Chapter 8: Managing in Competitive, Monopolistic, and Monopolistically Competitive Markets

Question 1

Key Conditions for Perfect Competition

Answer 1

1. There are many buyers and sellers in the market, each of which is “small” relative to the market.
2. Each firm in the market produces a homogeneous (identical) product.
3. Buyers and sellers have perfect information.
4. There are no transaction costs.
5. There is free entry into and exit from the market.

Question 2

Perfect Substitutes

Answer 2

The first four assumptions imply that no single firm can influence the price of the product.

The fact that there are many small firms, each selling an identical product, means that consumers view the products of all firms in the market as perfect substitutes.

Because there is perfect information, consumers know the quality and price of each firm’s product. There are no transaction costs (such as the cost of traveling to a store); if one firm charged a slightly higher price than the other firms, consumers would not shop at that firm but instead would purchase from a firm charging a lower price.

Thus, in a perfectly competitive market all firms charge the same price for the good, and this price is determined by the interaction of all buyers and sellers in the market.

Small: small means the firms have no control whatsoever over the prices they charge for the product.

Question 3

Perfect Competition: Price

Answer 3

No single firm operating in a perfectly competitive market exerts any influence on price; price is determined by the interaction of all buyers and sellers in the market. The firm manager must charge this “market price” or consumers will purchase from a firm charging a lower price.

Question 4

Demand at Firm Level corresponds to market demand

Answer 4

The relation between the market demand for a product and the demand for a product produced by an individual per­fectly competitive firm:

In a competitive market, price is determined by the intersection of the market supply and demand curves. Because the market supply and demand curves depend on all buyers and sellers, the market price is outside the control of a single perfectly competitive firm.

In other words, because the individual firm is “small” relative to the market, it has no perceptible in­fluence on the market price.

Question 5

Firm Demand Curve

Answer 5

The demand curve for an individual firm’s product; in a perfectly competitive market, it is simply the market price.

Question 6

Market Demand Curve vs Firm Demand Curve

Answer 6

The distinction between the market demand curve and the firm demand curve facing a perfectly competitive firm:

The market demand curve, where the equilibrium price, Pe, is determined by the intersection of the market supply and demand curves (lefthand panel)

From the individual firm’s point of view, the firm can sell as much as it wishes at a price of Pe; thus, the demand curve facing an individual perfectly competitive firm is given by the horizontal line in the right­hand panel, labeled Df.

Question 7

Individual Firm’s Demand Curve

Answer 7

The fact that the individual firm’s demand curve is perfectly elastic reflects the fact that if the firm charged a price even slightly above the market price, it would sell nothing.

In a perfectly competitive market, the demand curve for an individual firm’s product is simply the market price.

Since the demand curve for an individual perfectly competitive firm’s product is perfectly elastic, the pricing decision of the individual firm is trivial: Charge the price that every other firm in the industry charges. All that remains is to determine how much output should be pro­duced to maximize profits.

Question 8

Short-Run Output Decisions

Answer 8

The short run is the period of time in which there are some fixed factors of produc­tion.

To maximize profits in the short run, the manager must take as given the fixed inputs (and thus the fixed costs) and determine how much output to produce given the variable inputs that are within his or her control.

Question 9

Maximizing Profits under Perfect Competition

Answer 9

Under perfect competition, the demand for an individual firm’s product is the market price of output, which we denote P.

If Q represents the output of the firm, the total revenue to the firm of producing Q units is R = PQ. Since each unit of output can be sold at the market price of P, each unit adds exactly P dollars to revenues.

Question 10

Marginal Revenue

Answer 10

The change in revenue attributable to the last unit of output; for a competitive firm, MR is the market price.

There is a linear relation between revenues and the output of a competitive firm. Marginal revenue is he slope of the revenue curve. In other words, the marginal revenue for a competitive firm is the market price.

