Download Foundations of Economics, 3e (Bade/Parkin)

Foundations of Economics, 3e (Bade/Parkin) - Testbank 3
Chapter 14 Monopoly
1) What are the conditions that define a monopoly?
Answer: There is only one firm producing a good or service with no close substitutes for the good or service
sold and there are barriers to entry that prevent competing firms from entering the market.
Topic: Monopoly
Skill: Level 1: Definition
Objective: Checkpoint 14.1
Author: TS
2) Describe the three general types of barriers.
Answer: Barriers to entry can be divided into legal barriers, ownership barriers, natural barriers. Legal barriers
occur when government action blocks competition in a market. For instance, the government could
grant a public franchise, government license, patent, or copyright. In all cases, the government action
prevents other firms from entering the market. Ownership barriers occur when a firm buys a
significant portion of a natural resource. For instance, DeBeers controls over 80 percent of the world's
diamond market. The last barrier to entry is a natural barrier. A natural barrier to entry occurs when
economies of scale are so large that they make it possible for one firm to meet the entire market
demand at a lower price than could two or more firms. In this case, the market will "naturally" evolve
to become a monopoly as a larger firm uses its cost advantage to cut its price and drive its high-cost,
smaller competitors out of business.
Topic: Monopoly
Skill: Level 2: Using definitions
Objective: Checkpoint 14.1
Author: TS
3) Are some monopolies created by government legislation that gives a firm the unique right to produce a good
or service?
Answer: Yes, some monopolies are created by government legislation, such as patent or copyright laws and the
granting of public franchises. Monopolies that are created because of legal barriers to entry are called
legal monopolies.
Topic: Legal barriers to entry
Skill: Level 2: Using definitions
Objective: Checkpoint 14.1
Author: WM
4) What is a legal barrier to entry?
Answer: A legal barrier to entry arises when entry is restricted because the government has granted a franchise,
patent, license, or copyright to one person or firm.
Topic: Legal barriers to entry
Skill: Level 2: Using definitions
Objective: Checkpoint 14.1
Author: SA
5) Competition keeps prices lower for consumers. So why do we have patent laws?
Answer: Patent laws are necessary to promote innovation. Without such laws an inventor might spend
countless hours and a great deal of money developing a new product, put the product out into the
market only to have a competitor copy it without incurring any of the time or costs to develop it. In
the long run, this prospect would serve as a mighty disincentive to innovate and so would drastically
reduce the supply of new products that come into the market.
Topic: Legal barriers to entry
Skill: Level 3: Using models
Objective: Checkpoint 14.1
Author: JC
6) What is price discrimination?
Answer: A firm price discriminates when it sells different units of a good or service for different prices. For
instance, a firm price discriminates when it sells its good or service to different people for different
prices, such as when airlines charge different customers different fares for the same flight. A firm also
price discriminates when it sells different units of its product to the same person for different prices,
such as when an ice cream store charges a lower price for a second scoop of ice cream.
Topic: Price discrimination
Skill: Level 1: Definition
Objective: Checkpoint 14.1
Author: MR
7) A monopoly, unlike a perfect competitor, has total control in its market because it is the single producer.
Why, then, must a single-price monopoly decrease its price if it wants to increase its output?
Answer: Because the monopoly does control the market, the monopoly sets the price at the maximum level that
sells all the output the monopoly produces. This maximum price is determined from the demand for
the product. The downward sloping market demand curve shows that the only way to increase the
quantity consumers will buy is to lower the price. As a result, when a monopoly wants to produce
more output, demanders will not buy the additional output at the initial price. As the downward
sloping demand curve indicates, in order to sell the extra production, the monopolist must lower its
price.
Topic: Demand
Skill: Level 4: Applying models
Objective: Checkpoint 14.2
Author: SA
8) What is the relationship between the marginal revenue curve and the demand curve for a single-price
monopoly?
Answer: For a single-price monopoly, price exceeds marginal revenue. The price is obtained from the demand
curve, so for a single-price monopoly, the marginal revenue curve lies below the demand curve.
Topic: Marginal revenue
Skill: Level 2: Using definitions
Objective: Checkpoint 14.2
Author: JC
9) How does marginal revenue compare to price for a single-price monopoly?
Answer: Marginal revenue is less than price.
