10.1 A Single-Price Monopolist

Question 1

What is a monopoly

Answer 1

A market containing a single firm.

Question 2

What is a monopolist

Answer 2

monopolist
A firm that is the only seller in a market.

Question 3

What is the demand curve for a monopolist?

Answer 3

Because a monopolist is the sole producer of the product that it sells, the demand curve it faces is simply the market demand curve for that product.

Question 4

What is the difference between the demand curve for a monopolist and a competitive firm?

Answer 4

Unlike a perfectly competitive firm, a monopolist faces a negatively sloped demand curve.

Question 5

How do we get Total revenue for a monoplist?

Answer 5

When the monopolist charges the same price for all units sold, its total revenue (TR) is simply equal to the single price times the quantity sold:

TR=p×Q

Question 6

How do we get average revenue for a monopolist?

Answer 6

Since average revenue is total revenue divided by quantity, it follows that average revenue is equal to the price:

AR= TR/Q = p×Q/Q = p

Question 7

How do we get the monopolists’ average revenue curve?

Answer 7

And since the demand curve shows the price of the product, it follows that the demand curve is also the monopolist’s average revenue curve

Question 8

Where do we find the monopolist’s marginal revenue (MR) curve?

Answer 8

The monopolist’s marginal revenue is less than the price at which it sells its output. Thus the monopolist’s MR curve is below its demand curve.

Question 9

What is the formula for Marginal Revenue (MR) ?

Answer 9

As price declines and quantity sold increases, marginal revenue is calculated as the change in total revenue divided by the change in quantity:

MR=ΔTR/ΔQ

Question 10

Why is Marginal Revenue less than price?

Answer 10

Marginal revenue is less than price because the price must be reduced on all units in order to sell an additional unit.

Question 11

What is an important contrast between a monopolist and a firm in perfect competition?

Answer 11

That marginal revenue is always less than the price for a monopolist is an important contrast with perfect competition. Recall that in perfect competition, the firm’s marginal revenue from selling an extra unit of output is equal to the price at which that unit is sold. The reason for the difference is not difficult to understand. A perfectly competitive firm is a price taker; it can sell all it wants at the given market price. In contrast, the monopolist faces a negatively sloped demand curve; it must reduce its price in order to increase its sales.

Question 12

Where do we find maximum TR?

Answer 12

TR rises (MR is positive) as price falls, reaching a maximum where p=$5 and MR=0. Then, as the price continues to fall, TR falls (MR is negative).

Question 13

What is the relationship between elasticity and total revenue?

Answer 13

Using the relationship between elasticity and total revenue that we first saw in Chapter 4, it follows that demand is elastic (η>1) when MR is positive and demand is inelastic (η<1)when MR is negative.

Question 14

What happens to the value of elasticity as we move down the demand curve?

Answer 14

The value of elasticity (η)(η) declines steadily as we move down the demand curve.

Question 15

Where on the demand curve does the profit-maximizing monopolist produce?

Answer 15

a profit-maximizing monopolist will always produce on the elastic portion of its demand curve (that is, where MR is positive).

Question 16

Recall the two general rules about profit maximization from Chapter 9:

Answer 16

Rule 1: The firm should produce only if price (average revenue) exceeds average variable cost.

Rule 2: If the firm does produce, it should produce a level of output such that marginal revenue equals marginal cost.

Question 17

What determines the firm’s profit-maximizing quantity?

Answer 17

Recall that it is the intersection of the MR and MC curves that determines the firm’s profit-­maximizing quantity.

Question 18

Where do we find the profit level on a monopolists graph

Answer 18

The profit-maximizing output is Q∗, where MR=MC; price is p∗. The rules for profit maximization require MR=MC and p>AVC. (AVC is not shown in the graph, but it must be below ATC.) With average costs given by the ATC curve, unit costs at Q∗are given by c and the monopolist makes positive profits shown by the shaded rectangle.

Question 19

Why does price exceed marginal cost for a monoploist?

Answer 19

The profit-maximizing level of output is determined where MR=MC (Rule 2); and since MR is less than price for a monopolist, it must follow that price exceeds marginal cost.

Question 20

Why does a monopolist not have a supply curve?

