. False; page 283
3. False; page 283
Multiple choice
1. c; page 281
2. d; page 282
3. b; page 282
4. c; page 283
5. b; page 284
Complete the graph
1. Figure 11.7 shows that the perfectly competitive price is $20 an ostrich and the quantity is 30,000 ostriches. The monopoly price
is $30 an ostrich and the quantity is 20,000
ostriches a year. The deadweight loss is the
dark triangular area; page 282.
FIGURE 11.7
Price and cost (dollars per ostrich)
50
40
Deadweight
loss
S=MC
30
20
10
MR
D=MB
0
5 10 15 20 25 30 35 40 45 50
Quantity (thousands of ostriches per year)
Short answer and numeric questions
1. The price set by a monopoly firm exceeds
the price in a competitive market and the
quantity produced by a monopoly is less
than the quantity produced in a competitive
market; page 281.
2. Consumer surplus decreases with a singleprice monopoly. Consumer surplus decreases because the monopoly produces less
Chapter 11 . Monopoly
output and charges a higher price; page
282.
3. Rent seeking is the act of obtaining special
treatment by the government to create
economic profit or to divert consumer
surplus or producer surplus away from
others. Rent seeking harms society because
in a competitive rent-seeking equilibrium,
the amount of the deadweight loss
increases; page 284.
■ CHECKPOINT 11.4
Fill in the blanks
It is sometimes possible for a monopoly to
charge different customers different prices. The
key idea behind price discrimination is to convert consumer surplus into economic profit.
Price discrimination results in consumers with a
higher willingness to pay paying a higher price
than consumers with a lower willingness to
pay. Perfect price discrimination results in zero
consumer surplus and does not create a deadweight loss.
True or false
1. False; page 286
2. False; page 286
3. True; page 289
Multiple choice
1. d; page 286
2. a; page 286
3. c; page 286
4. a; pages 288-289
5. c; page 290
Complete the graph
1. a. The economic profit is the light blue rectangle in Figure 11.8. The economic profit
equals the area of the rectangle, which is
$60 a day; page 287.
b. The economic profit is increased by the
addition of the two darker blue areas. The
economic profit is now the sum of the initial economic profit plus the additional
economic profit, which is a total of $120 a
day; page 289.
181
FIGURE 11.8
Price and cost (dollars per article of clothing)
10
9
8
7
6
5
4
3
2
1
0
MC
MR
10
ATC
D
20
30
40
50
Quantity (articles of clothing per day)
Short answer and numeric questions
1. Price discrimination decreases consumer
surplus and increases economic profit. Price
discrimination allows the firm to charge a
price closer to the maximum the consumer
is willing to pay, which is the marginal
benefit of the good. Consumer surplus is
converted into economic profit; page 286.
2. With perfect price discrimination, the monopoly increases output to the point at
which price equals marginal cost. This output is identical to that of perfect competition. Deadweight loss with perfect price discrimination is zero. So perfect price discrimination produces the efficient quantity;
page 290.
■ CHECKPOINT 11.5
Fill in the blanks
Economies of scale can lead to natural monopoly. Efficiency is attained if a natural monopoly
is regulated using a marginal cost pricing rule.
An average cost pricing rule allows a natural
monopoly to earn a normal profit.
True or false
1. False; page 292
2. True; page 293
3. False; page 293
182
Part 3 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
Multiple choice
1. b; page 292
2. d; page 292
3. a; page 293
4. b; page 293
5. c; page 293
Short answer and numeric questions
1. A natural monopoly is a situation in which a
single firm can produce at a lower average
total cost than a larger number of smaller
firms can. Where such significant economies
of scale exist, it would be wasteful not to
have a monopoly. So creating competition
in a market that is a natural monopoly
would be wasteful; page 292.
2. The average total cost curve is sloping
downward at the point where it intersects
the demand curve; page 293.
3. A natural monopoly can be regulated using
a marginal cost pricing rule or an average
cost pricing rule. The marginal cost pricing
rule is a price rule for a natural monopoly
that sets price equal to marginal cost. The
advantage of this rule is that the firm produces the efficient quantity of output. The
disadvantage is that the firm suffers an economic loss. An average cost pricing rule is a
price rule for a natural monopoly that sets
the price equal to average total cost and enables the firm to cover its costs and earn a
normal profit. The advantage of this rule is
that the firm earns a normal profit. The disadvantage is that the firm produces less
than the efficient quantity of output and a
deadweight loss is created; pages 292, 293.