economics

Please complete questions for review #1-4 and problems and applications #1,7. Thank you.

A
ot
e,

ly
~n

~s,

to

[lS

ly
1te

• A monopolist often can raise its profits by charg-
ing different prices for the same good based on
a buyer’s willingness to pay. This practice of
price discrimination can raise economic welfare
by getting the good to some consumers who
otherwise would not buy it. In the extreme case
of perfect price discrimination, the deadweight
loss of monopoly is completely eliminated, and
the entire surplus in the market goes to the
monopoly producer. More generally, when price
discrimination is imperfect, it can either raise or

1. Give an example of a government-created
monopoly. Is creating this monopoly necessarily
bad public policy? Explain.

2. Define natural monopoly. What does the size of a
market have to do with whether an industry is a
natural monopoly?
Why is a monopolist’s marginal revenue less
than the price of its good? Can marginal
revenue ever be negative? Explain.
Draw the demand, marginal-revenue, average-
total-cost, and marginal-cost curves for a
monopolist. Show the profit-maximizing level
of output, the profit-maximizing price, and the
amount of profit.

A publisher faces the following demand schedule
for the next novel from one of its. popular authors:

Price Quantity Demanded

$100
90
80
70
60
50
40
30
20
10
0

0 novels
100,000
200,000
300,000
400,000
500,000
600,000
700,000
800,000
900,000

1,000,000

‘

CHAPTER 15 MONOPOLY 325

lower welfare compared to the outcome with a
single monopoly price.

• Policymakers can respond to the inefficiency of
monopoly behavior in four ways. They can use
the antitrust laws to try to make the industry more
competitive. They can regulate the prices that the
monopoly charges. They can turn the monopolist
into a government-run enterprise. Or if the market
failure is deemed small compared to the jnevitable
imperfections of policies, they can do nothing at all.

5. In your diagram from the previous question,
show the level of output that maximizes total
surplus. Show the deadweight loss from the
monopoly. Explain your answer.

6. Give two examples of price discrimination. In
each case, explain why the monopolist chooses
to follow this business strategy.

7. What gives the government the power to regulate
mergers between firms? From the standpoint of
the welfare of society, give a good reason and a
bad reason that two firms might want to merge.

8. Describe the two problems that arise when
regulators tell a natural monopoly that it must
set a price equal to marginal cost.

The author is paid $2 million to write the book,
and the marginal cost of publishing the book
is a constant $10 per book.
a. Compute total revenue, total cost, and profit

at each quantity. What quantity would a
profit-maximizing publisher choose? What
price would it charge?

b. Compute marginal revenue. (Recall that
MR = A.TR/ A.Q.) How does marginal
revenue compare to the price? Explain.

c. Graph the marginal-revenue, marginal-:cost,
and demand curves. At what quantity do the
marginal-revenue and marginal-cost curves
cross? What does this signify?

326 PARTV FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY

d. In your graph, shade in the deadweight loss.
Explain in words what this means.

e. If the author were paid $3 million instead of
$2 million to write the book, how would this
affect the publisher’s decision regarding what
price to charge? Explain.

f. Suppose the publisher was not profit-
maximizing but was concerned with maxi-
mizing economic efficiency. What price
would it charge for the book? How much
profit would it make at this price?

2. A small town is served by many competing
supermarkets, which have the same constant
marginal cost.
a. Using a diagram of the market for groceries,

show the consumer surplus, producer
surplus, and total surplus.

b. Now suppose that the independent super-
markets combine into one chain. Using a new
diagram, show the new consumer surplus,
producer surplus, and total surplus. Relative
to the competitive market, what is the transfer
from consumers to producers? What is the
deadweight loss?

3. Johnny Rockabilly has just finished recording
his latest CD. His record company’s marketing
department determines that the demand for the
CD is as follows:

Price Number of CDs

$24 10,000
22 20,000
20 30,000
18 40,000
16 50,000
14 60,000

The company can produce the CD with no fixed
cost and a variable cost of $5 per CD.
a. Find total revenue for quantity equal to

10,000, 20,000, and so on. What is the
marginal revenue· for each 10,000 increase in
the quantity sold?

b. What quantity of CDs would maximize profit?
·What would the price be? What would the
profit be?

c. If you were Johnny’s agent, what recording
fee would you advise Johnny to demand
from the record company? Why?

4. A company is considering building a bridge
across a river. The bridge would cost $2 million
to build and nothing to maintain. The following
table shows the company’s anticipated demand
over the lifetime of the bridge:

‘\

Price per Crossing

$8
7
6
5
4
3
2
1
0

Number of Crossings,
in Thousands

0
100
200
300
400
500
600
700
800

a. If the company were to build the bridge,
what would be its profit-maximizing price?
Would that be the efficient level of output?
Why or why not?

b. If the company is interested in maximizing
profit, should it build the bridge? What
would be its profit or loss?

c. If the government were to build the bridge,
what price should it charge?

d. Should the government build the bridge?
Explain.