Question 11

Competitive Firm’s Demand

Answer 11

The demand curve for a competitive firm’s product is a horizontal line at the market price. This price is the competitive firm’s marginal revenue.
D f = P = MR

Question 12

Perfectly Competitive Firms: Profit

Answer 12

The profits of a perfectly competitive firm are simply the difference between revenues and costs: π = PQ − C(Q)

Question 13

Perfectly Competitive Firms: Profit on a Cost Curve

Answer 13

Profits are given by the vertical distance between the cost function, la­beled C(Q), and the revenue line.

For output levels to the left of point A, the cost curve lies above the revenue line, which implies that the firm would incur losses if it produced any output to the left of point A. The same is true of output levels to the right of point B.

For output levels between points A and B, the revenue line lies above the cost curve. This implies that these outputs generate positive levels of profit.

The profit­ maximizing level of output is the level at which the vertical distance between the revenue line and the cost curve is greatest. This is given by the output level Q.*

Question 14

Profit­ Maximizing Level of Output: Slope

Answer 14

The slope of the cost curve at the profit ­maximizing level of output (point E) exactly equals the slope of the revenue line.

The slope of the cost curve is marginal cost and the slope of the revenue line is marginal revenue. Therefore, the profit­ maximizing output is the output at which marginal revenue equals marginal cost.

Since marginal revenue is equal to the market price for a perfectly competitive firm, the manager must equate the market price with marginal cost to maximize profits.

Question 15

Competitive Output Rule

Answer 15

To maximize profits, a perfectly competitive firm produces the output at which price equals mar­ginal cost in the range over which marginal cost is increasing: P = MC(Q)

Question 16

Minimizing Losses

Answer 16

In some instances, short­ run losses are inevitable. There are procedures for minimizing losses in the short run. If losses persist into the long run, the best thing for the firm to do is exit the industry.

Question 17

Short-Run Operating Losses

Answer 17

Consider first a situation where there are some fixed costs of production. Suppose the market price, Pe, lies below the average total cost curve but above the average variable cost curve.

If the firm produces the output Q*, where Pe = MC, a loss of the shaded area will result. However, since the price exceeds the average variable cost, each unit sold generates more revenue than the cost per unit of the variable inputs. Thus, the firm should continue to produce in the short run, even though it is incurring losses.

The firm also has fixed costs that would have to be paid even if the firm decided to shut down its operation. Therefore, the firm would not earn zero economic profits if it shut down but would instead realize a loss equal to these fixed costs.

Since the price exceeds the average variable cost of producing Q* units of output, the firm earns revenues on each unit sold that are more than enough to cover the vari­able cost of producing each unit. By producing Q* units of output, the firm is able to put an amount of money into its cash drawer that exceeds the variable costs of producing these units and thus contributes toward the firm’s payment of fixed costs.

While the firm suffers a short­-run loss by operating, this loss is less than the loss that would result if the firm completely shut down its operation.

Question 18

The Decision to Shut down

Answer 18

Suppose the market price is so low that it lies below the average variable cost, as in Figure 8–5. If the firm produced Q*, where Pe = MC in the range of increasing marginal cost, it would incur a loss equal to the sum of the two shaded rectan­gles.

In other words, for each unit sold, the firm would lose
ATC(Q*) − Pe

When this per ­unit loss is multiplied by Q*, negative profits result that correspond to the sum of the two shaded rectangles.

Now suppose that instead of producing Q* units of output, this firm decided to shut down its operation.

Its losses would equal its fixed costs; that is, those costs that must be paid even if no output is produced. Geometrically, fixed costs are represented by the top rectangle since the area of this rectangle is
[ATC(Q) − AVC(Q)]Q*
which equals fixed costs.

Thus, when price is less than the average variable cost of produc­tion, the firm loses less by shutting down its operation (and producing zero units) than it does by producing Q* units.

Question 19

Short-Run Output Decision Under Perfect Competition

Answer 19

To maximize short­run profits, a perfectly competitive firm should produce in the range of increasing marginal cost where P = MC, provided that P ≥ AVC. If P < AVC, the firm should shut down its plant to minimize its losses.

