Week 8 - Monopoly and Natural Monopoly

Question 1

What defines a monopolist?

Answer 1

A firm is a monopolist if it is the only supplier of a product for which there is no close substitute.

Question 2

On what factors does the relevant market for a monopolist depend?

Answer 2

The relevant market depends on how wide the sector and the geographical area considered are.

Question 3

What are some possible reasons for the existence of a monopoly?

Answer 3

Patents, barriers to entry, economies of scale and scope (natural monopolies).

Question 4

Is Monopolist a price-maker?

Answer 4

Yes, It can choose any price and sell the quantity demanded at that price, or choose an output level and sell it at the market-clearing price.

Question 5

How is a monopolist’s revenue calculated?

Answer 5

Revenue is given by p(y)⋅y, where p(y) is the inverse demand curve and y is the quantity sold.

Question 6

What is the monopolist’s profit maximisation problem?

Answer 6

The problem is to maximize p(y)y−c(y), where
p(y) is the price function and
c(y) is the cost function.

Question 7

What is the first-order condition for a monopolist’s profit maximisation?

Answer 7

Note book

Question 8

How is the marginal revenue (MR) related to the price and marginal cost (MC) for a monopolist?

Answer 8

MC=MR must be satisfied for profit maximisation.

Question 9

What does a downward-sloping demand curve imply about marginal revenue (MR) and price?

Answer 9

Note book

Question 10

What does the price elasticity of demand measure?

Answer 10

The responsiveness of demand to changes in price, calculated as the proportionate change in quantity demanded divided by the proportionate change in price.

Question 11

What is the formula for price elasticity of demand?

Question 12

How is marginal revenue (MR) related to the price elasticity of demand? ( The formula)

Question 13

How can we rewrite marginal revenue using price elasticity of demand?

Question 14

What is the formula for marginal revenue (MR) using the absolute value of elasticity?

Question 15

What is the inverse elasticity rule?

Answer 15

Where it states that price is a markup over marginal cost that depends on the price elasticity of demand.

Question 16

How does the inverse elasticity rule apply to a competitive firm?

Answer 16

A competitive firm faces perfectly elastic demand, so
ε is infinite and p(y)=MC(y).

Question 17

How does the inverse elasticity rule apply to a monopolist?

Question 18

What is the formula for a linear inverse demand curve?

Answer 18

p(y)=a−by

Question 19

What is the monopolist’s profit maximisation problem with a linear demand curve?

Answer 19

maxy ((a−by)y−c(y))

Question 20

What is the first-order condition for the monopolist’s profit maximisation?

Question 21

How is the marginal revenue (MR) curve related to the demand curve in a monopoly with linear demand?

Answer 21

The MR curve has the same intercept as the demand curve but is twice as steep.

Question 22

How do you solve for the monopolist’s optimal output
𝑦*?

Question 23

How do you solve for the monopolist’s optimal price
𝑝*?

Question 24

What are the optimal output and price for a monopolist with constant marginal cost
c?

Question 25

What assumption about elasticity is made for the monopolist’s profit-maximising output?

Answer 25

It assumes ∣ε∣>1, meaning demand is elastic at the profit-maximising output.

Question 26

What is the main assumption for comparing monopoly to a competitive market

Answer 26

The comparison assumes one firm (monopolist) and many firms (competitive market) have the same MC curve, meaning they produce the industry output with the same costs.

Question 27

How is price and output determined in a competitive market?

Answer 27

Price and output in a competitive market are determined by the intersection of supply (MC) and demand, corresponding to the lowest point on firms’ long-run average cost curves.

Question 28

How does a monopolist determine its price and output?

Answer 28

A monopolist sets its output where MC equals MR, resulting in a lower output (ym) and higher price (pm) compared to a competitive market.

Question 29

What is the condition for Pareto improvement in the context of monopoly?

Answer 29

A Pareto improvement can occur if consumers willing to pay 𝑝𝑐 or more between
𝑦𝑚 and 𝑦𝑐 were supplied, as their willingness to pay exceeds the cost of production.

Question 30

Why won’t a monopolist supply additional consumers willing to pay more than the marginal cost?

