Monopoly

Question 1

What is an uncompetitive market?

Answer 1

A market in which firms are not necessarily price takers which can result from barriers to entry

Question 2

What is a monopolistic market?

Answer 2

A market with a single producer

Question 3

When would a monopolist harm welfare?

Answer 3

Consumer welfare is harmed if the monopolist would decrease CS, social welfare is harmed if the monopolist decreases CS + PS

Question 4

When does deadweight welfare loss occur?

Answer 4

When a monopolist and a consumer would have gained from supplying more of a good but the monopolist is not able to extract this surplus

Question 5

What decision does a monopolist make?

Answer 5

What price to set to maximise profit based on the inverse demand function P(q)

Question 6

What is the problem a monopolist (no PD) solves?

Answer 6

max_q P(q)q - c(q)
= max_q R(q) - c(q)
At interior solution will have R’(q) = c’(q) so MR = MC
Same as competitive market except p depends on q

Question 7

What is a monopolist’s marginal revenue?

Answer 7

MR(q) = R’(q) = P(q) + qP’(q)
P(q) is extra revenue for additional output
|P’(q)q| is lost revenue for every unit sold
MR(q) < P(q) for all q

Question 8

How does the monopolist’s choice differ from the competitive choice?

Answer 8

The price will be higher and the quantity will be lower as MR is steeper than market demand P(q)

Question 9

How would you show deadweight loss on a diagram?

Answer 9

Draw P(q), MR, MC
Competitive choice is q’’ where P(q) = MC, monopolist choice is q’ where MR = MC
Consumer and producer surplus can be labelled, with both parties losing the area between q’, MR, and MC

Question 10

What is the relationship between deadweight loss and price?

Answer 10

Deadweight loss only depends on quantity so a government forcing a lower production at a lower price (redistributing surplus) would have the same deadweight loss as a monopolist setting the same quantity at a higher price (extracting surplus)
Total surplus is area between demand and MC, doesn’t depend on price

Question 11

How does the monopolist’s choice relate to elasticity?

Answer 11

A monopolist would increase prices at an inelastic part of the demand curve as they can extract more surplus from the consumers so the monopolist’s choice will always be where the market demand is elastic

Question 12

What is elasticity as a function of quantity?

Answer 12

ε(q) = P(q)/P’(q)q < 0

Question 13

How does MR relate to elasticity?

Answer 13

MR(q) = P(q)(1 + 1/ε(q))

Question 14

What does the relationship between MR and elasticity say about the monopolist’s choice?

Answer 14

Since the monopolist would decrease production if MR(q) < 0, MR(q) ≥ 0
From formula for MR(q), ε(q) < -1 so monopolist’s choice will be where market demand is elastic

Question 15

What is the relationship between MC and elasticity and what does this say about the monopolist’s choice?

Answer 15

At the monopolist’s choice q’ MC(q’) = MR(q’) = P(q’)(1 + 1/ε(q’)) so P(q’) = (1/(1+1/ε(q’)))MC(q’) where first bracket is the markup
(p - MC)/p = 1/|ε| at monopolist’s choice

Question 16

When is a monopoly the most efficient option?

Answer 16

In the case of a natural monopoly there are typically high regular fixed costs so AC is decreasing up to a large volume of production and thus it is efficient to have one large firm

Question 17

What are the types of price discrimination?

Answer 17

No PD: non-personalised linear
1st: personalised non-linear
2nd: non-personalised non-linear
3rd: personalised linear

Question 18

If there is a higher and a lower valuation group of consumers, how does the monopolist make a choice under no PD?

Answer 18

Separately considering the case of only selling to the higher valuation group and the case of selling to both groups

Question 19

What is the breakdown of surplus under FDPD?

Answer 19

If the monopolist knows each consumer’s demand curve they can extract all surplus (CS = 0) by charging each consumer their marginal willingness to pay for each unit
There is no deadweight loss

Question 20

In the discrete case how will a monopolist under FDPD make their decision?

Answer 20

For each unit they will sell to whoever has the highest valuation until MC > MR (the next highest valuation)
This is the same as demand crossing MC like in competitive case

Question 21

If there is a higher and a lower valuation group of consumers, how does the monopolist make a choice under FDPD?

Answer 21

Calculating the CS for each group and charging this amount for the entire bundle that each bundle would be willing to buy

Question 22

How does a monopolist make a choice under SDPD?

Answer 22

Assume there is a higher and a lower group of consumers and that MC is constant
Then if both consumers are being served, the full surplus should be extracted from the lower valuation group (otherwise price could be raised with no downside), then the higher valuation group should be made indifferent between the two options (to extract some surplus from them) and the higher valuation group should choose the same quantity as under FDPD (where MC = D) at which point everything can be expressed in terms of quantity sold to lower valuation group and profit can be maximised over this quantity
i.e.
1) find quantity sold to higher group which is same as under FDPD
2) find price charged to lower group which is same as their surplus
3) find price charged to higher group so that they are indifferent between the bundles

Question 23

What choices does a monopolist under SDPD facing a higher and a lower valuation group make?

Answer 23

The quantities and prices of two bundles (q₁, {p₁}) and (q₂, {p₂})
This requires a trade-off as serving the higher group creates a surplus for the first group as the monopolist must make the higher valuation group indifferent between the two options to serve both groups

Question 24

How does a monopolist make a choice under TDPD?

Answer 24

If all markets are served, the optimal choice will have the MR in each market equal to the total MC which will yield a system of equations that can be solved to find the quantities and then prices
Graphically this corresponds to summing MRs from each market horizontally and finding the intersection of this with the total MC

Question 25

Under TDPD, when will the monopolist supply to a group?

Answer 25

If MC is not constant (so the decision in one market affects the other market) and the profit is greater from not selling to a particular market

Question 26

What are the welfare effects of price discrimination?

Answer 26

FDPD is efficient but CS = 0
No PD is inefficient, worst for monopolist
SDPD, TDPD are inefficient but may make consumer better off than no PD, can’t be compared in general for consumers
Other than FDPD can’t make general comparison of total welfare

Question 27

How do SDPD and no PD compare with regard to welfare?

Answer 27

SDPD certainly leaves more PS, CS may rise for some groups