Question 20

The Short-Run Firm and Industry Supply Curves

Answer 20

The profit­ maximizing perfectly competitive firm produces the output at which price equals marginal cost.

For example, when the price is given by P0 the firm produces Q0 units of output (the point where P = MC in the range of increasing marginal cost).

When the price is P1, the firm produces Q1 units of output. For prices between P0 and P1, output is determined by the intersection of price and marginal cost.

When the price falls below the AVC curve, however, the firm produces zero units because it does not cover the variable costs of production.

Thus, to determine how much a perfectly competitive firm will produce at each price, we simply determine the output at which mar­ginal cost equals that price. To ensure that the firm will produce a positive level of output, price must be above the average variable cost curve.

Question 21

The Firm’s Short-Run Supply Curve

Answer 21

The short­ run supply curve for a perfectly competitive firm is its marginal cost curve above the minimum point on the AVC curve.

Question 22

Market Supply Curve

Answer 22

The market (or industry) supply curve is closely related to the supply curve of individ­ual firms in a perfectly competitive industry.

The market supply curve reveals the total quantity that will be produced in the market at each possible price. Since the amount an individual firm will produce at a given price is determined by its marginal cost curve, the horizontal sum of the marginal costs of all firms determines how much total output will be produced at each price.

Since each firm’s supply curve is the firm’s mar­ginal cost curve above the minimum AVC, the market supply curve for a perfectly competi­tive industry is the horizontal sum of the individual marginal costs above their respective AVC curves.

Figure 8–7 illustrates the relation between an individual firm’s supply curve (MCi) and the market supply curve (S) for a perfectly competitive industry composed of 500 firms. When the price is $10, each firm produces zero units, and thus total industry output also is zero. When the price is $12, each firm produces 1 unit, so the total output produced by all 500 firms is 500 units. Notice that the industry supply curve is flatter than the supply curve of an individual firm and that the more firms in the industry, the farther to the right is the market supply curve.

Question 23

Long Run Decisions

Answer 23

Under the theory of perfect competition there is free entry and exit.

If firms earn short­ run economic profits, in the long run additional firms will enter the industry in an attempt to reap some of those profits. As more firms enter the industry, the industry supply curve shifts to the right.

The shift from S0 to S1 lowers the equilibrium market price from P0 to P1. This shifts down the demand curve for an individual firm’s product, which in turn lowers its profits.

If firms in a competitive industry sustain short­ run losses, in the long run they will exit the industry since they are not covering their opportunity costs. As firms exit the industry, the market supply curve decreases from S0 to S2, thus increasing the market price from P0 to P2. This, in turn, shifts up the demand curve for an individual firm’s product, which increases the profits of the firms remaining in the industry.

Question 24

Long-Run Decisions: Zero Economic Profits

Answer 24

Ultimately the market price is such that all firms in the market earn zero economic profits.

At the price of Pe, each firm receives just enough to cover the average costs of production (AC is used be­ cause in the long run there is no distinction between fixed and variable costs), and economic profits are zero. If economic profits were positive, entry would occur and the market price would fall until the demand curve for an individual firm’s product was just tangent to the AC curve. If economic profits were negative, exit would occur, increasing the market price until the firm demand curve was tangent to the AC curve.

Question 25

Long-Run Competitive Equilibrium

Answer 25

In the long run, perfectly competitive firms produce a level of output such that:
1. P=MC
2. P = minimum of AC

Question 26

Long-Run Properties of Perfectly Competitive Markets

Answer 26

The market price is equal to the marginal cost of production.

The market price reflects the value to society of an additional unit of output. This valuation is based on the preferences of all consumers in the market.

Marginal cost reflects the cost to society of producing another unit of output.

These costs represent the resources that would have to be taken from some other sector of the economy to produce more output in this industry.

