Section12

Question 1

What defines a monopoly?

Answer 1

Monopoly: A firm that is the sole seller of a product without close substitutes. It has market power, the ability to raise prices without losing all sales.

Question 2

What are the main causes of a monopoly?

Answer 2

• Ownership of a key resource (e.g., DeBeers with diamonds).
• Government-created monopolies through patents and copyrights.
• Natural monopolies: A single firm supplies at lower cost due to economies of scale.

Question 3

What is a natural monopoly?

Answer 3

A natural monopoly occurs when a single firm can supply the market more efficiently than multiple firms due to economies of scale. Example: water distribution with high fixed costs for infrastructure.

Question 4

How does a monopolist’s production and pricing differ from a competitive firm?

Answer 4

Monopolist:

• Sole producer.
• Faces a downward-sloping demand curve.
• Price maker: Reduces price to increase sales.

Competitive firm:

• One of many producers.
• Faces a horizontal demand curve.
• Price taker: Sells at the market price.

does the monopolist really reduce prices?

Question 5

What are the effects on revenue when a monopolist increases output?

Answer 5

Revenue effects:

1. Output effect: More output sold, so Q increases.
2. Price effect: Price decreases, so P falls.

The impact on total revenue depends on price elasticity of demand.

Question 6

How does a monopoly set its profit-maximizing output and price?

Answer 6

A monopoly maximizes profit where marginal revenue (MR) = marginal cost (MC). The price is determined using the demand curve at the profit-maximizing output.

Question 7

What is the welfare cost of a monopoly?

Answer 7

Monopolies charge a price above marginal cost, creating a wedge between consumer willingness to pay and producer cost. This results in lower quantities sold than the social optimum, leading to inefficiency.

Question 8

What is price discrimination?

Answer 8

Selling the same good at different prices to different customers based on their willingness to pay (e.g., discounts for students or seniors).

Question 9

What conditions are necessary for price discrimination?

Answer 9

1. Ability to separate customers by willingness to pay.
2. Prevention of arbitrage (resale at different prices).

Question 10

How can monopolies be regulated?

Answer 10

• Price controls: Setting price equal to marginal cost (P = MC) or average cost (P = AC).
• Implementing a two-part tariff: Fixed charge + variable cost covering marginal cost.