Lecture 3 - Monopoly

Question 1

What is a monopoly?

Answer 1

The only supplier of a good for which there is no close substitute.

Question 2

Monopolies are not price takers like…

Answer 2

Competitive firms.

Question 3

Monopoly output is the…

Answer 3

Market output.

Question 4

Monopoly demand curve is the…

Answer 4

Market demand curve.

Question 5

Monopolists can set their own…

Answer 5

Price given market demand.

Question 6

Because demand is downward sloping, monopolists set price above…

Answer 6

Marginal cost to maximise profit.

Question 7

Like all firms, monopolies maximise profits by…

Answer 7

Setting price or output so that marginal revenue (MR) equals marginal cost (MC).

Question 8

What does the slope of the demand curve represent?

Answer 8

The change of the quantity due to unit change of the price.

Question 9

With a downward sloping demand curve, if we increase price, what will happen to quantity demanded?

Answer 9

It will decrease.

Question 10

With a downward sloping demand curve, if we decrease price, what will happen to quantity demanded?

Answer 10

It will increase.

Question 11

What is elasticity?

Answer 11

The percentage change of the quantity demanded due to one percent change of the price.

Question 12

What is market power?

Answer 12

The ability of a firm to charge a price above marginal cost and earn a positive profit.

Question 13

Monopoly has market power. Which firms do not?

Answer 13

Competitive firms do not.

Question 14

What is the Lerner Index (or price markup)?

Answer 14

Another way to examine the way in which elasticity affects a monopoly’s price relative to its MC.

Question 15

Elasticity of the market demand curve depends on…

Answer 15

Consumers’ tastes and options.

Question 16

When does demand become more elastic, implying less market power for the firm?

Answer 16

• 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 17

As a profit maximising monopoly faces more elastic demand, it has to…

Answer 17

Lower its price.

Question 18

Fill in the blanks - Competition maximises _, which is the sum of _ and _ , because _ equals _.

Answer 18

Competition maximises welfare, which is the sum of consumer surplus and producer surplus, because price equals marginal cost.

Question 19

By contrast, in a monopoly…

Answer 19

• Price does not equal marginal cost.

- Marginal revenue lies below the demand curve.

Question 20

A monopoly sets price…

Answer 20

Above marginal cost (and above the competitive price).

Question 21

A monopoly causes consumers to buy…

Answer 21

Less than the competitive level of output.

Question 22

A monopoly generates…

Answer 22

Deadweight loss. This is one of the reasons governments are trying to prevent long term periods of monopoly power.

Question 23

What are the two reasons some markets are monopolised?

Answer 23

• Cost advantage over other firms.

- Government created monopoly.

Question 24

What are the cost advantages of monopoly?

Answer 24

1. Control of an essential facility, a scarce resource that a rival firm needs to use to survive.
   Example: owning the only quarry in a region generates a cost advantage in the production of gravel.
2. Use of superior technology or a better way of organising production.
   Example: Henry Ford’s assembly lines and standardisation.
3. Protection from imitation through patents or informational secrets.
   - Secrets are more common in new and improved processes; patents are more common with new products.
4. Natural monopoly.
   - 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.
   - Natural monopolies may have high fixed costs, but low and fairly constant marginal costs.

Question 25

What are the three ways governments typically create monopolies?

Answer 25

1. By making it difficult for new firms to obtain a license to operate.
   Example: U.S. cities require new hospitals to secure a certificate of need to demonstrate the need for a new facility.
2. By granting a firm the rights to be a monopoly.
   Example: public utilities operated by private company.
3. By auctioning the rights to be a monopoly.
   Example: selling government monopolies to private firms (privatisation).

Question 26

Governments reduce/limit monopolies’ market power in various ways. What are they?

Answer 26

1. Optimal Price Regulation: government regulates the monopoly by imposing a price ceiling that is equal to the competitive price, which eliminates DWL.
2. Non Optimal Price Regulation: government-imposed price ceiling is not set at the competitive level, which reduces but does not eliminate DWL. The price ceiling is set above/higher than the competitive level.
3. Increasing Competition: allowing/encouraging market entry by new domestic firms and ending import bans that kept out international firms. Consumers to shop at alternative suppliers.