5. Monopoly

Question 1

What is a monopoly?

Answer 1

A monopoly is a market structure where a single firm controls the entire market supply and can influence prices.

Question 2

What is monopoly power?

Answer 2

Monopoly power is the ability of a firm to set prices above marginal cost due to lack of competition.

Question 3

What are the sources of monopoly power?

Answer 3

Monopoly power arises from barriers to entry, control over key resources, government regulation, or economies of scale.

Question 4

What is the profit maximization condition for a monopolist?

Answer 4

A monopolist maximizes profit where marginal revenue (MR) equals marginal cost (MC).

Question 5

What is the monopolist’s profit maximization problem?

Answer 5

π(Q) = p(Q)Q - C(Q), where π is profit, p(Q) is price, Q is output, and C(Q) is the cost function.

Question 6

How do you calculate profit-maximizing output for a monopolist?

Answer 6

Profit-maximizing output occurs where dπ/dQ = 0, meaning the derivative of profit with respect to output is zero.

Question 7

How does a tax affect a monopolist’s output decision?

Answer 7

A monopolist’s output decision with a tax is determined by the condition MR = MC + t, where t is the tax.

Question 8

What is a multi-plant firm’s profit maximization condition?

Answer 8

For a multi-plant firm, profit is maximized when MR = MC1 = MC2, where MC1 and MC2 are the marginal costs of each plant.

Question 9

What is the pricing rule for a monopolist?

Answer 9

The pricing rule is P = MC / (1 + (1/Ed)), where P is price, MC is marginal cost, and Ed is the price elasticity of demand.

Question 10

What is the Lerner Index?

Answer 10

The Lerner Index measures monopoly power as L = (P - MC) / P, where P is price and MC is marginal cost.

Question 11

What is the equation for a monopolist’s markup over marginal cost?

Answer 11

The markup equation is
(P - MC) / MC = - 1 / (1 + Ed),
where P is price, MC is marginal cost, and Ed is the price elasticity of demand.

Question 12

What is deadweight loss due to monopoly?

Answer 12

Deadweight loss is the loss in total surplus due to inefficient output levels in a monopoly, calculated as B + C.

Question 13

What is rent seeking?

Answer 13

Rent seeking is the use of resources by a firm to gain monopoly power without creating value, often through lobbying or regulation.

Question 14

What are the social costs of monopoly power?

Answer 14

The social costs include deadweight loss, reduced consumer surplus, and inefficiency due to restricted output and higher prices.

Question 15

What is price regulation in a monopoly?

Answer 15

Price regulation is a government policy that limits the price a monopolist can charge to prevent excessive profits and protect consumers.

Question 16

What is a natural monopoly?

Answer 16

A natural monopoly occurs when a single firm can produce the entire market output at a lower cost than multiple firms due to economies of scale.

Question 17

How does a demand shock affect a monopolist’s output decision?

Answer 17

A positive demand shock increases demand, allowing the monopolist to increase output and price, while a negative shock reduces both.

Question 18

What is monopsony?

Answer 18

Monopsony is a market structure where there is only one buyer, giving the buyer power to influence prices and quantity demanded.

Question 19

How does the Lerner Index relate to price elasticity of demand?

Answer 19

The Lerner Index is inversely related to price elasticity of demand; as elasticity increases, the firm’s markup and market power decrease.

Question 20

What is the deadweight loss formula for a monopoly?

Answer 20

Deadweight loss = B + C, where B and C represent the lost consumer and producer surplus due to monopolistic pricing.

Question 21

How does a monopolist’s profit-maximizing price compare to a competitive market price?

Answer 21

A monopolist sets the price above marginal cost, resulting in a higher price than in a competitive market, where price equals marginal cost (P = MC).

Question 22

How does a multi-plant monopolist determine how much output to produce at each plant?

Answer 22

A multi-plant monopolist distributes production across plants so that the marginal cost (MC) is equal for each plant, and marginal revenue (MR) equals the common MC (MR = MC1 = MC2).

Question 23

How does the Lerner Index measure a firm’s market power?

Answer 23

The Lerner Index measures market power by comparing the markup over marginal cost; the higher the index (L = (P - MC) / P), the greater the firm’s power to raise prices above marginal cost.

Question 24

How does rent seeking create inefficiency in a market?

Answer 24

Rent seeking wastes resources as firms invest in non-productive activities, like lobbying, to gain monopoly power, which leads to inefficiency without creating additional value for society.

Question 25

How does price regulation reduce the social costs of monopoly?

Answer 25

Price regulation forces a monopolist to set prices closer to marginal cost, reducing prices for consumers and increasing output, which helps reduce deadweight loss and increase efficiency.

Question 26

How does a monopolist’s pricing rule take into account the price elasticity of demand?

