Download chapter 9 monopoly answers to online review questions

CHAPTER 9
MONOPOLY
ANSWERS, SOLUTIONS, AND EXERCISES
ANSWERS TO ONLINE REVIEW QUESTIONS
1. It is sometimes difficult to decide whether a firm is a monopoly because defining close
substitutes for a particular product can be difficult. When there is just one seller of a good
for which very few buyers could find a substitute, it is known as a perfect monopoly.
Markets for electricity and natural gas often qualify as perfect monopolies (although
these are in the process of becoming more competitive).
2. Monopolies arise because of barriers to entry such as economies of scale, control of a
scarce input, or barriers created by government. Economies of scale over a very large
range of output are a barrier to entry since they mean that one firm can produce at a lower
cost per unit than can two or more firms. If a firm has control of a scarce input needed for
production, other firms may not be able to enter that market. Finally, when a government
believes that it is in the public’s interest to have a single seller, it will prevent entry.
3. The government can create a monopoly by awarding patents and copyrights and by
granting legal and exclusive franchises. The government might award patents and
copyrights to encourage firms and individuals to bear the costs and risks of innovation.
Or, if the government believes that the market is a natural monopoly, it may grant a legal
and exclusive franchise to a firm.
4. The CEO is wrong to believe that he can set any price he wants and sell as many units as
he wants at that price. Once the CEO decides what price he wants to sell at, the demand
curve will dictate how much output can be sold at that price. Conversely, the CEO may
decide how much output he wants to sell, and the demand curve will give the maximum
price at which he can sell that output.
5. False. A monopoly doesn’t have a supply curve because it is a price setter.
6. Unlike a perfectly competitive firm, a monopoly will not always shut down if price is less
than AVC. If the monopoly provides goods or services considered vital, the government
may not let it shut down. Also, the monopoly may not shut down if it views the situation
of price less than AVC as temporary. For example, the monopoly may endure losses in
the short run if it feels that doing so will promote the goodwill of its customers and
profits in the long run.
7. A monopoly can earn an economic profit in the long run since there are barriers to entry
that keep competitors from entering and driving down its profit. Under perfect
competition, unhindered entry is what reduces economic profit to zero in the long run.
8. In perfect competition, the market supply curve gives the marginal cost of producing one
more unit of output at each of the perfectly competitive firms. If a monopoly takes over,
it will produce output at one of the previously competitive firms, and its marginal cost
curve for producing that output will be the same as it was for the previously perfectly
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competitive firms. Thus, the marginal cost for the monopoly will be the amount given by
the competitive market supply curve.
9. To maximize profit, each firm produces where marginal revenue equals marginal cost.
This means that firm A has a marginal revenue of 50 and firm B has a marginal revenue
of 3 at the point of profit maximization. In perfect competition, price equals marginal
revenue. Firm A is probably a perfectly competitive firm, since its price equals its
marginal revenue. Firm B is probably a monopoly, since its price exceeds its marginal
revenue.
10. For a given technology of production, monopolies charge higher prices and produce lower
output than perfectly competitive firms. Monopolies may, however, be able to change the
technology of production and shift down the marginal cost curve. This would cause prices
to fall and output to increase. The net effect depends on the strength of each of these forces.
11. Government regulation and rent-seeking activities often drive the economic profits of
monopolies to zero. Firms that are granted a government franchise must accept government
regulation in return. The government may require the firm to submit prices to a public
commission for approval. The commission will try to set prices so that economic profit is
zero. Other firms may have to conduct costly rent-seeking activities to retain their
monopoly status, thereby driving economic profits to zero.
12. A single-price monopoly charges the same price to everyone, while a pricediscriminating monopoly charges different prices to different customers for reasons other
than differences in production costs. In order for a monopoly to price discriminate, it
must face a downward-sloping demand curve; it must be able to identify consumers who
are willing to pay more, and it must be able to prevent low-price consumers from
reselling to high-price consumers. A downward-sloping demand curve means that there
are some customers who are willing to pay for the product at a higher price. To charge
some consumers a higher price, the firm must be able to identify those who are willing to
do so. Finally, if low-price customers could resell the product to high-price customers,
then no one would pay the high price to the firm, so price discrimination would be
impossible.
13. False. If price discrimination lowers the price below what some consumers would pay
under a single-price monopoly, then those consumers will benefit from price
discrimination.
PROBLEM SET
1.
a.
