Chapter 10 Monopoly and Other Forms of Imperfect Competition

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Chapter 9
Monopoly, Oligopoly, and
Monopolistic Competition
6 additional Questions
Even-numbered Qs
Additional Question #1
Market power measures the firm’s ability to
A)
B)
C)
D)
E)
Under cut its competitors.
Resist union wage demands.
Raise its price without losing all of its sales.
Influence the price its competitors charge.
Force consumers to pay prices higher than their reservation
prices.
Ans: C
• This is the way that economists define what market power is.
– A firm has more market power if it is able to raise the price
of its product more and not losing as many customers.
• Firms in a perfectly competitive market do not have any
market power at all.
- Substitution goods are available
– If a firm raises its price in a perfectly competitive market,
all its customers will switch to another firm which is selling
the same product at the market price.
• A firm which is a monopolist has the most market power.
• Because it is the only firm selling a certain kind of product, if it
raises the price, there will still be some customers staying
behind.
• Of course, that does not mean when a firm has market power,
it will not lose any sales at all. When price rises, quantity
demanded inevitably drops (law of demand).
• It just mean the firm will not lose all its customers, unlike in
the case of perfect competition.
Additional Question #2
Suppose a firm increases its labour usage and office space
(the only inputs used) by 10% and observes a 13% increase
in output. The firm has
A)
B)
C)
D)
E)
Increasing returns to scale.
Constant returns to scale.
Violated the law of diminishing marginal returns.
Increased its average costs.
Reduced its total costs.
Ans: A
• A firm is said to have constant returns to scale when an x%
increase in inputs results in an x% rise in output.
• A firm is said to have decreasing returns to scale when an x%
increase in inputs leads to a less than x% rise in output.
• A firm is said to have increasing returns to scale when an x%
increase in inputs causes a more than x% rise in output.
Additional Question #3
a) For a monopolist to maximize profit,
the firm will choose to produce __ units
and charge a price of ___.
A) 3.5; $33.50 B) 7; $19.30
C) 7; $5 D) 3.5; $5 E) 3.5; $22.50
b) The socially efficient price and
output combination is
A) $5 and 7. B) $5 and 3.5.
C) $19.30 and 7. D) $22.50 and 3.5. E)
$33.50 and 3.5.
• A) For a monopolist to
maximize profit, the firm
will choose to produce ?
Units and charge a price of
? .
P
• Is the firm a price setter or
a price taker?
MC
• Price setter (monopolist)
MR
• Therefore, we can simplify
the diagram into this.
D
Q
• The π-max quantity is where
MR=MC.
P
• Therefore, Q*=3.5.
• A monopolist will charge the
reservation price of Q*
according to the Demand
schedule.
• Therefore, Price will be
$22.50 (E)
22.50
MC
MR
3.5
D
Q
• B) The socially efficient Price
and Output combination is
? .
P
• The Socially Efficient point is
where MC meets Demand.
• This is the point where all
potential surpluses have
been extracted.
• The respective P and Q are
$5 and 7. (A)
MC
5
MR
D
7
Q
Additional Question #4
The difference between
consumer surplus given the
monopoly market structure
and consumer surplus with
the socially efficient quantity
is the area _______.
A)
B)
C)
D)
E)
LEI
GCEI
0GI
GJI
GCEL
Ans. B
• The Socially Eff. Point is
where MC meets D.
Price
• The CS when it is socially
efficient is area GJI.
J
MC
I
G
MR
D
Quantity
• But if it is a monopoly, P
will be higher and Q will be
lower.
Price
J
• Q is determined by MR=MC
MC
• P is the corresponding
reservation price on the
Demand curve.
C
E
I
G
MR
A
D
Quantity
• CS under monopoly is area
CJE.
Price
• The difference between CS
(monopoly) and CS (social
efficient) is area GCEI.
J
MC
C
E
• Ans. B
I
G
MR
A
D
Quantity
Additional Question #5
Which of the following situations will come closest to
perfect price discrimination?
A)
B)
C)
D)
E)
Charging a different price on different days.
Charging a different price at the end of the year.
Negotiating a price with a group of customers.
Negotiating a price with each individual consumer.
Offering instant, in store rebates.
Ans: D
• Price Discrimination is a way to reduce inefficiency in a
monopoly, and also a way for monopolist to capture the
entire consumers’ surplus.
• The practice of charging each buyer a different price for
essentially the same good or service.
