Monopoly

Question 1

Total revenue

Answer 1

TR = P(Q) * Q

Question 2

Average revenue

Answer 2

Given by the demand curve, AR = P (Q)

Question 3

Marginal revenue (for a monopolist)

Answer 3

Additional revenue from selling one more unit

MR = dTR/dQ

R = Qp(q)
Differentiate to get
MR = QdP/dQ + p

Question 4

In a monopoly, are firms price takers or makers?

Answer 4

Makers

Question 5

Uniform pricing

Answer 5

No price discrimination, the monopolist’s sets the same price for everyone

Question 6

What’s the difference between a firm in a perfectly competitive market & a monopoly in terms of the firm’s demand curve?

Answer 6

PC = firm’s demand is perfectly elastic (horizontal)

Monopoly = since they are the only firm in the market, they face the entire market’s demand curve which is typically downward sloping

Question 7

Poisoning effect

Answer 7

by selling another unit, I “poison” all my previous sales; in order to sell another unit, I have to lower my price & then I make less profit on all of my previous sales (only in uniform pricing assumption)

Question 8

Generally, how will the slopes of the MR curve and demand curve relate? (monopoly & uniform pricing)

Answer 8

MR curve will be steeper than the demand curve

Question 9

Marginal revenue equation (in terms of elasticity of demand)

Answer 9

MR = p(1+1/elasticity of demand for the firm/market)

elasticity of demand in PC = negative infinity, so that’s why MR = p

Question 10

Describe the relationship between elasticity of demand and marginal revenue for a monopolist

Answer 10

As the elasticity of demand (which is almost always negative) increases in absolute value, the marginal revenue will increase. As the elasticity of demand decreases in absolute value, the marginal revenue will decrease. If the elasticity equals -1 then marginal revenue will equal 0 and when the elasticity equals negative infinity the marginal revenue will equal p∗ .

Question 11

What’s key when deciding on the profit-maximizing price for a monopolist (after finding the quantity)

Answer 11

You need to plug it back into the demand equation - you HAVE to respect the demand curve

Question 12

Shutdown rule for monopolists

Answer 12

Same as PC; p > AVC

Question 13

Market power

Answer 13

the ability to charge a price above marginal cost

Question 14

Markup equation

Answer 14

Price - MC / price = -1/elasticity of demand

How much more you’re charging than your MC in percentage terms

Question 15

Why don’t monopolists just charge whatever they want?

Answer 15

Still constrained by people’s ability to substitute across goods (no competition in market, but competition across markets)

Market elasticity of demand constrains monopolists - how substitutable their good is for other goods

Question 16

If the market demand is less elastic, a monopolists’ markup will be….[ ]…with uniform pricing

Answer 16

higher

Question 17

If the market demand is more elastic, a monopolists’ markup will be….with uniform pricing

Answer 17

lower

Question 18

If the market demand is perfectly elastic, a monopolists’ markup will be….with uniform pricing

Answer 18

zero

Question 19

Explain the relationship between elasticity of demand and markup for monopolists with uniform pricing

Answer 19

The markup that monopolists can charge depends upon the elasticity of market demand (Markup = -1/elasticity of market demand). According to that definition, the markup will fall as market demand becomes more elastic, rise as demand becomes more inelastic and go to zero when demand is perfectly elastic. The markup between marginal cost and price determines how much profit the monopolist will make, so profits will also fall as market demand becomes more elastic, rise as demand becomes more inelastic and go to zero when demand is perfectly elastic. Intuitively, this is true because as market demand becomes more elastic customers are more willing to substitute away from the monopolist good and into other markets. This substitution prevents monopolists from charging higher prices and reaping larger profits.

Question 20

What is the relationship between monopoly and DWL?

Answer 20

Monopoly leads to deadweight loss

Monopolies will hold units off the market because it is more profit-maximizing to them, and therefore create a DWL

Question 21

How does social welfare in a monopolist market with uniform pricing compare to social welfare in a perfectly competitive market?

Answer 21

In a monopoly market, producer surplus will go up because the monopolist will produce at the quantity that maximizes profit/producer surplus. Consumer surplus will go down, because the restricted quantity produced will drive some consumers out of the market and the higher price will lower the surplus for the remaining consumers. Social welfare will go down, because restricting the quantity supplied will prevent some beneficial transactions from occurring.

Question 22

Perfectly price discriminating monopolist

Answer 22

Monopolist can charge whatever price they want to each individual consumer

They will end up at the competitive outcome because there’s no poisoning effect

Question 23

How does social welfare in a monopolist market with perfect price discrimination compare to social welfare in a perfectly competitive market?