Topic: Marginal revenue
Skill: Level 2: Using definitions
Objective: Checkpoint 14.2
Author: TS
10) What does the marginal revenue equal when a monopoly's total revenue is maximized? What is the elasticity
of demand when the total revenue is maximized?
Answer: When the total revenue is at its maximum, the marginal revenue equals 0 and the elasticity of demand
equals 1.
Topic: Total revenue
Skill: Level 2: Using definitions
Objective: Checkpoint 14.2
Author: WM
11) A monopoly can set any price it wants. So why does it still produce at a point where MC = MR, just like a
perfectly competitive firm?
Answer: The point where MC = MR maximizes any firm's profit for the same reason it maximizes a perfectly
competitive firm's profit. In particular, any unit for which MR > MC is a profitable unit to produce and
so the firm wants to produce all of these units. As it increases its output, its total profit increases even
as the difference between MR and MC shrinks. But as long as MR > MC, the unit is profitable and
therefore is produced. Eventually the firm gets to the point where MR = MC. The firm does not want
to go beyond this level of output, because for every unit beyond it MC > MR. Producing these units
would cost the firm profit. So, once it starts producing, the firm won't stop producing additional units
of output before it reaches the level for which MR = MC. Then, once it reaches this point, it won't go
beyond this amount. Therefore the condition MR = MC determines the profit maximizing level of
output.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 14.2
Author: SA
12) "A single-price monopoly will always charge a price that is on the elastic range of the demand for the
monopoly's output." Explain why the previous statement is correct or incorrect.
Answer: The statement is correct. Only when the demand is elastic is marginal revenue positive. (When
demand is unit elastic, marginal revenue is zero and when demand is inelastic marginal revenue is
negative.) Because marginal cost is always positive, a single-price monopoly will always produce in
the elastic range of the demand because it produces where marginal cost equals marginal revenue.
Hence the price that the monopoly sets will always be on the elastic range of the demand.
Topic: Profit maximization, price
Skill: Level 3: Using models
Objective: Checkpoint 14.2
Author: JC
13) Why will a profit-maximizing, single-price monopoly NEVER produce the amount of output that maximizes
its total revenue?
Answer: When total revenue is at its maximum, the demand is unit elastic and marginal revenue equals zero.
However, to maximize its profit, a single-price monopoly produces so that its marginal revenue equals
its marginal cost. If marginal revenue equals zero, then in order for this level of output to maximize
the monopoly's profit, marginal cost also must equal zero. But marginal cost will never equal zero
because to produce another unit always incurs some costs. Because marginal cost cannot equal zero, it
is impossible for a profit-maximizing single-price monopoly to produce the amount of output that
maximizes its total revenue.
Topic: Profit maximization
Skill: Level 5: Critical thinking
Objective: Checkpoint 14.2
Author: JC
14) Can a monopoly earn an economic profit in the long run? Explain your answer.
Answer: A monopoly can earn an economic profit in the long run. The fact that the monopoly is protected by a
barrier to entry allows the firm to earn an economic profit in the long run. If the monopoly is earning
an economic profit, other competitors want to enter the market but the barrier to entry keeps them out.
Topic: Profit maximization, long run
Skill: Level 3: Using models
Objective: Checkpoint 14.2
Author: SB
15) What kind of profit can a monopoly earn in the short run? In the long run? Explain your answers.
Answer: In the short run, a monopoly can earn an economic profit, a normal profit, or incur an economic loss.
In other words, any sort of profit outcome is possible in the short run. In the long run, a monopoly can
earn an economic profit or a normal profit. A monopoly will not incur an economic loss in the long
run because it would shut down. The key result that differentiates it from firms in other types of
markets is that a monopoly can earn an economic profit in the long run. It can do so because there are
barriers to entry. These barriers prevent other firms from entering the market and usurping part of the
economic profit.
Topic: Profit maximization, long run
Skill: Level 3: Using models
Objective: Checkpoint 14.2
Author: CD
16) The above table gives a monopoly's demand schedule. Complete the table by calculating the total revenue
and the marginal revenue.
Answer:
The completed table is above.
Topic: Marginal revenue
Skill: Level 3: Using models
Objective: Checkpoint 14.2
Author: WM
17) The above table gives a monopoly's demand schedule. Complete the table by calculating the total revenue
and the marginal revenue.
