T2 1.1: Monopoly

Question 1

Define a monopoly?

Answer 1

An industry structure where there is only one firm in the market, a monopolist

Question 2

2 points on how a monopolist can set prices?

Answer 2

• price setter, not price taker

- price they set is constrained by the demand curve

Question 3

What is a monopolists profit function?

Answer 3

Max(wrt y): r(y)-c(y)

Question 4

What is the optimality condition?

Answer 4

at the optimal level of output, marginal cost (MC) equals marginal revenue (MR)

Question 5

What happens to revenue if output increases?

Answer 5

• Sells more -> gains the price multiplied by the new units of output: pΔ𝑦
• Increasing output REDUCES the price -> loses the difference in price multiplied by the units of output that were already being sold: yΔp (with Δ𝑝 < 0)
• Unlike the competitive case, there is no gain in market share from reducing price.
tf: Δ𝑟 = pΔ𝑦 +𝑦Δ𝑝

Question 6

Using Δ𝑟 = pΔ𝑦 +𝑦Δ𝑝, what is marginal revenue?

Answer 6

Δ𝑟/Δ𝑦 = pΔ𝑦/Δ𝑦 + 𝑦Δ𝑝/Δ𝑦 = 𝑝+𝑦Δ𝑝/Δ𝑦

Question 7

What is PED?

Answer 7

A measure of the responsiveness of demand for a good when its price changes

Question 8

See my notes and show i can prove optimality condition in term of elasticity

Answer 8

NOW

Question 9

Where will a monopolist operate in terms of demand elasticity?

Answer 9

They will operate only where demand is elastic tf absolute value of it>1

Question 10

What is the markup price and how is it determined?

Answer 10

Firms set output so MC=MR, then charge the maximum possible price for that output level

Question 11

How do we know a monopolist will always charge a price above MC?

Answer 11

Since they operate where absolute value of elasticity is greater than 1, tf 1/value is less than one; using equation in notes for markup, we see that must be tf greater than 1 so when multiplied by MC for price, shows price also must be greater than MC

Question 12

See diagram

Answer 12

Bottom of my notes p1

Question 13

Where is the profit maximising output level? (see diagram)

Answer 13

The profit maximising output level is found where the mark-up adjusted MC curve crosses the demand curve.

Question 14

What is the Lerner index?

Answer 14

An index measuring the degree of a firm’s monopoly power

Question 15

Prove the lerner index is equal to 1/|ε(y)|

Answer 15

see slides

Question 16

What determine a firms level of monopoly power?

Answer 16

The smaller the PED (less elastic) at the profit maximising output, the greater the markup and tf the larger the firm’s degree of monopoly power

Question 17

What will the makeup of a market with elastic demand be?

Answer 17

Elastic demand results in smaller markup and tf less monopoly power

Question 18

Define economic efficiency?

Answer 18

Where no change in output can be made that improves the welfare for anyone without being at the expense of others (eg. perfect competition)

Question 19

Explain, using a diagram, why perfectly competitive markets are efficient?

Answer 19

See notes:

All potential surplus is being exploited tf market is efficient

Question 20

Explain, using a diagram, why monopoly markets aren’t efficient?

Answer 20

Monopolies charge prices above the efficient level and produce output below the efficient level tf producers gain and consumers lose out. (SEE DIAGRAM) CS is reduced by A, PS is reduced by B, tf DWL=A+B (see slide 33)

Question 21

What is a pareto improvement?

Answer 21

An action that makes no one worse off and makes at least one person better off

Question 22

Why doesn’t the monopolist increase its output (charging for an extra unit where P>MC)?

Answer 22

Because the monopolist would have to lower the price on all the existing units of output they produce. These units are “inframarginal” units of output.

Question 23

When do natural monopolies occur?

Answer 23

When the efficiency condition P=MC means providing an output level that isn’t profitable, but is socially preferable
Often when FIXED COSTS are high and MC are small (eg. gas mains system)

Question 24

Draw a diagram showing a natural monopoly when using MC pricing and explain?

Answer 24

See notes for diagram. It shows the AC minima is to the right of the demand curve, tf P=MC is below average cost tf production is not at competitive equilibrium

Question 25

What is the solution to the pricing problem faced by natural monopolies? Use a diagram to explain

Answer 25

(see notes for diagram)
Use average cost pricing; price and quantity are determined by the intersection of the AC curve and the demand curve. Regulators view as a fair way to regulate behaviour of NM, since price falls above p(c) and below p(m)

Question 26

Problem with average cost pricing?

Answer 26

Due to poor governance/corruption, problems can arise when determining how much p’ should be above p(c)

Question 27

Another solution to natural monopoly problem?

Answer 27

Nationalise the natural monopoly, charge P=MC and use public money to subsidise losses

Question 28

3 causes of monopoly and explained?

Answer 28

1) Market structure (high MES relative to demand) (see slide 41!!!)
2) Historical dominance (if a firm has always dominated it may be natural for them to continue dominating)
3) Law (legal monopolies enshrined by patents)

Question 29

4 cases where a monopoly market is acceptable?

Answer 29

1) Natural monopolies
2) Patents (providing a ST monopoly -> increase in R&D and investment)
3) When duplication is wasteful (eg. railway tracks)
4) Economies of Scale - when a monopoly charging with SNP is still cheaper than a PC market

Question 30

6 types of monopoly?

Answer 30

CNELGP
Cartels
Natural monopoly driven by market structure
Economic monopoly
Legal/technical monopoly
Geographical monopoly
Platform monopoly

Question 31

What is a cartel monopoly?

Answer 31

When powerful firms conspire to reduce output and increase price

Question 32

What is a natural monopoly driven by market structure?

Answer 32

Only 1 firm can be sustained in market

Question 33

What is an economic monopoly?

Answer 33

Arises due to economies of scale and tf huge efficiency of the producer and tf unmatchable low prices (entry deterrent)

Question 34

What is a geographical monopoly?

Answer 34

Geographical restrictions can give ordinary firms monopoly power (eg. petrol station on a motorway)

Question 35

What is a platform monopoly (and examples)?

Answer 35

When a platform connects users together, tf as more members join its usefulness increases (eg. Uber, Amazon, Facebook)
Huge amounts of data gives these firms market power, despite them not tending to sell output

Question 36

See

Answer 36

Regulate? • Economics of data privacy • Can consumers really opt out of engaging with Platform Monopolies? • Google chooses to enter markets that generate new data (e.g. Alexa)
 Let them be? • The promise of years of monopoly rents provides a powerful incentive to innovate. The profits monopolies can bring allow bold long-term plans and ambitious research projects that “firms locked in competition can’t dream of”. (Guardian, 2017) • Difficult challenges to regulation – international companies; how to regulate the internet.

Question 37

Draw diagram showing a tax on a monopoly, assuming constant MC?

Answer 37

See notes

Question 38

With linear demand, how much of the tax is passed on to the consumer? Prove it. Also see notes on rest of stuff

Answer 38

1/2

see proof and notes

Question 39

Note about monopolist regarding MC and budget constraint/demand curve

Answer 39

Unlike under perfect competition, the monopolist does not need to set price equal to marginal cost. However, the monopolist is still constrained by the Demand Curve.