Sup­pose price exceeded marginal cost in equilibrium. This would imply that society would value another unit of output more than it would cost to produce another unit of output. If the indus­try produced at a level such that price exceeded the marginal cost of the last unit produced, it would thus be inefficient; social welfare would be improved by expanding output. Since in a competitive industry price equals marginal cost, the industry produces the socially efficient level of output.

Question 27

Long-Run competitive equilibrium

Answer 27

Price equals the minimum point on the average cost curve. This implies not only that firms are earning zero economic profits (i.e., just covering their opportunity costs) but also that all economies of scale have been exhausted. There is no way to produce the output at a lower average cost of production.

The fact that a firm in a perfectly competitive industry earns zero economic profits in the long run does not mean that accounting profits are zero; rather, zero economic profits implies that accounting profits are just high enough to offset any implicit costs of production. The firm earns no more, and no less, than it could earn by using the resources in some other capacity. This is why firms continue to produce in the long run even though their economic profits are zero.

Question 28

Monopoly

Answer 28

A market structure in which a single firm serves an entire market for a good that has no close substitutes.

Question 29

Identifying a Monopoly

Answer 29

In determining whether a market is characterized by monopoly, it is important to specify the relevant market for the product.

For example, some utilities, such as electric or water companies, are local monopolies in that only one utility offers service to a given neighbor­hood. Even though there may be similar companies serving other towns, they do not directly compete against one another for customers.

The substitutes for electric services in a given city are poor and, short of moving to a different city, consumers must pay the price for local utility services or go without electricity.

It is in this sense that a utility company may be a monopoly in the local market for utility services.

Question 30

Identifying a Monopoly

Answer 30

A monopoly need not be a large firm.

The relevant consideration is whether there are other firms selling close substitutes for the good in a given market.

For example, a gas station located in a small town that is several hundred miles from another gas station is a monopolist in that town. In a large town there typically are many gas stations, and the market for gasoline is not characterized by monopoly.

Question 31

Monopoly Power

Answer 31

The fact that a firm is the sole seller of a good in a market clearly gives that firm greater market power than it would have if it competed against other firms for consumers. Since there is only one producer in the market, the market demand curve is the demand curve for the mo­ nopolist’s product. This is in contrast to the case of perfect competition, where the demand curve for an individual firm is perfectly elastic. A monopolist does not have unlimited power, however.

Question 32

Monopolist Demand Curve

Answer 32

Since all consumers in the market demand the good from the monopolist, the market demand curve, DM, is the same as the demand for the firm’s product, D f.

In the absence of legal restrictions, the monopolist is free to charge any price for the product.

But this does not mean the firm can sell as much as it wants to at that price. Given the price set by the monopolist, consumers decide how much to purchase.

For example, if the monopolist sets the relatively low price of P1, the quantity de­manded by consumers is Q1.

The monopolist can set a higher price of P0, but there will be a lower quantity demanded of Q0 at that price.

In summary, the monopolist is restricted by consumers to choose only those price quantity combinations along the market demand curve. The monopolist can choose a price or a quan­tity, but not both. The monopolist can sell higher quantities only by lowering the price. If the price is too high, consumers may choose to buy nothing at all.

Question 33

Sources of Monopoly Power

Answer 33

There are four primary sources of monopoly power. One or more of these sources create a barrier to entry that prevents other firms from entering the market to compete against the monopolist.

Question 34

Economies of Scale

Answer 34

Exist whenever long-run average costs decline as output increases.

For many technologies, there is a range over which economies of scale exist and a range over which diseconomies exist

Question 35

Diseconomies of Scale

Answer 35

Exist whenever long-run average costs increase as output increases.

Question 36

Markets with One Firm vs Two Firms

Answer 36

If the market were composed of a single firm that produced QM units, consumers would be willing to pay a price of PM per unit for the QM units.

Since PM > ATC(QM), the firm sells the goods at a price that is higher than the average cost of pro­duction and thus earns positive profits.