Answer 30

Supplying additional consumers would mean lowering the price for all units sold, which reduces the monopolist’s profit.

Question 31

What does the area between
𝑦𝑚 and 𝑦𝑐 in the monopoly diagram represent?

Answer 31

It represents the potential trades that could improve Pareto efficiency but are not made by the monopolist due to profit considerations.

Question 32

What does consumer surplus measure?

Answer 32

Consumer surplus measures the difference between the amount consumers are willing to pay for a good and the amount they actually pay.

Question 33

How is consumer and producer surplus represented graphically?

Answer 33

Draw it

Question 34

What is producer surplus?

Answer 34

Producer surplus is the difference between the amount producers receive for selling a good and the minimum amount they would be willing to accept.

Question 35

How does producer surplus differ between a competitive market and a monopoly?

Answer 35

In a competitive market, producer surplus is lower due to a lower price, whereas in a monopoly, producer surplus is higher due to a higher price.

Question 36

What happens to consumer surplus in a monopoly compared to a competitive market?

Answer 36

Consumer surplus decreases in a monopoly because the price is higher and quantity is lower compared to a competitive market.

Question 37

What is deadweight loss in the context of monopoly?

Answer 37

Deadweight loss is the loss of welfare that occurs because the monopolist produces less output (ym) than the competitive quantity (yc), leading to lost consumer and producer surplus.

Question 38

How is deadweight loss represented graphically in the comparison between monopoly and competitive market?

Answer 38

Deadweight loss is shown as the green area in the diagram, representing the welfare loss due to the monopolist’s reduced output.

Question 39

Why does deadweight loss occur in a monopoly?

Answer 39

Deadweight loss occurs because the monopolist produces less than the socially optimal quantity, leading to missed opportunities for beneficial trades between consumers and producers.

Question 40

What is the impact of monopoly pricing on welfare?

Answer 40

Monopoly pricing reduces overall welfare by creating a deadweight loss, transferring some consumer surplus to producer surplus, and reducing total consumer surplus.

Question 41

What is a natural monopoly?

Answer 41

A natural monopoly occurs when a single firm can supply the entire market at a lower average cost than multiple firms due to economies of scale.

Question 42

What is meant by increasing returns to scale?

Answer 42

Increasing returns to scale means that as a firm increases its output, the average cost of production decreases over the full range of output.

Question 43

Why might a natural monopoly be preferred in certain industries?

Answer 43

A natural monopoly may be preferred in industries with high fixed costs and low marginal costs, such as water supply, because it avoids the inefficiency of duplicating infrastructure.

Question 44

How does the average cost curve behave under increasing returns to scale?

Answer 44

Under increasing returns to scale, the average cost (AC) curve is always downward-sloping.

Question 45

Why is competition not feasible in an industry with a natural monopoly?

Answer 45

Competition is not feasible because multiple firms would result in much higher average costs due to duplicated fixed costs.

Question 46

What is the role of government in managing natural monopolies?

Answer 46

The government can either control the natural monopoly directly, setting prices and covering any losses, or regulate a private monopoly to ensure prices are fair and the firm can at least break even.

Question 47

What is the minimum efficient scale?

Answer 47

The minimum efficient scale is the level of output at which a firm fully exploits economies of scale, minimizing average costs.

Question 48

What happens when demand is low relative to the minimum efficient scale in an industry?

Answer 48

When demand is low relative to the minimum efficient scale, a competitive market is not feasible because firms cannot cover their average costs, leading to a monopoly being more efficient.

Question 49

How does a natural monopoly determine its output and price?

Answer 49

A natural monopoly determines its output where marginal cost (MC) equals marginal revenue (MR), resulting in a price higher than marginal cost and lower output compared to a competitive market.

Question 50

What is the economic problem with natural monopolies in essential services?

Answer 50

The problem is that the monopoly price may be seen as undesirable for essential services like water supply, leading to potential government intervention or regulation to set lower prices.

Question 51

Describe the concept of deadweight loss in the context of a natural monopoly.

Answer 51

Deadweight loss occurs because the monopolist produces less than the socially optimal quantity, leading to missed opportunities for beneficial trades and a loss of total welfare.

Question 52

Draw the natural monopoly graph