• Perfect price discrimination is also called ‘First Degree Price
Discrimination’.
• The price charged is the maximum or the exact reservation
price the customer is willing to pay.
• In view of this, Option D is the closest to perfect price
discrimination.
Additional Question #6
In its efforts to keep medical costs down, the government has decided to
impose a $15 price ceiling on a weekly dose of this drug. What is likely to
happen?
a)
The firm will produce 400 doses per
week causing excess supply of this
drug on the market.
b)
This drug will disappear from the
market.
125
c)
The firm will produce 325 doses per
week, just meeting consumer
demand.
45
d)
The firm will produce 200 doses per
week, the quantity at which price
equals MC.
e)
New firms will enter this market due
to the high quantity demanded at
$15.
P
D
150
25
15
ATC
MC
150 220
MR
250
300 350 400
Q
Ans: B
P
D
$150
125
$45
$25
$15
Loss
ATC
MC
150 220
MR
250
300 350 400
Q
• As there is a price ceiling of $15, the MR of selling a dose is no
longer the original MR that is derived from the Demand curve.
• The MR is now $15
• Therefore, if the manufacturer is to produce anything, the
profit-max quantity would be where MC meets the new MR
($15).
• Price ceiling is $15.
• Profit-max quantity is 220.
P
D
• However, the AC of each
dose is $45.
• Therefore, the producer will
be making a loss when
there is a price ceiling.
$45
ATC
$15
MC
• It will choose not to
produce at all. (B)
220
Q
Chapter 9, Problem 2
2) State whether the following statements are true or false, and
explain why.
a) In a perfectly competitive industry, the industry demand curve is
horizontal, whereas for a monopoly it is downward-sloping.
False
b) Perfectly competitive firms have no control over the price they
charge for the product.
True
c) For a natural monopoly, average cost declines as the number of
units produced increases over the relevant output range.
True
2a) In a perfectly competitive industry, the industry demand curve
is horizontal, whereas for a monopoly it is downward-sloping.
False
Perfectly competitive firm:
Firms are price-taker, no control and no influence over price.
Goal is to choose the optimal output level to maximize the profit.
Firms can sell as much as it wishes at the given price level.
Therefore, Demand curve is perfectly elastic (horizontal)
Price
D
Quantity
Imperfectly competitive firm:
Have market power: a firm’s ability to raise the price of a good
without losing all its sales.
They are price setter.
Face a negatively sloped Demand curve
Price
D
Quantity
In the firm’s point of view,
Demand curve is horizontal for Perfectly Competitive Firm
Demand curve is downward-sloping for Imperfectly Competitive
Firm
However, the industry demand curve is downward-sloping in BOTH
case. Supply curve and Demand curve intersect to determine the
equilibrium price.
2b) Perfectly competitive firms have no control over the price they charge
for the product.
True, according to the assumption of Perfectly Competitive Firm.
Perfectly Competitive Firm is a price-taker and has no control or no
influence over the price at which it sells its product.
Their goal is to choose the optimal output level to maximize its profit.
They can sell as much output as they wish at the market price.
If they set price higher than market price, they will lose all their
businesses, can’t sell any of its output.
If they set price lower than market price, they will not be maximizing
profit.
2c) For a natural monopoly, average cost declines as the number of
units produced increases over the relevant output range.
True. This is the essential feature of natural monopoly.
TC = FC + VC (or MC*Q)
ATC = FC/Q + MC
For a natural monopoly, its production usually entails large fixed
start-up costs and low variable costs. i.e. software production
The invention of new software usually entails a large fixed start-up
cost. Once the invention is done, additional copies of the software
can be produced at a very low marginal cost.
As quantity increases, marginal cost of an additional output is low
and ATC declines steadily.
Chapter 9, Problem 4
4) If a monopolist could perfectly price-discriminate:
a) The marginal revenue curve and the demand curve would
coincide.
b) The marginal revenue curve and the marginal cost curve would
coincide.
c) Every consumer would pay a different price.
d) Marginal revenue would become negative at some output level.
e) The resulting pattern of exchange would still be socially
inefficient.
Ans: a
Perfectly discriminating monopolist: a firm that charges each buyer
exactly the highest price he is willing to pay (his reservation price).
So that each unit would generate revenue that is identical to the
reservation price. MR = D
Demand curve captures the buyer’s reservation price.
MR curve captures the Monopolist’s revenue from selling an
additional unit of output.
