8. Perfect competition and pure monopoly

Question 1

In a perfectly competitive market, both buyers and sellers believe that their own actions have no effect on the market price. In contrast, a monopolist, the only
seller or potential seller in the industry, sets the price.

Answer 1

1

Question 2

The short-run supply curve is the SMC curve above the point at which the SMC curve crosses the lowest point on the SAVC curve.

Answer 2

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Question 3

A firm’s long-run supply curve, relating output supplied to price in the long run, is that part of its LMC curve above its LAC curve.

Answer 3

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Question 4

When economic profits are zero the firm makes normal profits. Its accounting profits just cover the opportunity cost of the owner’s money and time.

Answer 4

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Question 5

Entry is when new firms join an industry.

Exit is when existing firms leave.

Answer 5

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Question 6

The marginal firm is the last firm to enter the market; it makes zero long-run
profits.

Answer 6

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Question 7

The shutdown price is the price below which the firm cuts its losses by making no output.

Answer 7

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Question 8

Comparative statics examines how equilibrium changes when demand or cost conditions shift.

Answer 8

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Question 9

In short-run equilibrium, the price equates the quantity demanded to the total quantity supplied by the given number of firms in the industry when each firm is on its short-run supply curve.
In long-run equilibrium, the price equates the quantity demanded to the total quantity supplied by the number of firms in the industry when each firm is on its long-run supply curve and firms can freely enter or exit the industry.

Answer 9

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Question 10

A monopolist is the sole supplier and potential supplier of the industry’s product

Answer 10

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Question 11

The excess of price over marginal cost is a measure of monopoly power.

Answer 11

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Question 12

At an output below the efficient level, the deadweight loss shows the loss of social surplus.

Answer 12

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Question 13

The social cost of monopoly is the failure to maximize social surplus.

Answer 13

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Question 14

A discriminating monopoly charges different prices to different people.

Answer 14

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Question 15

A natural monopoly’s average costs keep falling as its output rises. It undercuts all smaller competitors.

Answer 15

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Question 16

A two-part tariff charges a fixed sum for access to the service and then a price per unit that reflects the marginal cost of production.

Answer 16

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Question 17

Regulatory capture implies that the regulator gradually comes to identify with the interests of the firm it regulates, becoming its champion not its watchdog.

Answer 17

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Question 18

In a competitive industry each buyer and seller is a price-taker, believing individual actions have no effect on the market price. Competitive supply is most
plausible when many firms make a standard product, with free entry and exit, and easy verification by buyers that the products of different firms really are the same.

Answer 18

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Question 19

For a competitive firm, the price is its marginal revenue. Output equates price to marginal cost. The firm’s supply curve is its SMC curve above SAVC. At a lower
price, the firm temporarily shuts down. In the long run, the firm’s supply curve is its LMC curve above its LAC curve. At a lower price, the firm eventually exits the industry

Answer 19

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Question 20

Adding at each price the quantities supplied by each firm, we obtain the industry supply curve. It is flatter in the long run both because each firm can fully adjust
all factors and because the number of firms in the industry can vary. In the extreme case where all potential and existing firms have identical costs, the long-run industry supply curve is horizontal at the price corresponding to the lowest point on each firm’s LAC curve.

Answer 20

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Question 21

An increase in demand leads to a large price increase but only a small increase in quantity. The existing firms move up their steep SMC curves. Price exceeds
average costs and the ensuing profits attract new entrants. In the long run, output increases still further but the price falls back. In long-run equilibrium, the
marginal firm makes only normal profits and there is no further change in the number of firms in the industry.

Answer 21

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Question 22

An increase in costs for all firms reduces the industry’s output and increases the price. In the long run, the marginal firm must break even. A higher price is
required to match the increase in its average costs.

Answer 22

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Question 23

Pure monopoly is the only seller or potential seller of a good and need not worry about entry, even in the long run. Though rare in practice, this case offers an important benchmark against which to compare less extreme forms of monopoly power.

Answer 23

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Question 24

Profit-maximizing monopolist has a supply rule – choose output to set MC equal to MR – but not a supply curve uniquely relating price and output. The
relationship between price and MR depends on the demand curve.
Where a monopoly and a competitive industry can meaningfully be compared, the monopolist produces a smaller output at a higher price. Compared to a perfectly competitive market, a monopoly creates a deadweight loss. This is the loss in social surplus caused by the monopolist’s restriction of output compared to perfect competition.

Answer 24

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Question 25

Discriminating monopolist charges different prices to different customers. To equate the marginal revenue from different groups, groups with high elasticity of
demand must pay a lower price. Successful price discrimination requires that customers cannot trade the product among themselves.

Answer 25

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Question 26

Monopolies may have more internal resources available for research and may have a higher incentive for cost-saving research because the profits from
technical advances will not be eroded by entry. Although small firms do not undertake a great deal of expensive research, it appears that the patent laws
provide adequate incentives for medium- and larger-sized firms. There is no evidence that an industry has to be a monopoly to undertake cost-saving research.

Answer 26

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Question 27

Supply decisions of a perfectly competitive firm
Marginal condition: (1)
Average condition:
Short run (2)
Long run (3)

Answer 27

1. Produce output where P = MC
2. If P > SAVC, shut down temporarily
3. If P > LAC, exit industry

Question 28

A monopolist does not have a supply curve independent of demand conditions.
Rather, a monopolist simultaneously examines demand (hence marginal revenue) and cost (hence marginal cost) to decide how much to produce and what to charge.

Answer 28

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