Number of Hot Dogs per Day
0
Total Cost
$ 63
Marginal Cost
$0.40 = ($73 –
63)/25
25
73
0.20
50
78
0.40
75
88
0.60
100
105
0.88
125
125
1.12
150
153
175
188
200
233
1.40
1.80
b. With marginal revenue of $1 per hot dog, the profit-maximizing quantity is found
where MC is closest to $1 (without exceeding $1). That occurs with a quantity of 125
hot dogs per day. Selling 125 hot dogs at $1 each will generate total revenue of $125.
From the table, the cost of producing that quantity is also $125. Therefore, profit will
be zero.
c.
Number of Hot
Dogs per Day
0
Total Cost
$ 63
25
73
50
78
75
88
Marginal
Cost
Total
Revenue
$ 0
$0.40
$6.00
150
0.20
4.00
250
0.40
2.00
300
0.60
100
103
1.00
325
0.88
125
125
0.75
343.75
1.12
150
153
–0.25
337.5
1.40
175
188
–1.25
306.25
1.80
200
233
Marginal
Revenue
–2.25
250
d. As a monopolist, Zeke should choose the quantity at which MR is greater than, and
most nearly equal to, MC. That is, he should sell 100 hot dogs per day and charge a
price of $3.25 each. His profit would be ($3.25 x 100) – $103 = $222.
e. From parts (b) and (d), we know that becoming a monopolist would enable Zeke to
increase his daily profit from zero to $222. If the lobbyist can make him a monopolist
at a cost of $200 per day, Zeke should take him up on it. In that case, Zeke’s daily
profit would be $222 – $200 = $22, which is greater than the zero profit he would
earn as a perfect competitor.
2.
$
MC
ATC
P*
D
MR
Q*
Quantity
The monopolist produces where marginal cost equals marginal revenue and charges P*
dollars per unit. It makes a profit of zero since the ATC associated with Q* equals P*.
3. Using the figures given, we can compute marginal revenue and marginal cost.
Q
100,000
TR
10,000,000
MR
TC
2,000,000
60
200,000
16,000,000
10
3,000,000
20
300,000
18,000,000
20
5,000,000
–20
400,000
16,000,000
500,000
10,000,000
MC
40
9,000,000
–60
65
15,500,000
a. To maximize profit, Warmfuzzy should keep increasing output as long as marginal
revenue exceeds marginal cost. It should produce 300,000 copies at $60 per book.
b. Warmfuzzy’s maximum profit is $18,000,000 – $5,000,000 = $13,000,000.
c. Total cost increases by $1,000,000 at each level. The new total cost and marginal cost
figures are
TC
MC
3,000,000
10
4,000,000
20
6,000,000
40
10,000,000
65
16,500,000
Although total cost has increased, marginal cost has not changed, and marginal revenue is
unaffected. Warmfuzzy should still publish 300,000 copies. (Warmfuzzy’s profit under
this new scenario will fall to $12,000,000.)
4. The marginal revenue curve was drawn under the assumption that No-Choice Airline
charges a single price. When No-Choice begins charging two different prices, there is a
different marginal revenue curve. Firms still equate MR and MC to find output, but with
price discrimination, marginal revenue is different for different types of consumers.
Equating MR and MC for the different types of consumers will give the level of output
that the firm should allocate to each type.
5. a.
Price
Number of Total Cost
Visits
$200
2
Marginal
Cost
$100
Total
Revenue
$400
$50
$175
3
$150
$125
$525
$50
$150
5
$250
$112.50
$750
$50
$125
8
$400
$83.33
$1000
$50
$100
12
$600
$50
$1200
$50
$75
18
$900
$25
$1350
$50
$50
23
$1150
-$40
$1150
$50
$25
25
$1250
Marginal
Revenue
-$262.50
$625
The doctor will charge $125 per patient and see 8 patients per day or she will charge
$100 per patient and see 12 patients per day.
b. If the doctor can perfectly price discriminate, her marginal revenue curve is the same
as her demand curve. She will see 23 patients per day.
6. a. You will tutor two students, and will charge them each $35, for total weekly earnings
of $70.
b. You will tutor four students, charging each student the highest price they are willing
to pay. That is, you will charge prices of $40, $35, $27, and $26. Your total weekly
earnings will be $128.
c. No, because your total revenue ($70) from two students will be less than your total
cost ($75).
d. Yes, because your total revenue ($128) from these four students will be more than
your total cost ($125).
7.
Your graph should show output (Q*) where MC and MR intersect. At Q*, the ATC curve
should lie above the demand curve, but the AVC curve should lie below the demand
curve. Because P > AVC, the firm will stay open in the short run. But because P < ATC,
the firm will exit in the long run.
