Week 7 - Monopoly

Question 1

What is are 3 assumptions of imperfect competition?

Answer 1

1. in most situations, firms can differentiate their products from their competitors
2. many firms are price setters (have at least some latitude to set their own prices)
3. they have market power (ability to raise the price of a good without losing all of its sales)

Question 2

What is the difference between perfect competition and imperfect competition in terms of graphs?

Answer 2

The perfectly competitive firm faces a perfectly elastic demand curve for its product. (D=AR=MR)

The imperfect competitive firm faces a downward sloping demand curve. (D=AR)

Question 3

What are the three different forms of imperfect competition?

Answer 3

1. Pure monopoly
2. Oligopoly
3. Monopolistic competition

Question 4

What is a pure monopoly?

Answer 4

a market in which a single firm (monopolist) is the only seller of a unique product.

(opposite to perfect competition)

Question 5

What is an oligopoly?

Answer 5

a market structure which only a few firms (oligopolists) sell a given product

Question 6

What is monopolistic competition?

Answer 6

consists of a relatively large number of firms that sell the same product with slight differentiations

Question 7

What are the 5 assumptions of a monopoly?

Answer 7

1. Many buyers (not one of which is large relative to the overall market)
2. One seller
3. No close substitutes
4. Buyers are well informed about the offerings of competing suppliers
5. Either technological or legal barriers completely block entry

Question 8

What is the average revenue when the Quantity is 0? AR = 8 - q

Answer 8

It is not 8, it will be zero

Question 9

What is the average revenue formula?

Answer 9

AR = a -bq
suppose if the firms faces a downward sloping demand curve so is given by this formula

Question 10

What is the total revenue formula?

Answer 10

is given by AR x Quantity sold
TR = aq - bq^2

Question 11

Why does total revenue drop after a certain level of output?

Answer 11

TR put on a graph is a maximum curve, increases up to certain point

Question 12

What is the marginal revenue formula?

Answer 12

MR = dTR / dq
given by the rate of change of total revenue with respect to quantity sold

Question 13

What is the similarity of AR and MR on a graph?

Answer 13

MR has the same y intercept as AR, but MR is twice as steep

Question 14

When the MR = 0 what does this mean for TR?

Answer 14

TR is maximised when MR = 0

Question 15

What is the shape of total costs determined by?

Answer 15

by the law of diminishing marginal product (in the short run) and, by economics and diseconomies of scale (in the long run). Typically costs are an inverse S shape.

(looks like a sort of inflection point curve)

Question 16

What is the formula of TC?

Answer 16

aq^3 - bq^2 + cq + d

Question 17

What happens to TC the more you produce?

Answer 17

the higher the TC

Question 18

Why does the gradient reduce in the middle of the TC graph?

Answer 18

MC is the slope of the TC, is slows down in the middle suggesting MC reduces at a certain point, then continuing marginal cost increases

(through specialisation up to a certain point)

Question 19

How do we calculate AC?

Answer 19

AC = TC / q
= aq^2 - bq + c + d/q

Question 20

What is the formula of MC?

Answer 20

MC = dTC / dq
= 3aq^2 - 2bq + c

Question 21

When is profit maximised?

Answer 21

When MR = MC
Where TR > TC (vertical distance between TR and TC is greatest)

slope of TR is MR
slope of TC is MC

Question 22

What curves and lines are on a monopoly graph?

Answer 22

MC, MR, AC, D=AR

Question 23

How to find the price on a monopoly graph?

Answer 23

Draw a vertical line through where MR=MC up to D=AR and then across

Question 24

How to find total revenue on the graph?

Answer 24

still P x Q

Question 25

How to find total cost?

Answer 25

vertical from q through MC=MR up to where it hits the AC curve

Question 26

How to find profit on the monopoly graph?

Answer 26

The rectangle of TR minus TC (where vertical q line goes through MR=MC up to AC)

Question 27

Algrbraic example:
Suppose that TR is given by pq and TC given by cq^2. Suppose that the inverse demand function is given by p=p_0 - aq

So profit represented as
= (p_0 - aq)q - cq^2
=p_0q - aq^2 - cq^2

What point is profit maximised (slope profit function is 0 because stationary point)

in this, MR = p_0 - 2aq
MC = 2cq
so…

Answer 27

d Profit/ dq
= p_0 - 2aq - 2cq
= p_0 - 2q(a+c)

0 = p_0 - 2q(a+c)
p_0 = 2q(a+c)

where a=0, similar to perfectly competitive case
if a>0 (ie firm has monopoly power) output will be lower than under perfect competition

second way: make MR=MC

Question 28

Why is a monopoly inefficient?

Answer 28

producer surplus is the profit made (mini rectangle)

consumer surplus is the triangle above the profit

it is inefficient because it has less consumer surplus than perfect competition

Question 29

Does perfect competition have producer surplus?

Answer 29

no only consumer surplus, triangle above where P=AC, no supernormal profit, has a greater consumer surplus than monopoly

Question 30

What is price discrimination?

Answer 30

where customers are charged different prices for the same good

Question 31

What are the 3 conditions necessary for profitable price discrimination?

Answer 31

1. The firm must be a price maker
2. The firm must be able to identify which consumer is which
3. Consumers must not be able to arbitrage (process where customers, who firms charge low prices, make purchases that they then resell to customers who would otherwise have to pay high prices)

Question 32

What are the 3 different types of price discrimination?

Answer 32

1. First degree price discrimination (perfect price discrimination)
2. Second degree price discrimination
3. Third degree price discrimination

Question 33

What is first degree discrimination (perfect price discrimination)?

Answer 33

The monopolist knows exactly the willingness to pay of each consumer in the market. It then sells each unit of output at a price just equal to the buyer’s maximal willingness to pay for that unit.

(theoretical doesnt exist in the real world)

Question 34

What is the second degree price discrimination?

Answer 34

The monopolist knows that its customers have different willingness to pay but it cannot tell who is who. The same price schedule is offered to all buyers but they sort themselves through self selection.

Question 35

What is third degree price discrimination?

Answer 35

The monopolist doesnt know each consumer’s willingness to pay. Instead, the monopolist sees an observable characteristic (such as age, gender, race, and so on) of its consumers that is related to their willingness to pay. The monopoly then charge different prices based on these.