Module 10 Study Guide Flashcards
What are the characteristics or assumptions of the monopoly model?
Monopoly firms are protected from competition. Three barriers to entry: natural barrier to entry, ownership barrier to entry, and a legal barrier to entry
(Look up the definitions for these in the book)
The market demand curve IS the demand curve in monopoly - They’re exactly the same thing because they’re only one firm.
They have lots of price power because they’re the only place you can go to. (They have to answer to consumer demand - The best price that consumers are willing to pay but they’re not competing with anyone else.)
(Marginal revenue is the change in total revenue as we produce the next unit of output.)
For each of the following markets, explain the sources of monopoly power/barriers to entry: electric company, diamonds, new life-saving drug.
A firm that confronts economies of scale over the entire range of outputs demanded in its industry is a natural monopoly. Utilities that distribute electricity, water, and natural gas to some markets are examples. In a natural monopoly, the LRAC of any one firm intersects the market demand curve where long-run average costs are falling or are at a minimum. If this is the case, one firm in the industry will expand to exploit the economies of scale available to it. Because this firm will have lower unit costs than its rivals, it can drive them out of the market and gain monopoly control over the industry.
De Beers acquired rights to nearly all the world’s diamond production, giving it enormous power in the market for diamonds. With new diamond supplies in Canada, Australia, and Russia being developed and sold independently of De Beers, however, this power has declined, and today De Beers controls a substantially smaller percentage of the world’s supply.
With life-saving drugs, pharmaceutical companies will patent the product so that nobody else is allowed to make it, creating a monopoly. Governments allows this to encourage companies to work to develop these new, life-saving products.
In what part of the demand curve will a monopolist operate? Why?
Because a monopoly firm will generally operate where marginal revenue is positive, it will operate in the elastic range of its demand curve.
What is the relationship between demand and marginal revenue for a monopolist?
But a monopoly firm can sell an additional unit only by lowering the price. That fact complicates the relationship between the monopoly’s demand curve and its marginal revenue. Marginal revenue is less than price for the monopoly firm.
Will a monopoly firm be able to sustain positive profits in the long run? Explain.
What is price discrimination? What are the conditions for price discrimination?
Yes because they’re blocking entry.
Price discrimination is when a situation in which a firm changes different prices for the same good or service to different consumers, even though there is not difference in the cost of the firm of supplying these consumers.
The conditions necessary for price discrimination:
A Price-Setting Firm. The firm must have some degree of monopoly power. It must be a price setter. A price-taking firm can only take the market price as given; it is not in a position to make price choices of any kind. Thus, firms in perfectly competitive markets will not engage in price discrimination. Firms in monopoly, monopolistically competitive, or oligopolistic markets may engage in price discrimination.
Distinguishable Customers. The market must be capable of being fairly easily segmented—separated so that customers with different elasticities of demand can be identified and treated differently.
Prevention of Resale. The various market segments must be isolated in some way from one another to prevent customers who are offered a lower price from selling to customers who are charged a higher price. If consumers can easily resell a product, then price discrimination is unlikely to be successful. Resale may be particularly difficult for certain services, such as dental checkups.
Compare the monopoly outcome to a perfectly competitive outcome with respect to price and output.
In a perfectly competitive outcome, price is determined by demand and supply; each firm is a price taker. Price equals marginal cost.
In a monopoly, the firm determines price; it is a price setter. Price is greater than marginal cost.
A monopoly firm produces an output that is less than the efficient level. The result is a deadweight loss to society, given by the area between the demand and marginal cost curves over the range of output between the output chosen by the monopoly firm and the efficient output. Output is lower and price higher than in the competitive solution.
Which market structure is more efficient, monopoly or perfect competition? Why?
Perfect competition. Because a monopoly firm charges a price greater than marginal cost, consumers will consume less of the monopoly’s good or service than is economically efficient.
In perfect competition, the equilibrium solution is efficient because price equals marginal cost.
In a monopoly, the equilibrium solution is inefficient because price is greater than marginal cost.
