Download Monopoly Exercise #1 Answers

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Monopoly Exercise #1 Answers (
points)
Please limit your answers to the spaces provided. If necessary, write on the back of the page.
Do not attach printout or additional pages. All questions pertain to the Monopoly module in the
SimEcon® software package.
Make sure that you have read the “Monopoly Manual” and “SimEcon® Operation
Instructions.” These materials may be found at the Class Web site prior to beginning the
exercise. For many of the exercise’s questions, it will be necessary to refer to those instructions.
For many of the exercise’s questions, it will be necessary to refer to your text.
Open the Monopoly module of SimEcon®. Write down the initial conditions below:
Total Output (kwh):
Entry Cost:
Total Revenue:
Total Cost:
Total Profit:
10,000,000.00
$ 300,000.00
$ 3,037,000.00
$ 1,802,377.29
$ 1,234,622.71
Price:
Marginal Revenue:
Marginal Cost:
Average Total Cost:
$ 0.3037
$ 0.2369
$ 0.1301
$ 0.1802
Is the above Monopolist maximizing profit? No (Yes, No). Why or why not? Because
marginal revenue is greater than marginal cost. Should this monopolist increase production,
decrease production, or leave output unchanged? The monopolist should increase production.
Note that the price is greater than marginal revenue. Is this always the case with a monopolist?
Yes (Yes, No). Why or why not? This is because the monopolist faces the market demand
curve. In order to increase output, he or she must lower the price. Must the monopolist
always be earning an economic profit? No (Yes, No). Why or why not? The monopolist’s
level of profit also depends on average total cost. Even if a firm has monopoly power, the
firm’s costs may still be too high to make an economic profit possible.
Click “Continue.” Leave the monopolist’s entry costs at $300. Click “Make Decisions.” Set the
output level equal to 20,000,000 units. Click “See Results.” Fill in the table below:
Total Revenue:
Total Cost:
Total Profit:
$ 4,738,000.00
$ 3,061,461.58
$ 1,676,538.42
Price:
Marginal Revenue:
Marginal Cost:
Average Total Cost:
$ 0.2369
$ 0.1033
$ 0.1228
$ 0.1531
What has happened to profit compared to the last example? It has increased. Do you think that
increasing production compared to the last example was a wise decision? Yes (Yes, No). Is the
above monopolist maximizing profit? No (Yes, No). Why or why not? Because marginal
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Monopoly Exercise #1 Answers
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revenue is less than marginal cost. Should this monopolist increase production, decrease
production, or leave output unchanged? The monopolist should decrease production.
How does the monopolist maximize profits (or minimize losses)? The monopolist maximizes
profits or minimizes losses by producing the output where marginal revenue is equal to
marginal cost. Click “See Graph”, and draw the resulting graph that you see below. Indicate
the monopolist’s current level of production (Q´) and the profit maximizing level of production
(Q*).
$
MR
Q´ Q*
D
ATC
MC
Q
Q´ represents the current level of production. The output at the intersection of the MC and
MR curves, indicated by Q*, shows the profit maximizing level of production.
Click the “Back” button, and then click “Regulate.” Select the button entitled, “Regulate Price.”
In a few moments when the progress bar has completed its second sweep you will get the results.
Fill in the table below.
Item
Your Monopoly
Average Cost Price
Price:
Output:
Profit:
$ 0.2369
20,000,000.0000
$1,676,538.4200
$ 0.1393
36,604,000.0000
$ 0.0000
Marginal Cost Price
$ 0.1178 _
37,829,500.0000
- $ 742,839.9000
Which regulation generates the most output? Marginal cost pricing. Which regulation results
in the lowest price? Marginal cost pricing. Which regulation scheme benefits the consumer the
most? Marginal cost pricing. Which scheme generates the least output? Your monopoly.
Which scheme generates the highest profit for the monopolist? Your monopoly. Under all
three schemes, the amount of profit indicated represents economic profit or loss. Under average
cost pricing, is the monopolist still earning an accounting profit? Yes (Yes, No). Under
average cost pricing, is the monopolist earning a below normal, normal, or above normal rate of
return? Normal rate of return. Considering the level of output, the price to the consumer and
the profits to the monopolist, which scheme provides the best overall balance between the
welfare of the consumer and the ability of the monopolist to stay in business?
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Monopoly Exercise #1 Answers
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Average cost pricing. Elaborate on your reasons for your answer. Average cost pricing
generates almost as much output and consumer surplus as marginal cost pricing, and it
generates that output at almost the same price as marginal cost pricing. Yet, since
economic profits are zero with average cost pricing, it allows the monopolist to earn a
normal rate of return. Marginal cost pricing, which does not allow this firm to make a
normal rate of return is not usable in the long run, since the firm would go out of business
if put in that situation (unless there was a government subsidy or two part pricing – a price
for access to the grid and another for the electricity--neither considered in this module).