$
MC
ATC
AVC
D
Q*
MR
Quantity
A technological change that lowers only the monopolist's fixed cost would cause the
ATC curve to shift downward, but leave all other curves unaffected. In the graph below,
if the ATC curve shifts down to the curve labeled "ATC," the firm would break even, and
be indifferent between exiting or staying in the industry in the long run. If the ATC curve
shifts down to the curve labeled ATC2, the firm would make a profit, and would not exit
in the long run.
8. a.
Output
Price
0
$5.60
Total
Revenue
$0
1
$5.50
$5.50
2
$5.40
$10.80
3
$5.30
$15.90
Marginal
Revenue
Total Cost
$0.50
$5.50
$3.00
$1.95
$1.00
$20.80
$6.90
$25.50
$5.05
$8.90
$30.30
$4.90
$34.30
$16.60
$4.50
$13.40
$4.00
7
$13.90
$2.00
$4.80
6 = Q*
$9.45
$0.45
$4.70
$5.10
$5.35
$6.45
$4.90
5
$2.00
$5.45
$5.10
$5.20
Profit
-$0.50
$3.50
$5.30
4
Marginal
Cost
$16.90
$7.00
$20.40
The firm will produce 6 units of output and will earn a profit of $16.90.
$13.90
b.
Output
Price
0
$5.60
Total
Revenue
$0
Marginal
Revenue
Total Cost
$0.50
$5.50
1
$5.50
$5.50
$5.40
$5.30
$15.90
4
$5.20
$20.80
5 = Q*
$5.10
$25.50
6
$5.05
$30.30
$7.45
$9.45
$6.45
$1.45
$10.90
$4.70
$9.90
$3.00
$13.90
$4.80
$11.60
$5.50
$19.40
$4.00
$4.90
$3.35
$2.00
$4.90
7
$1.00
$2.95
$5.10
3
-$0.50
$4.50
$10.80
$34.30
Profit
$4.00
$5.30
2
Marginal
Cost
$10.90
$8.00
$27.40
$6.90
The firm will produce 5 units of output and will earn a profit of $11.60.
c.
Output
Price
0
$5.60
Total
Revenue
$0
1
$5.50
$5.50
2
$5.40
$10.80
Marginal
Revenue
Total Cost
$0.50
$5.50
$2.60
$1.55
$15.90
$5.20
$5.25
$20.80
$5.10
$25.50
6 = Q*
$5.05
$30.30
7
$4.90
$34.30
$10.65
$0.05
$5.30
$4.70
5
$6.15
$0.60
$4.90
4
$2.40
$4.65
$5.10
$5.30
Profit
-$0.50
$3.10
$5.30
3
Marginal
Cost
$15.50
$1.60
$6.90
$4.80
$18.60
$4.10
$11.00
$4.00
$19.30
$6.60
$17.60
$16.70
The firm will produce 6 units of output, as in part a, but will earn a profit of $19.30.
9.
If the price of using a fixed input rises, the monopolist’s average total cost curve will
shift upward. But marginal cost, which is the change in variable cost as quantity varies, will be
unaffected. Similarly, average variable cost will be unaffected. Because marginal cost and
marginal revenue are unaffected, the short-run profit-maximizing price and quantity will be
unchanged.
10. a. As a monopolist, Patty will maximize her profit by producing the output at which MC =
MR. We know that MC = $0.50 per swimmer. From Table 1, admitting the sixth swimmer has a
MR = $2, so it makes sense to admit that person. What about the seventh? Again, from the
table, we see that MR = $0. With a marginal cost of $0.50, Patty would suffer a decline in profit
by admitting that person. So, Q = 6 is the profit-maximizing output level.
At Q = 6, the admission fee would be $7 per swimmer. Table 1 indicates that TR = $42.
TC = TFC + TVC = $25 + (6 x $0.50) = $28. So, profit = $42 – $28 = $14. (Note that at Q = 7,
TR = $42, TC = $25 + (7 x $0.50) = $28.50. so profit would be be lower at $13.50).
b. The excise tax would affect Patty’s marginal cost – raising it by $2 to $2.50 per swimmer.
As in part (a), she maximizes profit by setting MC = MR. This would require an output of 5
swimmers per day (because a sixth would lower MR to $2, which is less than marginal cost
with the excise tax).
With Q = 5, she will charge $8 per swimmer, resulting in a total revenue of TR = $40 per day.