5. Larry, Curly, and Moe run the only saloon in town.
Larry wants to sell as many drinks as possible
without losing money. Curly wants the saloon to
bring in as much revenue as possible. Moe wants
to make the largest possible profits. Using a single
diagram of the saloon’s demand curve and its cost
curves, show the price and quantity combinations
favored by each of the three partners. Explain.

6. The residents of the town Ectenia all love
economics, and the mayor proposes building an
economics museum. The museum has a fixed
cost of $2,400,000 and no variable costs. There
are 100,000 town residents, and each has the
same demand for museum visits: Q0 = 10 – P,
where P is the price of admission.
a. Graph the museum’s average-total-cost curve

and its marginal-cost curve. What kind of
market would describe the museum?

b. The mayor proposes financing the museum
with a lump-sum tax of $24 and then opening
the museum free to the public. How many
times would each person visit? Calculate
the benefit each person would get from the
museum, measured as consumer surplus
minus the new tax.

c. The mayor’s anti-tax opponent says the
museum should finance itself by charging an
admission fee. What is the lowest price the
museum can charge without incurring losses?
(Hint: Find the number of visits and museum
profits for prices of $2, $3, $4, and $5.)

d. For the break-even price you found in part
(c), calculate each resident’s consumer surplus.
Compared with the mayor’s plan, who is
better off with this admission fee, and who is
worse off? Explain.

e. What real-world considerations absent in the
above problem might argue in favor of an
admission fee?

7. For many years, AT&T was a regulated
monopoly, providing both local and long-distance ·
telephone service. ·
a. Explain why long-distance phone service

was originally a natural monopoly.
b. Over the past two decades, many companies

have launched communication satellites, each
of which can trans~t a limited number of
calls. How did the growing role of satellites
change the cost structure of long-distance
phone service?

After a lengthy legal battle with the government,
AT&T agreed to compete with other companies
in the long-distance market. It also agreed to
spin off its local phone service into the “Baby
Bells,” which remain highly regulated.

c. Why might it be efficient to have competition
in long-distance phone service and regulated
monopolies in local phone service?

8. Consider the relationship between monopoly
prking and price elasticity of demand:
a. Explain why a monopolist will never produce

a quantity at which the demand curve is
inelastic. (Hint: If demand is inelastic and the
firm raises its price, what happens to total
revenue and total costs?)

b. Draw a diagram for a monopolist, precisely
labeling the portion of the demand curve that
is inelastic. (Hint: The answer is related to the
marginal-revenue curve.)

c. On your diagram, show the quantitr and
price that maximizes total revenue.

If the government wanted to encourage a monopoly
to produce the socially efficient quantity, should
it use a per-unit tax or a per-unit subsidy? Explain
how this tax or subsidy would achieve the socially
efficient level of output. Among the various inter-
ested parties-the monopoly firm, the monopoly’s
consumers, and other taxpayers-who would
support the policy and who would oppose it?
You live in a town with 300 adults and 200
children, and you are thinking about putting
on a play to entertain your neighbors and make
some money. A play has a fixed cost of $2,000,

CHAPTER 15 MONOPOLY 327

but selling an extra ticket has zero marginal
cost. Here are the demand schedules for your
two types of customer:

Price

$10
9
8
7
6
5
4
3
2
1
0

Adults

0
100
200
300
300
300
300
300
300
300
300

Children

0
0
0
0
0

100
200
200
200
200
200

a. To maximize profit, w9M price would you
charge for an adult ti,d

b. The city council passes a law prohibiting you
from charging different prices to different
customers. What price do you set for a ticket
now? How much profit do you make?

c. Who is worse off because of the law prohib-
iting price discrimination? Who is better off?
(If you can, quantify the changes in welfare.)

d. If the fixed cost of the play were $2,500 rather
than $2,000, how would your answers to
parts (a), (b), and (c) change?

11. Only one firm produces and sells soccer balls in
the country of Wiknam, and as the story begins,
international trade in soccer balls is prohibited.
The following equations describe the monopolist’s
demand, marginal revenue, total cost, and
marginal cost:

Demand: P = 10 – Q
Marginal Revenue: MR = 10 – 2Q

Total Cost: TC = 3 + Q + O.SQ2
Marginal Cost: MC = 1 + Q

where Q is quantity and P is the price measured
in Wiknamian dollars.
a. How many soccer balls does the monopolist

produce? At what price are they sold? What
is the monopolist’s profit?

b. One day, the King of Wiknam decrees that
henceforth there will be free trade-either
imports or exports- of soccer balls at the
world price of $6. The firm is now a price
taker in a competitive market. What happens
to domestic production of soccer balls? To
domestic consumption? Does Wiknam export
or import soccer balls?