Now suppose another firm entered the market and the two firms ended up sharing the market (each firm producing QM∕2).

The total quantity pro­duced would be the same, and thus the price would remain at PM.

But with two firms, each producing only QM∕2 units, each firm has an average total cost of ATC(QM∕2)—a higher aver­age total cost than when a single firm produced all the output.

For example, in a market with overhead costs and two firms, each firm must incur these costs of production, and each can only spread the costs over half as much output as a monopolist.

Each firm’s average cost is greater than PM, which is the price consumers are willing to pay for the total QM units produced in the market. Having two firms in the industry leads to losses, but a single firm can earn positive profits because it has higher volume and enjoys
reduced average costs due to economies of scale. Thus, we see that economies of scale can lead to a situation where a single firm services the entire market for a good.

Note: there are economies of scale for output levels below Q* (since ATC is declining in this range) and diseconomies of scale for output levels above Q* (since ATC is increas­ing in this range).

In terms of Figure 8–11, the demand for gasoline in a small town typically is low relative to Q, which gives rise to economies of scale in the relevant range (outputs below Q). In large cities the demand for gasoline is large relative to Q*, which makes it possible for several gas stations to coexist in the market.

Question 37

Economies of Scope

Answer 37

Exist when the total cost of producing two products within the same firm is lower than when the products are produced by separate firms, that is, when it is cheaper to produce outputs Q1 and Q2 jointly.

Pharmaceutical companies often enjoy econo­mies of scope in their development of new drugs; breakthroughs in developing a product that cures one disease may reduce the cost of developing additional products that cure other illnesses.

Question 38

Economies of Scope: lead to Monopoly Power

Answer 38

In the presence of economies of scope, efficient production requires that a firm produce several products jointly. While multiproduct firms do not necessarily have more market power than firms producing a single product, economies of scope tend to encourage “larger” firms. In turn, this may provide greater access to capital markets, where working capital and funds for investment are obtained. To the extent that smaller firms have more difficulty obtaining funds than do larger firms, the higher cost of capital may serve as a barrier to entry. In ex­treme cases, economies of scope can lead to monopoly power.

Question 39

Cost Complementarities

Answer 39

Exist in a multiproduct cost function when the marginal cost of pro­ducing one output is reduced when the output of another product is increased; that is, when an increase in the output of product 2 decreases the marginal cost of producing output 1.

Multiproduct firms that enjoy cost complementarities tend to have lower marginal costs than firms producing a single product. This gives multiproduct firms a cost advantage over single­product firms. Thus, in the presence of cost complementarities, firms must produce several products to be able to compete against the firm with lower marginal costs. To the ex­ tent that greater capital requirements exist for multiproduct firms than for single­product firms, this requirement can limit the ability of small firms to enter the market. In extreme cases, monopoly power can result.

Example of a multiproduct cost function with cost complementarities: the produc­tion of doughnuts and doughnut holes.

Question 40

Patents and Other Legal Barriers

Answer 40

A government may grant an individual or a firm a monopoly right.

For example, a city may prevent another utility company from competing against the local utility company. Another example is the potential monopoly power generated by the patent system.

Question 41

Patent System

Answer 41

The patent system gives the inventor of a new product the exclusive right to sell the prod­uct for a given period of time.

The rationale behind granting mo­nopoly power to a new inventor is based on the following argument: Inventions take many years and considerable sums of money to develop.

Once an invention becomes public information, in the absence of a patent system, other firms could produce the product and compete against the individual or firm that developed it.

Since these firms do not have to expend resources developing the product, they would make higher profits than the original developer.

In the absence of a patent system, there would be a reduced incentive on the part of firms to develop new technologies and products.

It is important to stress that patents rarely lead to absolute monopoly because competitors are often quick to develop similar products or technologies in order to get a piece of the action. Furthermore, several firms taking different R&D paths may each obtain a patent for a product that is a close substitute for other patented products.