Answer 20

A monopolist does not have a supply curve because it is not a price taker; it chooses its profit-maximizing price-quantity combination from among the possible combinations on the market demand curve.

Question 21

Why does a monopolist create an inefficient market outcome?

Answer 21

A monopolist restricts output below the competitive level and thus reduces the amount of economic surplus generated in the market. The monopolist therefore creates an inefficient market outcome.

Question 22

What is the main reason that monopolists are so rare?

Answer 22

The main reason monopolists are so rare is that when they do exist they tend to earn very large profits, and this profitability quickly attracts other firms into the industry. When those other firms enter the industry, the first firm is no longer a monopolist.

Question 23

On what occasions do monopolists actually persist?

Answer 23

In the rare circumstances where a monopolist is able to persist, it is usually either heavily regulated by government or, as in the case of Canadian electric utilities, owned outright by government. The government involvement is usually motivated by a desire to ensure that the monopolist is not able to set a high price and restrict output in such a way as to significantly reduce market efficiency

Question 24

What is an entry barrier?

Answer 24

If monopoly profits are to persist, the entry of new firms must be prevented. Anything that prevents the entry of new firms is called an entry barrier.

Any barrier to the entry of new firms into an industry. An entry barrier may be natural or created.

Question 25

How do most natural barriers of entry arise?

Answer 25

Natural barriers most commonly arise as a result of economies of scale. When the long-run average cost curve is negatively sloped over a large range of output, big firms have significantly lower average total costs than small firms.

Question 26

What is the MES?

Answer 26

minimum efficient scale (MES) is the smallest-size firm that can reap all the economies of large-scale production. It occurs at the level of output at which the firm’s long-run average cost curve reaches a minimum.

Question 27

What is a natural monopoly?

Answer 27

An industry characterized by economies of scale sufficiently large that only one firm can cover its costs while producing at its minimum efficient scale.

Question 28

What is the second type of natural barrier?

Answer 28

The second type of natural entry barrier is limited access to key natural resources. For example, in order to produce diamonds or gold or copper, it is necessary to possess a mine that is rich enough in its deposits and large enough in scale that the production costs are reasonably close to those of existing mining firms.

Question 29

What is a network effect?

Answer 29

A third type of entry barrier comes from what are called network effects. For some products, the benefits accruing to any individual consumer depend importantly on the existence of a large network of other consumers. The benefits you receive from using Twitter, for example, obviously depend on the number of other users. Once Twitter has established a large network of users, it is very difficult for other businesses to “break in” to this industry by offering a competing product.

Question 30

What are created entry barriers?

Answer 30

Many entry barriers are created by conscious government action. Patent laws, for instance, prevent entry by conferring on the patent holder the sole legal right to produce a particular product for a specific period of time. A firm may also be granted a charter or a franchise that prohibits competition by law. Canada Post, for example, has a government-sanctioned monopoly on the delivery of first-class mail.

Question 31

What are some extreme examples of created barriers?

Answer 31

Other entry barriers can be created by the firm or firms already in the market. In extreme cases, the threat of force or sabotage can deter entry. The most obvious entry barriers of this type are encountered in organized crime, where operation outside the law makes available an array of illegal but potent barriers to new entrants.

Question 32

What are some created barriers that firms can use against other firms?

Answer 32

But law-abiding firms must use legal tactics in an attempt to increase a new entrant’s costs and thereby deter their entry. Such tactics range from the threat of price cutting—designed to impose unsustainable losses on a new entrant—to heavy brand-name advertising.

Question 33

What are some ways that new firms can get around a monopoly?

Answer 33

A firm may be able to develop a new production process that circumvents a patent upon which a monopolist relies to bar the entry of competing firms. A firm may compete by producing a somewhat different product satisfying the same need as the monopolist’s product. Finally, a firm may get around a natural monopoly by inventing a technology that produces at a low minimum efficient scale (MES) and allows it to enter the industry and still cover its full costs.

Question 34

How are entry barriers often circumvented?

Answer 34

Entry barriers are often circumvented by the innovation of production processes and the development of new goods and services. Such innovation explains why monopolies rarely persist over long periods.