6a. Monopoly, Cartels, Monopolistic Competition

Question 1

Are monopolies price takers?

Answer 1

NO!

Monopolies are not price takers like competitive firms

Question 2

Monopoly output is the _______________

Answer 2

Monopoly output is the market output

Question 3

Monopoly demand curve is the _______________

Answer 3

Monopoly demand curve is the market demand curve

Question 4

What is the profit maximisation quantity for a monopolist?

Answer 4

MC = MR

Question 5

If MC=MR is the profit max quantity for both PC as well as monopolists, where is the key difference?

Answer 5

MR is NOT FLAT like in PC !!!

Question 6

How do you calculate the MR function?

Answer 6

take the supply function, eg. p = 18-Q

Calculate TR by multiplying this by Q
(18 - Q) * Q = (18Q - Q^2)

Calculate the MR by finding the derivative of TR
(18Q - Q^2) = 18 - 2Q

As this is MR, just make this equal the given MC !

Question 7

What does the MR depend on?

Answer 7

The price elasticity of demand!

Question 8

What is the PED of MR in perfect competition?

Answer 8

Horizontal MR..

Perfectly elastic demand!

Question 9

In what part of the demand curve would the monopolist NOT produce?

Answer 9

The monopolist will NEVER produce beyond where MR becomes negative.

Question 10

What does this diagram show?

Answer 10

q where MC = MR,

plotted up to find price,
plotted down from same point onto the AC
-> 60pi (profit)

Question 11

What is the shutdown decision for a monopolist?

Answer 11

SAME as PC firms,

a monopoly should shut down in the monopolist’s price is less than its AVC.

Question 12

What is the definition of “market power”

Answer 12

Market power is the ability of a firm to charge a price above marginal cost and earn a positive profit

Question 13

What is the “market power” related to?

Answer 13

Market power is related to the price elasticity of demand

! The more elastic the demand curve, the less a monopoly can raise its price above MC without losing sales (and vice versa). !

Question 14

What does this function show?

Answer 14

This formula is often used to determine the optimal price p in relation to the marginal cost MC when the elasticity of demand is known.

where:
p = price
e = PED

Question 15

What is the lerner index?

Answer 15

The Lerner Index is a measure of a firm’s market power and its ability to set prices above marginal cost

Question 16

What is the equation for the Lerner Index?

Answer 16

p - MC / p

Question 17

Why would the demand curve become more elastic? (less market power)

Answer 17

Demand becomes more elastic (which implies less market power for the firm):
- as better substitutes for the firm’s product are introduced
- as more firms enter the market selling a similar product
- as firms that provide the same service locate closer to the firm

Question 18

Does a monopolist generate DWL?

Answer 18

YES!

The competitive equilibrium has none, but in this case the firms do not operate where MC = D, rather, where MC = MR

Question 19

Why are some markets monopolized?

Answer 19

• Cost advantage over other firms
• Government created monopoly

Question 20

What are some sources of cost advantages?

Answer 20

1. Control of an essential facility
2. Use of superior technology or a better way of organizing production
3. Protection from imitation through patents or informational secrets.

Monopolist can sell at a lower price than other firms; other firms do not enter the market.

Question 21

What is a Natural Monopoly?

Answer 21

A market has a natural monopoly if one firm can produce the total output of the market at lower cost than several firms could.
-> Examples: public utilities such as water, gas, electric, and mail delivery.

Question 22

Natural monopolies have __________________________

Answer 22

Natural monopolies have economies of scale for all output levels.
- HIGH fixed costs
- LOW and consistent marginal costs

Question 23

Are the fixed costs of natural monopolies high?

Answer 23

YES

Question 24

What does this DIG show?

Answer 24

two firms that produce 6 units, have an AC of 20, whereas the natural monopoly can produce 12 units at 15 AC… so will always beat multiple firms

Question 25

What are some Government actions that create monopolies?

Answer 25

• Barrier to Entry. By making it difficult for new firms to obtain a license to operate
• By granting a firm the rights to be a monopoly
• By auctioning the rights to be a monopoly

Question 26

What are the 3 ways in which a government may limit monopoly power?

Answer 26

• Optimal Price Regulation
• Non-optimal Price Regulation
• Increasing competition

Question 27

What is “Optimal Price Regulation”?

Answer 27

With optimal price regulation, the government imposes a price ceiling that is equal to the competitive price.

Question 28

What are some problems with “Optimal Price Regulation”?

Answer 28

1. Governments lack knowledge on demand and costs of the firm!
   -> tough to find the optimal
2. What if the price is so low that the firm shuts down? This is the case for natural monopolies!

Question 29

What is “Non-Optimal Price Regulation”?

Answer 29

Nonoptimal Price Regulation: government-imposed price ceiling is not set at the competitive level, which reduces but does not eliminate DWL. – e.g. regulation of Natural Monopolies.

Question 30

Can a monopoly ever be good for society?

Answer 30

Yes!

What firm would invest in developing new drugs, for example, if they couldn’t be protected by patents?

Tradeoff:
Monopolies are inefficient, but that they also provide needed innovation to the market, innovation that wouldn’t occur if firms couldn’t be assured they could get the profits for some amount of time. Empirical answer!

However,
- Innovation does not always respond to incentives! Monopoly can hinder innovation.
-> Neither perfect competition or iron-clad monopoly help innovation. In between market helps innovation.