Chapter 9 Monopoly
Review Questions
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.
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.
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.
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. When the monopoly takes over, it will produce output at one of the previously competitive firms, and the marginal cost of producing that output will be the same as it was for the previously perfectly competitive firms. Thus, the marginal cost for the monopoly will be the dollar amount given by the competitive market supply curve.
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.
12. A single-price monopoly charges the same price to everyone, while a price-discriminating 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.
Problems and Exercises
2.
a. In perfect competition, the market demand curve is downward sloping, while the demand curve facing an individual firm is horizontal, indicating that it is a price taker. In monopoly, the market demand curve and the demand curve facing the firm are both the same—a downward-sloping curve.
b. In perfect competition, the firm’s marginal revenue curve coincides with its demand curve, since every unit is sold at the same price. In the case of a monopoly, the marginal revenue curve lies below the demand curve, and both curves are downward sloping. To sell an additional unit of output, the monopoly must lower the price on that unit and all previous units of output.
4.
For a perfect price discriminator, the marginal revenue curve is the same as the demand curve. While a single-price monopoly must lower the price on all units of output if it wants to sell another unit, a perfect-price discriminator only has to lower the price on the additional unit that she wants to sell. This implies that the price-discriminating monopolist’s revenue rises by the price of the additional unit, so the marginal revenue curve coincides with the demand curve.
6. 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.
8. 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 costs ($75).
d. Yes, because your total revenue ($128) from these four students will be more than your total costs ($125).
10.
A technological change that reduced only the monopolist’s fixed costs would shift only its ATC curve downward. If the new ATC curve fell below point E at Q*, then the monopolist would no longer incur an economic loss, and would no longer have an incentive to shut down. For example, if the ATC curve shifted to ATC2, the monopolist would produce at Q*, and would earn the economic profit shown by the shaded area.
A technological change that reduced the monopolist’s variable costs, while leaving its fixed costs alone, would shift its AVC, MC, and ATC curves downward. If these curves shifted down by enough to allow the firm to cover its average total costs at its new profit-maximizing quantity of output, the firm would not have to go out of business. (The graph shows the case where the technological change will allow the monopolist to earn zero profits.)
Challenge Questions
2. 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.
Economics Applications Exercises
2. a. A menu of prices allows a firm to discriminate among consumers, hoping to charge those willing to pay a higher price more, allowing them to increase their profit.
b. If a firm price discriminates, then it can charge higher prices to those with lower price elasticity of demand. For those with higher price elasticities, firms will charge lower prices.
c. If an online company can place an individual within a particular category – student; long-time customer; large wish list but no purchases; etc – then it can charge different prices to different individuals. Because a person is only in one group, and not the others, it does not know what other prices are available.