Week 6 - Pricing With Market Power 1

Question 1

Characteristics of a Monopoly Market

Answer 1

1) Single Seller = High Concentration (100%)
2) No close substitute = Product is Unique
3) Must be barriers to entry (competition is restricted by mechanisms)

Question 2

Examples of Legal Barriers to Entry

Answer 2

• Exclusive right over a goods production (patent, copyright)
• Public franchise (Australian Post); Government licences (Taxis, practice of medicine)

Question 3

Why are there monopolies?

Answer 3

Natural Barriers to Entry:
- Control over an essential input not available to other firms
- Monopolist might simply have a lower cost of production that effectively allows them to prevent other firms from entering the market
- Technology/level of demand makes one producer more efficient than a number of producers

Question 4

What is a Natural Monopoly

Answer 4

Results from a situation where a single firm can supply an entire market at a lower cost than 2+ firms could supply at the market

Question 5

Examples of a Natural Monopoly

Answer 5

Telecommunications network, electricity transmission, tap water provision

Question 6

What implies a natural monopoly?

Answer 6

Declining LR ATCs:
- Substantial economies of scale (a ‘natural’ barrier to entry)
- Often large capital costs (infrastructure), with now low supply MCs

Question 7

Characteristics of Monopoly Market (Price searcher or Price Maker)

Answer 7

1) Only one seller = monopolist can decide price of their products to maximise profit
2) Demand curve for a monopoly firm is the same as demand curve for market since 1 seller
3) Monopolist is price maker, hence demand curve is downward sloping (market curve)

Question 8

Describe the Market Power of a Monopolist

Answer 8

1) Firm with a low price elasticity of demand for its output can raise price and not lose all customers
2) Can raise prices above level existing in perfectly competitive industry and not lose all customers

Question 9

Total Profits is

Answer 9

TR - TC

Question 10

How does changing quantity impact price

Answer 10

• q increases by 1 unit = price falls by same amount
• q decreases by 1 unit = price increases by same amount

Question 11

What causes a trade-off for a monopolist

Answer 11

Selling less q for a higher p or selling more q for a lower p

Question 12

MR incorporating effects

Answer 12

Output and Price Effect

Question 13

What is the Output Effect?

Answer 13

As you sell more units, you obtain extra revenue from additional units sold

Question 14

What is the Price Effect?

Answer 14

As you sell more units, price falls and you lose revenue on the existing units sold

Question 15

Impact of the MR effects

Answer 15

MR is not the same as P, MR < P

Question 16

Impact of profit greatest (Qb) where difference between TR and TC is greatest

Answer 16

Profits are maximised when a monopolist sets MR = MC

Question 17

Why are profits maximised for a monopolist when MR = MC

Answer 17

If MR > MC, monopolist can increase profit by selling one extra unit
If MR < MC, profit falls from selling last product, so better off not selling that unit

Question 18

Compare profit maximisation for competitive and monopolist firms

Answer 18

Competitive, P = MR = MC
Monopolist, P > MR = MC

Question 19

Impact on Elasticity on Demand and MR Curves

Answer 19

1) When Demand = Elastic:
- Small decrease in price leads to a large increase in quantity demanded, TR increases = MR is positive
2) When Demand = Inelastic:
- Small decrease in price leads to small increase in quantity demanded, TR decreases = MR is negative

Question 20

What will a profit maximising monopolist never do

Answer 20

Produce at an output in the inelastic range of its demand curve

Question 21

How to derive the MR Curve?

Answer 21

dTR/dQ, for TR = p * q

Question 22

What can we determine once we know the profit-max output

Answer 22

The price to be charged (from the demand curve)

Question 23

What is a summary of a Monopoly?

Answer 23

1) A monopolist will not charge the highest possible price (maximise profit not price)
2) Monopolist will not maximise profits per unit, but total profits, where MR = MC
3) Monopolies are not always making profit, losses are possible (sometimes weak demand or high costs)

Question 24

Economic Effects of a Monopoly (assuming same cost curve and no economies of scale)

Answer 24

Monopolist charges a higher price (pM) and produces a smaller quantity (qM), compared to the competitive industry (pC, qC)

Question 25

What is Deadweight Loss (DWL)

Answer 25

Surplus loss from the restriction of output (occurs as Monopolist restricts qM < q*, below the competitive level)

Question 26

What is Rent Seeking Behaviour

Answer 26

Activity of trying to obtain a monopoly in order to order economic profit

Question 27

What does Rent Seeking Behaviour Imply

Answer 27

A firm is willing to spend up to the monopoly profit in order to obtain a monopoly (Buying a monopoly, Creating a Monopoly, Creating Barriers to Entry)