Monopoly

Question 1

What is a monopoly?

Answer 1

One firm In a market, they set equilibrium price and quantity

Question 2

what is oligopoly?

Answer 2

Few firms in market, decisions of each firm affect payoff of all other firms.

Question 3

What is a dominant firm?

Answer 3

One large firm , many small firms. Decisions of large firm affect payoffs of all other firms, but decisions of small firms do not affect any other firm.

Question 4

What is Monopolistic completion?

Answer 4

Many firms with slightly differing products, no decision of any firm affects the payoffs of any other firm.

Question 5

What is pure competition?

Answer 5

• Many firms making same product
• No firm has any influence in the market, they are price takers
• Free to vary price but will only be in equilibrium where price= marginal cost.
• If a firm sets price above equilibrium price then its demand will be 0
• If a firm sets its price below equilibrium price the its demand will equal total market demand

Question 6

Monopoly characteristics

Answer 6

• opposite of pure competition
• Influence over market price ad quantity produced
• These are set so that profit is maximised
• Decision of market price and output is not completely independent (For a given price the monopolist can only sell what the market is able to buy, if price is to high the monopolist will only sell a fraction of its output)
• Therefore they can either set the price and let market choose output OR set output and market chooses price. (consumer constrains price and output)

Question 7

Why do monopolies exist?

Answer 7

• Patented (new drug)
• Legal fiat (US postal system)
• Sale of ownership of a resource of production (e.g. toll highway)
• Creation of cartel (e.g. OPEC)

Question 8

When is profit maximised?

Answer 8

Marginal revenue= Marginal cost

Question 9

Why is optimal condition MR=MC?

Answer 9

Because when MC>MR there is incentive to cut output to make up for the loss in revenue and when MC

Question 10

What is marginal revenue?

Answer 10

The rate of change of revenue when output is increase (Derivative of revenue function with respect to y) dP(y)y/dy

Question 11

What is marginal cost?

Answer 11

The rate of change of cost when output is increased (derivative of cost with respect to output) dC(y)/dy

Question 12

Why is monopoly inefficient?

Answer 12

MC is smaller than Price which means there are customers willing to but more product at a lower price than market price but higher than marginal cost which means customers will be satisfied and so too will producers as they have earned more profit. However this cannot be done without lowering the price of all the output which would lower profits.

Question 13

When is pareto’s efficiency reached?

Answer 13

When the condition (utility or profit) of the supplier or consumer cannot be improved without harming the condition of the consumer/ supplier.

Question 14

What is DWL?

Answer 14

Dead weight loss. Gains to trade not achieved due to inefficiency of the market. In monopoly the monopolist produces less than the efficient output so sells this at a price higher than market price under perfect competition.

Question 15

What is mark up pricing?

Answer 15

As the monopolist sets price at a level where mR=mC,, P>mC so price is just a mark up of marginal cost.

Question 16

What does the magnitude of the mark up depend on?

Answer 16

Price elasticity of demand. If demand is highly elastic (sensitive to price changes/ gentle slope e.g 1) then mark up will be small. If demand is highly inelastic (insensitive to price/ steep slope e.g 0) the mark up will be large.

Question 17

What formula links price, marginal cost and elasticity of demand?

Answer 17

P= MC(y)/1-1/ε

This shows that mark up price depends on elasticity

Question 18

What happens when profit tax is levied on a monopolist?

Answer 18

• Monopolists aim to maximise profits
• profit tax reduces monopolists profits from π(Y) where Y= profit maximising output, to (1-t)π(y*)
• The only way to maximise post tax profits is to maximise pre tax profits.
• Therefore this does not change the suppliers choice of output, price or customer demand.
• Profit tax is a neutral tax

Question 19

What happens when quantity tax is levied on a monopolist?

Answer 19

• A tax of £T increases MC by £T
• This reduces profit maximising output
• This increase profit maximising price
• This reduces demand
• Quantity tax is distortionary

Question 20

In what scenario is pareto’s efficiency achieved in monopoly? At what cost?

Answer 20

1. Under natural monopoly

2. Such a firm makes a negative profit

Question 21

Describe a situation that results in natural monopoly

Answer 21

• They arise when there are extremely high fixed costs such as the case of distribution of infrastructure to ensure supply.
• This is normally the case for public utilities
• E.G. cables ad grids for electricity, pipelines for gas and water, network for rail services.

Question 22

What is the effect of a new entrant in a natural monopoly?

Answer 22

• May cause potential inefficiency as infrastructure is duplicated (more is produced than demanded by market)
• Waste of resources
• May be efficient to allow one firm

Question 23

What is the ‘entry defence’ in natural monopoly?

Answer 23

• Incumbent firm uses the threat of predatory price
• Predatory price is when the dominant firm cuts price to such a level the new entrant makes a negative profit, thereby inducing their exit.