Total cost is TC = TFC + TVC = $25 + (5 x $2.50) = $37.50. Profit would be $40 – 37.50 =
$2.50 per day.
c. The swimming tax would raise Patty’s fixed costs to FC = $25 + $2 = $27 per day. It would
not affect marginal cost, and therefore would not affect her optimal choice of output. Her
profit-maximizing output level would be Q = 5 and the corresponding admission fee would
be $8/swimmer.
What about profit? TR would still be $40 per day. But now, TC = TFC + TVC = $27 + (5 x
$2.50) = $39.50. Her profit would now fall to $0.50 per day.
d. As in part (c), marginal cost would not be affected, but fixed cost would increase to $25 + $5
= $30 per day. If she chose the profit-maximizing output level, she would admit 5 swimmers
per day and charge them $8 each for admission.
Profit would now be determined by comparing TR = $40 with TC = TFC + TVC = $30 + (5 x
$2.50) = $42.50. She would suffer a loss of $2.50 per day.
e. In the short run, Patty will continue to operate because her TR of $40 per day exceeds her
TVC of $30 per day. Also, from a profit perspective, It is better for her to lose $2.50 per day
than to shut down and suffer a daily loss equal to her TFC of $30 per day. In the long run,
however, she will be better off leaving this industry.
f. The first statement is true. The excise tax was $2 per swimmer, but it resulted in Patty
raising her admission fee from $7 to $8 per person. The tax of $2 was shared between
consumers (who paid $1 more per admission) and the producer (whose marginal revenue net
of the tax fell from $7 to $6).
The second statement is not true as stated. A fixed tax has no effect on monopoly unless it is
so large as to create a kiss and cause the firm to exit in the long run.
MORE CHALLENGING QUESTIONS
11. a. With MC = $5, Patty will determine her profit-maximizing output rate by setting MC =
MR. From Table 1, we can see that she will admit Q = 5 swimmers per day, charging each of
them an $8 admission fee. Her profit would be TR – TFC – TVC = $40 – $24 – (5 x $5) = $40 –
$49 = a loss of $9 per day.
To determine whether she should shut down, we can use the shutdown rule, comparing
her TR = $40 to her TVC = $24. Because TR > TVC, she will continue to operate in the short
run, because she would be covering all her variable cost and part of her fixed cost. Shutting
down would entail a larger loss equal to her fixed cost of $24 per day. In the long run, however,
she will leave this industry.
b. The demand curve provides information about potential swimmers’ willingness to pay for
admission. Specifically, we can see that some swimmer is willing to pay as much as $12 to
swim. A second swimmer is willing to pay $11, a third is willing to pay $10 … down to an eight
person willing to pay $5, but no more.
Using this information, and assuming that Patty can determine which swimmers are
willing to pay at least $8 per day and which are willing to pay $5 per day (but less than $8), she
can adjust her pricing according. She will charge $8 to the “first” 5 swimmers and $5 per day to
the “next” 3 swimmers. In this case, she will admit Q = 8 swimmers.
Under this pricing scheme, her TR = (5 x $8) + (3 x $5) = $40 + 15 = $55. TC = TFC +
TVC = $24 + (8 x $5) = $64. Her loss would be $9 per day, so as in part (a) she will continue to
operate in the short run, but leave the industry as soon as she can.
c. By analogy to the reasoning in part (b), Patty would charge a price of $10 to the “first” 3
swimmers, $8 to the next 2, and $5 to another 3 swimmers. She would admit a total of 8
swimmers per day, thereby generating TR = (3 x $10) + (2 x $8) + (3 x $5) = $30 + $16 + $15 =
$61. TC would still be $64, so Patty would now lose $3 per day. She will continue to operate in
both the short run, but leave the industry in the long run.
d. Under perfect price discrimination, Patty will charge each swimmer the maximum amount he
or she would be willing to pay. To determine how many swimmers to admit, she would look for
the quantity at which a horizontal MC = $5 curve crosses the demand curve. That would be Q =
8 swimmers per day. Her total daily cost would still be $64 per day. But now, her TR = $12 +
$11 + $10 + $9 + $8 + $7 + $6 + $5 = $68 per day. If she can practice perfect price
discrimination, she can earn a profit of $4 per day and she willl be happy to continue operating in
both the short run and the long run.
12. Setting MR = 20 – 8Q and MC = Q2 equal to each other, we have 20 – 8Q = Q2, or Q2 +
8Q – 20 = 0. This is a quadratic equation with solution Q = 2.