Practice Questions Tutorial 9 Flashcards
The government considers whether to impose a lump-sum tax on a monopoly or to
offer it a per-unit subsidy.
Why might the government want to intervene
Because for a monopoly, long run equilibrium is not efficient:
• Price > MC;
• Monopoly produces below the level where LRAC is minimum.
So compared to perfectly competitive firms, it charges more and produces less.
The government considers whether to impose a lump-sum tax on a monopoly or to
offer it a per-unit subsidy.
) Examine the effects of a lump-sum tax
Lump sum tax increases fixed costs, therefore the AC shifts upwards. The MC does not
move. The bigger the tax, the more the AC shift upwards. The more the AC shifts
upwards, the lesser the supernormal profits that the monopoly earns.
The government considers whether to impose a lump-sum tax on a monopoly or to
offer it a per-unit subsidy.
) Examine the effects of a per-unit subsidy (again, draw a diagram).
) Examine the effects of a per-unit subsidy (again, draw a diagram).
) Per-unit subsidy reduces the variable costs of the monopoly, therefore moves both the
AC and the MC downwards (parallel shift downwards). Subsidies result in the monopoly
increasing Q and decreasing P, but the monopoly will make bigger supernormal profits.
The government considers whether to impose a lump-sum tax on a monopoly or to
offer it a per-unit subsidy.
Why might the government wish to adopt both policies simultaneously?
With both together, government can encourage the monopoly to increase Q and
decrease P (with subsidies), yet can still squeeze the supernormal profits of the
monopoly (tax).
As the case against Google illustrates, the issue of monopoly power is still an important
concern for most governments. Discuss whether this preoccupation with the dangers of
monopoly power is justified.
There is accusation that monopolies exploit market power to stifle competition in industry.
Compared to perfect competition, monopoly charges more (above marginal cost) and
produces less (lower than socially optimal quantity), resulting in deadweight loss. But some
economists argue that the market power of monopolies may have certain economic benefits
that weight against the deadweight loss.
Perfect price discrimination leads to zero consumer surplus. With this in mind, why do
economists argue that perfect price discrimination maximises total welfare?
Perfect price discrimination leads to zero consumer surplus. However, total welfare =
consumer surplus + producer surplus. With perfect price discrimination, the producer will
sell to every consumer a price exactly equal to their willingness-to-pay. Thus, the producer
extracts all possible economic surplus from the marketplace as their profit, which is a part of
total welfare.
