Download Chapter 14 Monopoly

Chapter 14
Monopoly
14.1 Monopoly and How It Arises
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
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Bade/Parkin œ Foundations of Economics, Third Edition
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
Chapter 14 Monopoly
295
14.2 Single-Price Monopoly
1) 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
2) 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
3) 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
4) 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
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5) 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
6) "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
Chapter 14 Monopoly
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7) 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
8) 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
9) 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
298
Bade/Parkin œ Foundations of Economics, Third Edition
Quantity
(units)
15
13
11
9
7
5
3
1
0
Price
(dollars)
0
1
2
3
4
5
6
7
8
Total revenue
(dollars)
____
____
____
____
____
____
____
____
____
Marginal revenue
(dollars)
____
____
____
____
____
____
____
____
____
10) The above table gives a monopoly's demand schedule. Complete the table by calculating
the total revenue and the marginal revenue.
Answer:
Quantity
(units)
15
13
11
9
7
5
3
1
0
Price
(dollars)
0
1
2
3
4
5
6
7
8
Total revenue
(dollars)
0
13
22
27
28
25
18
7
0
The completed table is above.
Topic: Marginal revenue
Skill: Level 3: Using models
Objective: Checkpoint 14.2
Author: WM
Marginal revenue
(dollars)
13
9
5
1
-3
-7
-11
-7
Chapter 14 Monopoly
Price
(dollars)
6
5
4
3
2
1
Quantity
(units)
1
2
3
4
5
6
Total revenue
(dollars)
____
____
____
____
____
____
Marginal revenue
(dollars)
____
____
____
____
____
____
11) The above table gives a monopoly's demand schedule. Complete the table by calculating
the total revenue and the marginal revenue.
Answer:
Price
(dollars)
6
5
4
3
2
1
Quantity
(units)
1
2
3
4
5
6
Total revenue
(dollars)
6
10
12
12
10
6
The completed table is above.
Topic: Marginal revenue
Skill: Level 3: Using models
Objective: Checkpoint 14.2
Author: PH
Marginal revenue
(dollars)
4
2
0
-2
-4
299
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Bade/Parkin œ Foundations of Economics, Third Edition
Quantity
(units)
0
1
2
3
4
5
6
7
8
Price
(dollars)
24
22
20
18
16
14
12
10
8
Marginal revenue
(dollars)
____
____
____
____
____
____
____
____
12) The demand schedule for a single-price monopoly is given in the above table. Calculate the
marginal revenue.
Answer:
Quantity
(units)
0
1
2
3
4
5
6
7
8
Price
(dollars)
24
22
20
18
16
14
12
10
8
Marginal revenue
(dollars)
The completed table is above.
Topic: Marginal revenue
Skill: Level 3: Using models
Objective: Checkpoint 14.2
Author: TS
22
18
14
10
6
2
-2
-6
Chapter 14 Monopoly
13) 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.
b.
c.
d.
Demand is elastic from 0 to 20 pounds of fish.
Demand is inelastic from 20 to 40 pounds of fish.
Total revenue is maximized when the price is $8 a pound.
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
301
302
Bade/Parkin œ Foundations of Economics, Third Edition
Quantity
(units)
1
2
3
4
5
6
7
8
Price
(dollars)
22
20
18
16
14
12
10
8
Marginal revenue Marginal cost
(dollars)
(dollars)
20
6
16
8
12
12
8
18
4
28
0
40
-4
54
-8
70
14) 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
Chapter 14 Monopoly
303
15) 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
304
Bade/Parkin œ Foundations of Economics, Third Edition
16) 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.
b.
c.
d.
e.
Ron produces 20 hamburgers per hour.
The price is $6 for a hamburger.
Ron's total revenue is $120 an hour.
Ron's total cost is $80 an hour.
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
Chapter 14 Monopoly
305
14.3 Monopoly and Competition Compared
1) "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
2) 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
3) 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
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4) 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
5) 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
6) "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
7) 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
Chapter 14 Monopoly
307
8) 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
9) "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
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Bade/Parkin œ Foundations of Economics, Third Edition
10) 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
Chapter 14 Monopoly
309
14.4 Price Discrimination
1) 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
2) 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
3) "Price discriminators lose money by being nice to their customers." Is the previous
statement correct or incorrect?
Answer: The statement is incorrectπprice discrimination allows the firm to increase its
economic profit.
Topic: Price discrimination
Skill: Level 2: Using definitions
Objective: Checkpoint 14.4
Author: SB
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Bade/Parkin œ Foundations of Economics, Third Edition
4) "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
5) 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
Chapter 14 Monopoly
311
6) 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
7) 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
312
Bade/Parkin œ Foundations of Economics, Third Edition
Quantity
(units)
1
2
3
4
5
6
7
8
Price
(dollars)
22
20
18
16
14
12
10
8
Marginal cost
(dollars)
9
10
12
16
22
30
40
52
8) 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
Chapter 14 Monopoly
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9) 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 the quantity Qm.
b. 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.
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Bade/Parkin œ Foundations of Economics, Third Edition
Answer:
a.
The price is labeled Pm and the quantity is labeled Qm.
b.
c.
The single-price monopoly's economic profit is the lightly shaded rectangle.
The quantity is labeled Qppd .
d. 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