Click the “Back” button once. You will return to the second table of this exercise. Click “New
Output” and select an output of 17,000,000 units. Fill in the table below.
Total Revenue:
Total Cost:
Total Profit:
$ 4,367,980.00
$ 2,690,715.73
$ 1,677,264.27
Price:
Marginal Revenue:
Marginal Cost:
Average Total Cost:
$ 0.2569
$ 0.1434
$ 0.1244
$ 0.1583
Comparing this table with an output level of 20,000,000 units, which output level has the highest
total cost? 20,000,000 units. Which output level has the higher profit? 17,000,000 units.
Which production level has the lower average cost? 20,000,000 units. Does the output level
with the minimum total costs have to be the output level with the highest profit? No (Yes, No).
Why or why not? Because you have to consider total revenue as well.
Is the above monopolist (17,000,000 units) maximizing profit? No (Yes, No). Why or why
not? Because marginal revenue is greater than marginal cost. Should this monopolist
increase production, decrease production, or leave output unchanged? The monopolist should
increase production.
Click “New Output.” Select an output level of 18,000,000 units. Click “See Results.” Fill in the
table below:
Total Revenue:
Total Cost:
Total Profit:
$ 4,504,680.00
$ 2,814,814.74
$ 1,689,865.26
Price:
Marginal Revenue:
Marginal Cost:
Average Total Cost:
$ 0.2503
$ 0.1300
$ 0.1238
$ 0.1564
Is the above monopolist (18,000,000 units) maxmimizing profit? No (Yes, No). Why or why
not? Because marginal revenue is greater than marginal cost. Is MR closer to MC than
before? Yes (Yes, No). Should this monopolist increase production, decrease production, or
leave output unchanged? The monopolist should increase production. Click “Firm Graph”,
and draw the resulting graph. Indicate the current (Q´) and profit maximizing (Q*) levels of
output.
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$
ATC
MC
MR
Q´ Q*
D
Q
Given your answers for 20,000,000 units and 18,000,000 units, in what range do you think is the
profit maximizing output? Between 20,000,000 and 18,000,000. Explain why you think the
profit maximizing output is in this range. At 20,000,000 marginal revenue is less than
marginal cost. At 18,000,000 marginal revenue is greater than marginal cost. In between
there must be an output where marginal revenue and marginal cost are equal and that is
the maximum profit output.
Considering the shapes of the marginal cost and average cost graphs that you have drawn in this
exercise, do you think that this industry is an increasing cost industry, a constant cost industry or
a decreasing cost industry? Decreasing cost. What are your reasons for this answer? All the
graphs show a steadily declining average total cost curve and numerically the larger the
output set the lower average and marginal cost turn out to be.
Which of the following organizations do you think would most typify the graphs and results
presented in this exercise: (1) a 7-Eleven Store; (2) a commodities exchange; (3) a public utility
such as the firm (or agency) supplying electricity to a region; or (4) a fast food restaurant? A
public utility. What is a natural monopoly?
A natural monopoly is an industry where
there is such a degree of decreasing costs with increasing scale of output that a single firm
is more efficient (lower cost) than a number of competing firms can.
Do the graphs and results presented in this exercise indicate a natural monopoly? Yes (Yes,
No). In what manner do these results indicate or not indicate a natural monopoly? These
results show a pattern of steadily declining average costs with increasing scale of
production.
Should the government allow a firm as described in this exercise to continue to operate? Yes
(Yes, No). Review the results that you obtained earlier in this exercise. Which regulation
scheme provides the best balance of competing interests? Average cost pricing.
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Is it easy to accurately measure the average total costs of a natural monopoly? No (Yes, No).
Has this type of problem situation caused political controversy in the United States? Yes (Yes,
No).
What pricing scheme does your utility bill reflect? Average cost pricing. Do you think that it
is difficult to measure the costs of providing electricity service? Yes (Yes, No). What
arguments might a public utility make in order to pressure the government to allow the utility to
charge higher rates? The public utility might argue that the current rates that it is allowed
to charge do not provide the company with a “fair” rate of profit, i.e. a normal rate of
return.
Does a public utility provide a good example of a “natural monopoly”? Yes (Yes, No). What
might be an argument in favor or deregulating a public utility and breaking up the monopoly into
smaller units? In most situations more competition means a higher total output at a lower
price.
What might be an argument against such deregulation? The industry is characterized by a
“natural monopoly” where the benefits of a large scale of production outweigh the
problems associated with a monopoly.