So, for the perfect price discriminator, marginal revenue curve
becomes identical with the demand curve.
Therefore, (A) is True.
(C) Every consumer would pay a different price.
False: Two or more consumers might have the same reservation price.
(D) Marginal revenue would become negative at some output level.
False: no such rule for perfectly price-discriminate. MR could be
negative even if it’s not under price-discriminate.
(E) The resulting pattern of exchange would still be socially inefficient.
False: The final unit of output would be sold at a price equal to MC---socially efficient.
Monopolist will charge exactly a the consumer’s reservation price until
the last consumer’s reservation price equals to the monopolist’s MC,
P=MC.
Chapter 9, Problem 6
What is socially desirable price for a natural monopoly to charge?
Why will a natural monopoly that attempts to charge the socially
desirable price invariably suffer an economic loss?
MC
MR
D
The socially efficiency price is achieved when marginal benefit to
consumer (not MB for monopolist) equals the marginal cost to
society.
Marginal benefit to consumer, the most that buyers willing to pay for
an additional unit of output, which is shown on the monopolist’s
demand curve.
Marginal cost to society is the same as the cost to monopolist,
which is shown on the monopolist’s marginal cost curve.
Therefore, social efficiency is achieved when market demand curve
intersects the monopolist’s marginal cost curve.
Why will a natural monopoly that attempts to charge the
socially desirable price invariably suffer an economic
loss?
• Economic loss when P < ATC.
• Natural monopolies are usually characterized by very large fixed
start-up costs and relatively low marginal costs.
ATC = FC/Q + MC
• The high fixed costs mean that average cost is greater than
marginal cost.
ATC > MC
• If a natural monopoly attempts to charge a socially desirable price,
P=MC
Economic loss when P < ATC
Firm with high FC
(Economic Loss)
Firm with low FC
(Economic Profit)
MC
ATC
MC
Mono.
Price
ATC
Mono.
Price
ATC
ATC
MR
D
MR
D
Chapter 9, Problem 8
Serena is a single-price, profit maximizing monopolist in the sale of
her own patented perfume whose demand and marginal cost curves
are as shown. Relative to the consumer surplus that would result at
the socially optimal quantity and price, how much consumer surplus
is lost from her selling at the monopolistic profit-maximizing quantity
and price?
P
$ per ounce
60
Net Loss in
consumer surplus
MC
40
Perfectly
competitive output:
P=MC
30
20
Loss in producer surplus
10
Monopolistic
output: P>MR=MC
Transfer from
CS to
0
monopoly
producers
MR
8
12
Ounces/day
D
24
Q
P
60
Gain in
producer
surplus
Net Loss in
consumer surplus
MC
40
30
Loss in producer surplus
20
10
MR
0
8
12
Ounces/day
D
24
Q
• Perfectly competitive output: P=MR=MC
– 12 ounces, $30 each ounce
• Monopolistic output: P > MR=MC
– The firm still produce at MR=MC, but it charges a price higher
than MC
– 8 ounces, $40 each ounce
– Serena produces less than the perfectly competitive output
• Consumers loss due to the monopolistic price
• Loss in consumer surplus
= the area of the trapezoid between $30 and $40
= (8 +12) * ($40 - $30) *1/2 = $100
• However, part of loss in consumer surplus is actually transferred to
the monopoly producers
• The portion of the loss of consumer surplus is not a loss to society.
It is a redistribution from consumers to the monopoly producers
• That is the area of rectangle between $30 and $40
• Transfer from consumer surplus to monopoly rent
= ($40 - $30) * 8 * = $80
• Net loss in consumer surplus (shown in green)
= $100 - $80 = $20
Chapter 9, Problem 10
Beth is a second-grader who sells lemonade on a street corner in
your neighborhood. Each cup of lemonade costs Beth 20 cents to
produce; she has no fixed costs. The reservation prices for the 10
people who walk by Beth’s lemonade stand each day are listed in
the following table.
Person
A
Reservation
Price
$1
B
C
D
E
F
$0.9 $0.8 $0.7 $0.6 $0.5
G
H
I
J
$0.4
$0.3
$0.2
$0.1
Beth knows the distribution of reservation prices (that is, she knows
that one person is willing to pay $1, another $0.9, and so on), but
she does not know any specific individual’s reservation price.
a) Calculate the marginal revenue of selling an additional cup of
lemonade. (Start by figuring out the price Beth would charge if she
produced only one cup of lemonade, an calculate the total revenue;
then find the price Beth would charge if she sold two cups of
lemonade; and so on.)