Answer:
The completed table is above.
Topic: Marginal revenue
Skill: Level 3: Using models
Objective: Checkpoint 14.2
Author: PH
18) The demand schedule for a single-price monopoly is given in the above table. Calculate the marginal
revenue.
Answer:
The completed table is above.
Topic: Marginal revenue
Skill: Level 3: Using models
Objective: Checkpoint 14.2
Author: TS
19) The above figure represents the demand and marginal revenue curves for Sue's Seafood, a seller of fresh fish.
a. Over what range of output is demand elastic?
b. Over what range of output is demand inelastic?
c. What price maximizes total revenue?
d. What is the price elasticity of demand at the revenue maximizing price?
Answer: a. Demand is elastic from 0 to 20 pounds of fish.
b. Demand is inelastic from 20 to 40 pounds of fish.
c. Total revenue is maximized when the price is $8 a pound.
d. Total revenue is maximized when demand is unit elastic.
Topic: Marginal revenue and elasticity
Skill: Level 3: Using models
Objective: Checkpoint 14.2
Author: SB
20) A single-price monopoly has the demand and marginal cost schedules given in the above table. What is the
profit-maximizing level of output and price?
Answer: The profit-maximizing output is 3 units, because that is the quantity for which the marginal revenue
equals the marginal cost. The price is $18 a unit.
Topic: Single-price monopoly, profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 14.2
Author: TS
21) In the above figure, draw and label the demand and cost curves of a monopoly. Identify the quantity a
single-price monopoly will produce by labeling it Qm and identify the price by labeling it Pm.
Answer:
The completed figure is above.
Topic: Single-price monopoly, profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 14.2
Author: WM
22) Ron's Hamburger Joint is the only restaurant in town. The above figure represents Ron's cost, the market
demand, and marginal revenue curves. Ron operates as a single-price monopoly.
a. How many hamburgers does Ron produce?
b. What price does Ron charge for a hamburger?
c. What is Ron's total revenue?
d. What is his total cost?
e. What is Ron's economic profit?
Answer: a. Ron produces 20 hamburgers per hour.
b. The price is $6 for a hamburger.
c. Ron's total revenue is $120 an hour.
d. Ron's total cost is $80 an hour.
e. Ron's economic profit is $40 an hour.
Topic: Single-price monopoly, profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 14.2
Author: SB
23) "A single-price monopoly charges a higher price and produces more output than a perfectly competitive
industry." Is the previous statement correct or incorrect? Explain your answer.
Answer: The statement is partially correct because a monopoly charges a higher price than is the case in a
perfectly competitive industry. However the statement also is partially incorrect because the
monopoly produces less output than is the case in a perfectly competitive industry.
Topic: Monopoly and competition compared, output and price
Skill: Level 2: Using definitions
Objective: Checkpoint 14.3
Author: JC
24) Compare the outcome in a market with a single-price monopoly to that in a perfectly competitive market.
Answer: The monopoly charges a higher price and produces less output than in a perfectly competitive market.
The monopoly creates a deadweight loss by producing less than the efficient quantity of output,
whereas a perfectly competitive market produces the efficient quantity of output and so has no
deadweight loss. The monopoly decreases consumer surplus and increases producer surplus from
what they would be if the market is perfectly competitive.
Topic: Monopoly and competition compared, output and price
Skill: Level 3: Using models
Objective: Checkpoint 14.3
Author: CD
25) Explain how a single-price monopoly determines its output and price. Compare this process to how a
perfectly competitive firm determines its output and price.
Answer: Single-price monopolies follow the same profit-maximizing rule as perfectly competitive firms and set
their output level where marginal revenue equals marginal cost. However, unlike perfectly
competitive firms, monopolies have control over price and can charge as much as the market will bear;
therefore, given the quantity they produce, the monopoly chooses its price from the market demand
curve.
Topic: Monopoly and competition compared, output and price
Skill: Level 4: Applying models
Objective: Checkpoint 14.3
Author: SB
26) Which creates a larger deadweight loss, perfect competition or a single-price monopoly?
Answer: The single-price monopoly creates a larger deadweight loss because perfect competition does not
create a deadweight loss.
