I: Monopoly
1. True/ False1.A profit maximizing monopolist facing no entry threat will operate on the elastic portion of the market demand curve.
2. If an unregulated monopolist- who is producing at the profit maximizing output- is making zero economic profit, then it must be true that the firm is producing at the point where average total cost is at a minimum
3.Since a monopoly is a "bad" thing for consumers but a "good" thing for producers, on balance, we cannot be sure that the monopoly is responsible for any loss in economic efficiency.
4. The quantity sold by a monopolist that maximizes its sales can never be equal to the quantity that would be sold under profit maximization if marginal costs are positive.
5. The profit maximizing price of a good that has a marginal cost of $5 and has an own-price elasticity (in absolute value) equal to 2 is $10
Answers: 1.T 2.F 3.F 4. T 5.T
2. Short Questions
1. Calculate the marginal revenue curves associated with the following inverse demand or demand functions
a). p = 130 - y
b). y = 100 - p
c). p = 1/yAnswers: a) 130-2y b) 100-2y c) 0.
3. Long Questions
1. The (inverse) market demand for snowshovels in Spuzzum is given by p = 50 - .5y
a). Snowgone Inc. is the only supplier of showshovels in Spuzzum.
Its total cost function is given by TC = 10yCalculate:
i). the profit maximizing level of output
ii). the profit maximizing price
iii). the consumers surplus
iv). the monopoly profits
v). the burden of monopoly (deadweight loss)b). Snowgone Inc. loses a legal battle and as a result has to pay licensing fee of $700 per year to MasterShovels Ltd. Its total costs therefore increase to TC = 10y + 700
With this new cost function, once again calculate
i). the profit maximizing level of output
ii). the profit maximizing price
iii). the consumers surplus
iv). the monopoly profits
v). the burden of monopoly (deadweight loss)Are your answers the same as in part (a) or different? Explain why.
c). If all potential showshovel suppliers have cost functions as shown in part (a), is Snowgone Inc. a natural monopoly? Explain (Hint: Calculate the residual demand function. Would another firm, facing this demand function, be able to make positive profits?).
d). If all potential showshovel suppliers have cost functions as shown in part (b), is Snowgone Inc. a natural monopoly? Explain.
Answers: a) y=40, p=30, CS=400, Profit=800, DWL=400; b) y=40, p=30, CS=400, Profit=100, DWL=400; c) NO the residual demand is y=60-2p.The profit for the potential entrant is 200. d) YES Because of the fixed cost the market cannot support the second firm. The potential entrant makes negative profits if enters, therefore will stay out.
II: Price Discrimination and Monopoly Practices
1. True/ False1. The efficiency loss under perfect price discrimination is larger than under either pure monopoly or ordinary price discrimination.
2. The higher the price elasticity of demand (in absolute value) for a product by a particular group of individuals, the lower will be the price set by a profit-maximizing , price-discriminating monopolist.
Answers: 1.F 2.T.
2. Short Questions
1. Grocery stores often sell more expensive and/or poorer quality food in poor areas.
a). Explain this using the theory of price discrimination. Illustrate your answer with a diagram.
b). Give at least two reasons why the price elasticity of demand might be different for rich and poor people.Answers:1.
- lower income individuals may be less likely to have a car therefore find it harder to travel, shop for bargains
- lower income individuals may have cash flow problems, therefore may be unable to stock up on, e.g., baked beans at 59 cents per can.
- lower income individuals may not have access to deep freezes, may be less informed about alternatives available (don't subscribe to a newspaper)
- there may be less competition in poor areas so each firm may face a relatively inelastic demand compared to stores in more competitive rich areas (compare quality of food in restaurants in poor area v. food quality in restaurants in wealthier area).3. Long Questions
1. A theater has a monopoly on the rights to show movies in the town of Moosejaw. The monopolist knows that the price elasticities of demand for movies by adults and by children are 2 and 4 respectively. Suppose the monopolist can charge different prices for adults and children. Explain, using the monopolist's profit-maximizing conditions, why the price of an adult ticket is higher than the price of a child's ticket.
2. A monopolist produces a commodity, Q, from a single plant but sells it in two separate markets. The total cost of production is TC = 100+Q2 The inverse demand functions for the two markets are
p1=240 - q1
p2 = 200 - 0.5q2
where q1 + q2=Q.
a). Calculate the profit maximizing price and quantity when the monopolist is able to price discriminate.
b). Calculate the profit maximizing price and quantity when the monopolist is not able to price discriminate.
c). Calculate the consumers' surplus and monopolist profits associated with the outcomes in part (a) and part (b).3. A monopolist has total production costs given by:
TC(Q) = 0.5Q2 The demand function in the "home" market is: P = 20 - 0.5 Qa). If the monopolist sells all its output in the home market, what is the simple monopoly, equilibrium, price?
b). Now suppose the monopolist has a choice between two markets, the home market, and a foreign market in which the monopolist can sell any amount of Q at a price of $12 per unit.
i). Will the monopolist sell in the foreign market?
ii). If the monopolist does sell in the foreign market, what would happen to the price the monopolist charges in the home market?
4.a). Find the simple monopoly equilibrium price under the following conditions. The "home" consumers' inverse demand function is $P = 12 - 0.25Q where Q represents the monopolist's production and sales, per period. The monopolist produces Q at a cost represented by the total cost function, TC= F+0.125Q2
b). At the equilibrium in part (a), suppose a second, "foreign" market were available to the monopolist. In this second market, the monopolist could sell any amount of Q for $6 per unit, and the monopolist is assured that no sales of Q from the second market to the "home" market in part (a) would occur.
i). Explain carefully whether or not the monopolist would sell Q at $6 in the second market.
ii). Would the "home" consumers be better, worse off, or unaffected if the monopolist made sales in the second market? Please explain your answer. [Hint: Remember MR1=MR2. What is MR1 as calculated in part (a)? Part (b) if the monopolist sells in the second market? What will happen to prices?]Answers:
1. Use the formula that expresses MR as a function of the price elasticity of demand.
2. a) q1=40, q2=40, p1=200, p2=180, CS1=800, CS2=400, Profit=8700; b) q1=53, q2=27, p=187, CS1=1423, CS2=178, Profit=8434;
3. a) p=15; b) i) Yes, the monopoly will sell 4 units in the foreign market and 8 units in the domestic market; ii) The price in the domestic market will increase to 16.
4. a) p=8; b) i) Yes, the monopoly will sell 12 units in the foreign market and 12 units in the domestic market; ii) The price in the domestic market will increase to 9 and the consumers will be worse off.