Answer 23

In a monopolist market with perfect price discrimination, the social welfare is the same as in a competitive market, because all the beneficial transactions still occur. The only difference is that the monopolist captures the surplus from these transactions and consumer surplus equals zero. This means that producer surplus will go up and consumer surplus will go down.

Question 24

Natural monopoly

Answer 24

Some markets have natural cost advantages (i.e. natural resources in a specific location)

For all relevant quantities, one firm can produce at a lower average cost than any other firm can; never makes sense to bring in another firm

AC is everywhere declining (within relevant range) - high fixed costs, low marginal costs

Question 25

How do monopolies arise?

Answer 25

1) Cost advantages -> natural monopoly; high fixed costs, etc.
2) Government actions (i.e. patent)

Question 26

Examples of government-sanctioned monopoly

Answer 26

US postal service
Patent - if you’re approved, you have a monopoly on providing a good for about 17 years. We create a DWL for those 17 years - but the government is okay with this because it promotes innovation/invention. Tradeoff between creating an inefficient monopoly vs. promote innovation

Question 27

Patents can increase or decrease welfare in a monopoly - how will we figure out which way welfare will go?

Answer 27

It depends on how much the demand curve shifts out from the promotion of innovation vs. how much the DWL is created from creating the inefficient monopoly

Question 28

Explain how government price ceiling could improve social welfare with a monopoly

Answer 28

Removes poisoning effect for initial units and removes the monopoly’s deadweight loss

Optimal monopoly price regulation induces the monopolist to produce the efficient quantity, because there is no poisoning effect. There is no poisoning effect, because the monopolist does not have the option to raise the price above the efficient price. Producing the efficient quantity and offering it at the efficient price will decrease deadweight loss. Consumers will be better off because more transactions will occur at a lower price. The producer will be worse off, because they will not be able to use their market power to restrict quantity and raise price in order to extract additional producer surplus.

Question 29

In order to do optimal monopoly price regulation, the government needs to know…

Answer 29

The government needs to know the demand curve and supply curve in order to determine what the efficient price ceiling will be. The current price and quantity are irrelevant to their decision if they know the demand curve and the supply curve.

Question 30

Which methods allow the government to estimate the demand curve?

Answer 30

The government can estimate the demand curve by asking consumers how much they value the good (contingent valuation) or studying the behaviors of consumers (revealed preference). Asking the monopolist will yield information about the supply curve, but not the demand curve. Optimal price regulation is the setting of efficient price ceiling not how to determine the demand curve.

Question 31

Suppose marginal cost is everywhere increasing. What will happen if the government sets the price ceiling below the marginal cost of the first unit?

Answer 31

If the price ceiling is below the marginal cost of the first unit, then the monopolist will lose money by producing the good, so it will shut down and the market for the good will disappear. This will increase deadweight loss because beneficial transactions will not occur.

Question 32

Contestable markets

Answer 32

Some market power, limited by barrier to entry
A monopoly market with a threat to entry (barrier to entry isn’t SO large that firms could enter at any time)

i.e. airlines

Question 33

What happened when the government deregulated airlines in 1978?

Answer 33

When the government deregulated airlines, it turned out that airlines were a mostly contestable market. More companies entered the market. These companies drove down prices and increased the number of routes offered (increased quantity) just as theory would predict. Since airlines could compete on price, airlines reduced their number of amenities in order to reduce their prices. Before airlines could not compete on price, so they competed by providing more amenities. We know that this tradeoff between price and amenities increased social welfare, because if consumers demanded more amenities, then a popular airline would emerge that offered these additional amenities at a higher price. Since none of the major airlines offer such additional amenities, we can conclude that most consumers value the lower prices more than the additional amenities.

Question 34

Assuming uniform pricing, returning a monopolist’s profits back to consumers…

Answer 34

Giving the monopolist’s profits back to consumers fails to eliminate the deadweight loss of monopoly

A monopolist will charge a higher price that leads to a suboptimal amount of goods being purchased. The deadweight loss is actually the summation over the individuals who no longer purchase the good and not the transfer of consumer surplus to producers.

Question 35

True/False? In a monopoly market, total social surplus is (weakly) higher under perfect price discrimination than under uniform pricing.

Answer 35

True

Question 36

True/False? Consumers (as a group) would prefer a monopolist to perfectly price discriminate rather than to charge a uniform price, because total social surplus is higher under perfect price discrimination.

Answer 36

When the monopolist perfectly price discriminates, each consumer is charged exactly her marginal willingness to pay and there is no surplus for the consumers. It is true that perfect price discrimination maximizes total social surplus, but this only benefits the monopolist who sees her producer surplus increase.