Topic: Monopoly and competition compared, deadweight loss
Skill: Level 2: Using definitions
Objective: Checkpoint 14.3
Author: MR
27) How do the price, output, consumer surplus, economic profit, and total surplus for a single-price monopoly
compare to that of a competitive industry?
Answer: For the monopoly, price is higher, output is lower, consumer surplus is less, economic profit is larger,
and total surplus is smaller relative to a competitive industry.
Topic: Monopoly and competition compared, surpluses
Skill: Level 2: Using definitions
Objective: Checkpoint 14.3
Author: TS
28) "Compared to a competitive market, a single-price monopoly decreases the consumer surplus and increases
the economic profit." Is the previous statement correct or incorrect? Explain your answer.
Answer: The statement is correct. A single-price monopoly produces less than a competitive market and sets a
higher price, both of which decrease the consumer surplus but increase the economic profit.
Topic: Monopoly and competition compared, surpluses
Skill: Level 2: Using definitions
Objective: Checkpoint 14.3
Author: TS
29) Suppose the government breaks up a single-price monopoly and turns it into a perfectly competitive
industry. What will happen to price and the quantity produced? What will happen to the monopoly's
economic profit and the deadweight loss associated with the monopoly?
Answer: The price will fall and output will increase to the efficient level. The monopoly's economic profit will
revert to the consumers as consumer surplus as the price falls and the quantity increases. The
deadweight loss will be eliminated as output and the consumer surplus increase.
Topic: Monopoly and competition compared, surpluses
Skill: Level 4: Applying models
Objective: Checkpoint 14.3
Author: SB
30) What is rent seeking? How does rent seeking affect the deadweight loss from monopoly?
Answer: 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 someone else. Often, rent seeking takes the
form of lobbying to increase the economic profit of the lobbyist. Rent seeking increases the deadweight
loss from monopoly. With rent seeking, not only does the monopoly create the (standard) deadweight
loss, but also resources are used up in the process of rent seeking itself.
Topic: Rent seeking
Skill: Level 1: Definition
Objective: Checkpoint 14.3
Author: PH
31) "Because of rent seeking, a monopoly may end up earning a normal profit." Is the previous statement correct
or incorrect? Why?
Answer: The statement is correct. Competition among rent seekers might cause the successful person striving to
create a monopoly to pay so much in order to create the monopoly that, when taking into account the
cost of creating the monopoly, the person earns only a normal profit.
Topic: Rent seeking
Skill: Level 1: Definition
Objective: Checkpoint 14.3
Author: TS
32) The above figure represents a perfectly competitive industry that is taken over by a single firm and operated
as a monopoly.
a. What was the competitive price and quantity?
b. What is the monopoly price and quantity?
c. What area represents consumer surplus under perfect competition?
d. What area represents consumer surplus under monopoly?
e. What area represents the deadweight loss of monopoly?
Answer: a. The competitive price was P2 and the competitive quantity was Q2.
b.
The monopoly price is P3 and the monopoly quantity is Q1.
c.
The consumer surplus with perfect competition is the area P4P2c.
d. The consumer surplus with monopoly is the area P4P3a.
e. The deadweight loss from the monopoly is the area abc.
Topic: Monopoly and competition compared, surpluses
Skill: Level 3: Using models
Objective: Checkpoint 14.3
Author: SB
33) Define price discrimination. What factors must be present in order for a firm to price discriminate? Why do
firms price discriminate?
Answer: Price discrimination is selling a good or service at a number of different prices. In order to price
discriminate, the firm must be able to identify and separate different types of buyers. In particular, the
firm must be able to identify which buyers are willing to pay a higher price than other buyers. And the
firm must sell a product that cannot be resold. Therefore it must not be possible for a buyer who pays
a low price to resell the product to a buyer who is willing to pay a higher price. Firms price
discriminate because it increases their profit. By price discriminating the firm can charge a buyer a
price that is closer to the maximum price the buyer is willing to pay. By setting the price closer to the
maximum a buyer is willing to pay the firm can gain added total revenue and thereby added
economic profit.
Topic: Price discrimination
Skill: Level 1: Definition
Objective: Checkpoint 14.4
Author: WM
34) Give an example of price discrimination.