Answer 26

The monopolist’s pricing rule, P = MC / (1 + (1/Ed)), shows that the firm sets a higher markup when demand is inelastic (low Ed) and a lower markup when demand is elastic (high Ed), indicating the firm’s ability to raise prices based on consumer responsiveness.

Question 27

How does a tax on a monopolist affect both output and pricing?

Answer 27

A tax increases the monopolist’s marginal cost, leading the firm to reduce output and raise prices as it adjusts its profit-maximizing condition to MR = MC + t, where t is the tax.

Question 28

How does the deadweight loss from monopoly compare to that in a competitive market?

Answer 28

In a monopoly, deadweight loss occurs because the monopolist produces less output and charges a higher price than in a competitive market, reducing total surplus by creating inefficiencies where consumer and producer surplus are lost.

Question 29

How does a natural monopoly arise from economies of scale?

Answer 29

A natural monopoly forms when one firm can supply the entire market at a lower cost than multiple firms due to significant economies of scale, making it inefficient for other firms to compete.

Question 30

How does rent-seeking behavior contribute to the persistence of monopoly power?

Answer 30

Rent-seeking allows monopolies to sustain their market power by using resources to influence policies or regulations that block entry, preventing competition and maintaining higher prices and profits at the expense of social welfare.

Question 31

How would you analyze the impact of price regulation on a natural monopoly?

Answer 31

Price regulation can force a natural monopoly to set prices closer to marginal cost, reducing prices and increasing output, but if prices are set too low, the firm may not cover its total costs, potentially requiring government subsidies to maintain service.

Question 32

How does the Lerner Index help evaluate the effectiveness of competition policies?

Answer 32

The Lerner Index measures the degree of monopoly power by comparing price to marginal cost. A high Lerner Index indicates significant market power, and policies aimed at reducing it would lower the index by promoting competition or regulating prices.

Question 33

How does the introduction of a tax change a monopolist’s decision-making process compared to a competitive firm?

Answer 33

A tax on a monopolist leads to a new output rule where MR = MC + t. Unlike in a competitive market where price equals marginal cost, the monopolist passes some of the tax burden to consumers through higher prices, but reduces output more than a competitive firm would.

Question 34

How would you evaluate the social costs of rent seeking in maintaining monopoly power?

Answer 34

Rent seeking wastes resources by diverting them from productive activities into efforts to secure or maintain monopoly power, resulting in a net social loss due to inefficiencies, higher prices, and restricted output that harms consumer welfare.

Question 35

How does deadweight loss in a monopolistic market compare when a tax is imposed versus when there is no tax?

Answer 35

Deadweight loss in a monopolistic market without tax occurs due to underproduction and higher prices. When a tax is imposed, deadweight loss increases as both consumer and producer surplus decrease further due to reduced output and additional inefficiencies caused by the tax.

Question 36

What is the monopolist’s profit maximization condition?

Answer 36

MR = MC, where marginal revenue (MR) equals marginal cost (MC) at the profit-maximizing output level.

Question 37

How do you calculate the monopolist’s profit using the profit function?

Answer 37

π(Q) = p(Q)Q - C(Q), where π is profit, p(Q) is the price at quantity Q, and C(Q) is the total cost at Q.

Question 38

What is the formula for a monopolist’s markup over marginal cost?

Answer 38

P - MC / MC = - 1 / (1 + Ed), where P is price, MC is marginal cost, and Ed is the price elasticity of demand.

Question 39

How do you calculate the deadweight loss due to monopoly?

Answer 39

Deadweight loss = B + C, where B and C represent the areas of lost consumer and producer surplus due to reduced output and higher prices.

Question 40

How does the Lerner Index relate to price and marginal cost?

Answer 40

L = (P - MC) / P, where L is the Lerner Index, P is price, and MC is marginal cost, indicating the firm’s price markup over cost.

Question 41

How do you calculate the monopolist’s output decision in the presence of a tax?

Answer 41

The output decision with a tax is determined by MR = MC + t, where t is the per-unit tax imposed on the monopolist.

Question 42

What is the multi-plant firm’s profit maximization condition?

Answer 42

For a multi-plant firm, profit is maximized when MR = MC1 = MC2, ensuring that marginal revenue equals the marginal cost at each plant.

Question 43

How do you calculate the price elasticity of demand in a monopoly’s pricing rule?

Answer 43

The pricing rule is P = MC / (1 + (1/Ed)), where Ed is the price elasticity of demand, P is the price, and MC is marginal cost.

Question 44

What is the formula for deadweight loss with a monopoly and tax combined?

Answer 44

Deadweight loss = B + C + D, where B and C are the areas of inefficiency due to monopoly, and D represents the additional loss from the tax.

Question 45

How do you solve for profit-maximizing output using the derivative of the profit function?

Answer 45

Set dπ/dQ = 0, where π(Q) = p(Q)Q - C(Q), and solve for the quantity Q that maximizes profit.