Question 42

Maximizing Profits

Answer 42

A manager’s goal is to characterize the price and output decisions that maximize the monop­olist’s profits.

Question 43

Elasticity Under a Monopoly

Answer 43

A linear demand curve is elastic at high prices and inelastic at low prices.

If the monopolist produces zero units of output, its revenues are zero.

As output is increased above zero, demand is elastic and the increase in output (which implies a lower price) leads to an increase in total revenue.

This follows from the total revenue test. As output is increased beyond Q0 into the inelastic region of demand, further increases in output actually decrease total revenue, until at point D the price is zero and revenues are again zero.

Total revenue is maximized at an output of Q0. This corresponds to the price of P0, where demand is unitary elastic.

Question 44

Marginal Revenue

Answer 44

The line labeled MR is the marginal revenue schedule for the monopo­list.

Marginal revenue is the change in total revenue attributable to the last unit of output; geometrically, it is the slope of the total revenue curve.

As Figure 8–12(a) shows, the marginal revenue schedule for a monopolist lies below the demand curve; in fact, for a linear demand curve, the marginal revenue schedule lies exactly halfway between the demand curve and the vertical axis.

This means that for a monopolist, marginal revenue is less than the price charged for the good.

Question 45

Marginal revenue schedule lies below the monopolist’s demand curve.

Answer 45

Marginal revenue is the slope of the total revenue curve [R(Q)] in Figure 8–12(b).

As output increases from zero to Q0, the slope of the total revenue curve decreases until it becomes zero at Q0.

Over this range, marginal revenue decreases until it reaches zero when output is Q0. As output expands beyond Q0, the slope of the total revenue curve becomes negative and gets increasingly neg­ative as output0 continues to expand.

This means that marginal revenue is negative for outputs in excess of Q .

Question 46

Monopolist’s Marginal Revenue

Answer 46

The marginal revenue of a monopolist is given by the formula: MR = P [(1 + E) / E]

Where E is the elasticity of demand for the monopolist’s product and P is the price charged for
the product.

Question 47

Inverse Demand Function

Answer 47

The inverse demand function, denoted P(Q), indicates the price per unit as a function of the firm’s output. The most common inverse demand function is the linear inverse demand func­ tion. The linear inverse demand function is given by
P(Q) = a + bQ

Question 48

MR for Linear Inverse Deman

Answer 48

d. For the linear inverse demand function, P(Q) =a + bQ,

Marginal revenue is given by
MR = a + 2bQ.

Question 49

The Output Decision

Answer 49

Revenues are one determinant of profits; costs are the other.

Since the revenue a monopolist receives from selling Q units is R(Q) = Q[P(Q)], the profits of a monopolist with a cost func­ tion of C(Q) are: π = R(Q) − C(Q)

Question 50

Graphing Monopolist Levels of Output

Answer 50

Typical revenue and cost functions are graphed in Figure 8–13(a).

The vertical distance between the revenue and cost functions in panel (a) reflects the profits to the monopolist of alternative levels of output.

Output levels below point A and above point B imply losses since the cost curve lies above the revenue curve.

For output levels between points A and B, the revenue function lies above the cost function, and profits are positive for those output levels.

Figure 8–13(b) depicts the profit function, which is the difference between R and C in panel (a).

As Figure 8–13(a) shows, profits are greatest at an output of QM, where the vertical distance between the revenue and cost functions is the greatest.

This corresponds to the maximum profit point in panel (b).

A very important property of the profit­ maximizing level of output (QM) is that the slope of the revenue function in panel (a) equals the slope of the cost function. In economic terms, marginal revenue equals marginal cost at an output of QM.

Question 51

Monopoly Output Rule

Answer 51

A profit­ maximizing monopolist should produce the output QM such that marginal revenue equals marginal cost:

MR(QM) = MC(QM)

Question 52

Expand Output when MR > MC

Answer 52

If marginal revenue was greater than marginal cost, an increase in output would increase revenues more than it would increase costs. Thus, a profit maximizing manager of a monopoly should continue to expand output when MR > MC. On the other hand, if marginal cost exceeded marginal revenue, a reduction in output would reduce costs by more than it would reduce revenue. A profit­ maximizing manager thus is motivated to produce where marginal revenue equals marginal cost.