First, we need to compute the Total Revenue according to different
people’s reservation price.
For example,
If she charges $1 for one lemonade, she attracts 1 customer.
TR = $1
If she charges $0.9 for one lemonade, she attracts 2 customers.
TR = $1.8
If she charges $0.8 for one lemonade, she attracts 3 customers.
TR = $2.4
And so on…
a)
Person
A
B
C
D
E
F
G
H
I
J
Quantity
1
2
3
4
5
6
7
8
9
10
Reservation
Price ($)
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
Total
Revenue ($)
1
1.8
2.4
2.8
3.0
3.0
2.8
2.4
1.8
1
Marginal
Revenue ($)
1
0.8
0.6
0.4
0.2
0
-0.2
-0.4
-0.6
-0.8
b) What is Beth’s profit-maximizing price?
Her profit-maximizing price is at the point where MR=MC.
Her MC to produce each cup of lemonade is $20 cents.
Person
A
B
C
D
E
F
G
H
I
J
Quantity
1
2
3
4
5
6
7
8
9
10
Reservation
Price ($)
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
Total
Revenue ($)
1
1.8
2.4
2.8
3.0
3.0
2.8
2.4
1.8
1
Marginal
Revenue ($)
1
0.8
0.6
0.4
0.2
0
-0.2
-0.4
-0.6
-0.8
Her profit-maximizing price is $0.6.
c) At the price, what are Beth’s economic profit and total consumer
surplus?
At the profit-maximizing price of $0.6, she produces 5 cups.
Total revenue: $3
Explicit cost: Each cup of lemonade costs 20 cents, $0.2 x 5 = $1
Her Economic profit = $3 - $1 = $2
c) Consumer Surplus: Difference between buyer’s reservation price
and the actual price they pay.
If Beth charges $0.6 each, 5 persons will buy the lemonade.
Person A:
Person B:
Person C:
Person D:
Person E:
($1 - $0.6) = $0.4
($0.9 - $0.6) = $0.3
($0.8 - $0.6) = $0.2
($0.7 - $0.6) = $0.1
($0.6 - $0.6) = $0
Total consumer surplus: $1
d) What price should Beth charge if she wants to maximize total
economic surplus?
Total economic surplus is maximized if she charges P=MC.
MC = $0.2
That is, she should set P=MC = $0.2 and sell 9cups of lemonade.
Total economic surplus:
($1 - $0.2) + ($0.9 - $0.2) + ($0.8 - $0.2) + ($0.7 - $0.2) + ($0.6 $0.2) + ($0.5 - $0.2) + ($0.4 - $0.2) + ($0.3 - $0.2) + ($0.2 - $0.2) =
$3.6
e) Now suppose Beth can tell the reservation price of each person.
What price would she charge each person if she wanted to
maximize profit? Compare her profit to the total surplus calculated
in part d.
Beth can charge each buyer exactly his or her reservation price to
maximize profit.
MC to produce one lemonade is $0.2.
Therefore, she will sell lemonade to nine consumers (consumer A
to I) and will charge exactly his or her reservation price.
Her total revenue is identical to the consumer’s reservation price.
By doing so, her TR is:
$1 + $0.9 + $0.8 + $0.7 + $0.6 + $0.5 + $0.4 + $0.3 + $0.2
= $5.4
TC to sell 9 cups of lemonade:
9 x $0.2 = $1.8
Economic profit:
$5.4 - $1.8
= $3.6
This economic profit is the same as the total surplus in part d.
•
•
Without Price Discrimination, Economic profit = $2, consumer
surplus = $1
With Price Discrimination, Economic profit = $3.6, consumer
surplus = $0 (because monopolist is charging exactly their
reservation prices, Economic surplus equals to producer surplus.)
• With Price discrimination, Monopolist could earn a larger economic profit.
• Price discrimination is:
• a way for monopolist to capture consumer surplus and to increase its
profits
• Monopolist charges exactly the consumer’s reservation price, so
consumer surplus equals to zero.
• All consumer surplus is transferred to the producer.
• Thus, Economic surplus equals exact to Producer surplus.
• a way to reduce inefficiency
• Monopolist will charge exactly a consumer’s reservation price until the
last consumer’s reservation price equals to the monopolist’s MC, P=MC.
• Thus, the usual deadweight loss associated with monopoly disappears.
End of Chapter 9

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