Answer: Price discrimination occurs when senior citizens get cheaper drugs, students get discounts at movies,
or children under two can enter museums free.
Topic: Price discrimination
Skill: Level 2: Using definitions
Objective: Checkpoint 14.4
Author: SA
35) "Price discriminators lose money by being nice to their customers." Is the previous statement correct or
incorrect?
Answer: The statement is incorrect price discrimination allows the firm to increase its economic profit.
Topic: Price discrimination
Skill: Level 2: Using definitions
Objective: Checkpoint 14.4
Author: SB
36) "Price discrimination allows a monopoly to increase his or her economic profits by capturing part of the
consumer surplus and turning it into economic profit." Is the previous statement correct or incorrect? If the
statement is correct, why is it important in understanding firms' behaviors? If it is incorrect, why is it
incorrect?
Answer: The statement is correct. The statement is important because it explains why firms want to price
discriminate, namely because they can convert some of the consumer surplus into extra economic
profit. Hence firms endeavor to price discriminate because if they can do so, they can increase their
economic profit.
Topic: Price discrimination
Skill: Level 2: Using definitions
Objective: Checkpoint 14.4
Author: PH
37) Why do some firms price discriminate? Relate your answer to the common practice of public colleges
charging lower tuition to in-state students and higher tuition to out-of-state students.
Answer: Price discrimination helps businesses capture more consumer surplus and hence increase their
economic profit. Basically the firm charges more to people who are willing to pay more. For a public
college, out-of-state students will likely have a higher willingness to pay for attending that college
because, by leaving their home state, they are demonstrating that they truly want to attend the college.
If the college charged in-state residents the same tuition as out-of-state residents, the college would
miss the chance to maximize revenue from each group. Charging in-state residents the same high price
as out-of-state residents would lead to a massive drop in quantity demanded and thus lower total
revenue. By separating their customers based on differing demand conditions, the college earns more
total revenue.
Topic: Price discrimination
Skill: Level 2: Using definitions
Objective: Checkpoint 14.4
Author: JC
38) Compare and contrast the effect of perfect competition to the effect of perfect price discrimination on:
a. efficiency.
b. consumer surplus.
c. economic profit in the long run.
Answer: a. Both perfect competition and perfect price discrimination create efficiency.
b. Consumers receive consumer surplus with perfect competition. However, there is no consumer
surplus with perfect price discrimination.
c. Perfectly competitive firms cannot earn an economic profit in the long run. A perfectly price
discriminating monopoly earns the maximum amount of economic profit.
Topic: Perfect price discrimination
Skill: Level 4: Applying models
Objective: Checkpoint 14.4
Author: PH
39) Which produces more output: a perfectly price discriminating monopoly or a single-price monopoly?
Answer: The monopoly practicing perfect price discrimination produces more output. Indeed, a perfectly price
discriminating monopoly produces the efficient level of output.
Topic: Perfect price discrimination
Skill: Level 3: Using models
Objective: Checkpoint 14.4
Author: SA
40) A monopolist has the market demand and marginal cost schedules given in the above table. If the monopoly
can perfectly price discriminate, what is the profit-maximizing level of output and price?
Answer: As a perfectly price discriminating monopoly, the profit-maximizing level of output is 4 units and the
price ranges from $22 to $16 for each unit.
Topic: Perfect price discrimination
Skill: Level 3: Using models
Objective: Checkpoint 14.4
Author: TS
41) The above figure represents the cost, market demand, and marginal revenue curves for a monopoly.
a.
Indicate the price and quantity a single-price monopoly selects by labeling the price Pm and
b.
the quantity Qm.
In the figure, lightly shade in the area that represents the single-price monopoly's economic profit.
c. Indicate the quantity a perfectly price-discriminating monopoly selects by labeling it Qppd.
d. In the figure, more darkly shade in the area that represents the additional economic profit the monopoly
earns as a result of the perfect price discrimination.
Answer:
a.
b.
The price is labeled Pm and the quantity is labeled Qm.
The single-price monopoly's economic profit is the lightly shaded rectangle.
c.
d.
The quantity is labeled Qppd.
The additional profit is the two darker areas in the figure.
Topic: Perfect price discrimination
Skill: Level 4: Applying models
Objective: Checkpoint 14.4
Author: SB