The marginal revenue curve intersects the marginal cost curve when QM units are produced, so the profit maximizing level of output is QM. The maximum price per unit that consumers are willing to pay for QM units is PM, so the profit maximizing price is PM.

Monopoly profits are given by the shaded rectangle in the figure, which is the base (QM) times the height [PM − ATC(QM)].

Question 53

Monopoly Pricing Rule

Answer 53

Given the level of output, QM, that maximizes profits, the monopoly price is the price on the demand curve corresponding to the QM units produced: PM = P(QM)

Question 54

The Absence of a Supply Curve

Answer 54

A supply curve determines how much will be produced at a given price.

Since per­fectly competitive firms determine how much output to produce based on price (P = MC), supply curves exist in perfectly competitive markets.

In contrast, a monopolist determines how much to produce based on marginal revenue, which is less than price (P > MR = MC).

This is because a change in quantity by a monopolist actually changes the market price.

Consequently, there is no way to express how a monopolist’s quantity choice would change for different given prices, so there is no supply curve for a monopolist.

In fact, there is no supply curve in markets served by firms with market power, such as monopolistic competition.

Question 55

Multipant Decisions

Answer 55

In many instances, a monopolist has different plants at different locations.

An im­portant issue for the manager of such a multiplant monopoly is the determination of how much output to produce at each plant.

Suppose the monopolist produces output at two plants. The cost of producing Q1 units at plant 1 is C1(Q1), and the cost of producing Q2 units at plant 2 is C2(Q2).

Further, suppose the products produced at the two plants are identical, so the price per unit consumers are willing to pay for the total output produced at the two plants is P(Q), where
Q=Q1 +Q2.

Profit maximization implies that the two­plant monopolist should produce output in each plant such that the marginal cost of producing in each plant equals the marginal revenue of total output.

Question 56

Multiplant Output Rule

Answer 56

Let MR(Q) be the marginal revenue of producing a total of Q = Q1 + Q2 units of output. Suppose the marginal cost of producing Q1 units of output in plant 1 is MC1(Q1) and that of producing Q2 units in plant 2 is MC2(Q2).

The profit maximization rule for the two­plant monopolist is to allocate output among the two plants such that MR(Q) = MC1(Q1) MR(Q) = MC2(Q2)

If the marginal revenue of producing output in a plant exceeds the marginal cost, the firm will add more to revenue than to cost by expanding output in the plant. As output is expanded, marginal revenue declines until it ultimately equals the marginal cost of producing in the plant.

The conditions for maximizing profits in a multiplant setting imply that MC1(Q1) = MC2(Q2)

If the marginal cost of producing in plant 1 is lower than that of producing in plant 2, the monopolist could reduce costs by producing more output in plant 1 and less in plant 2. As more output is produced in plant 1, the marginal cost of produc­ ing in the plant increases until it ultimately equals the marginal cost of producing in plant 2.

Question 57

Implications of Entry Barriers

Answer 57

If a monopolist is earning positive economic profits, the presence of barriers to entry prevents other firms from entering the market to reap a portion of those profits.

Thus, monopoly prof­its, if they exist, will continue over time so long as the firm maintains its monopoly power.

The presence of monopoly power does not imply positive profits; it depends solely on where the demand curve lies in relation to the average total cost curve.

Question 58

Monopolist Earning Zero Economics Profits

Answer 58

The monopolist earns zero economic profits because the optimal price exactly equals the average total cost of production. Moreover, in the short run a monopolist may even experience losses.

Question 59

Deadweight Loss of a Monopoly

Answer 59

The consumer and producer surplus that is lost due to the monopolist charging a price in excess of marginal cost.