Economics (McConnell), AP Edition, 20th Edition Chapter (8).docx

Chapter 12: Pure Monopoly Multiple-Choice Questions 1. Which of the following characteristics correctly describe a monopoly? I. The firm is the single seller in the industry. II. Barriers to entry exist in the industry. III. Unregulated monopolies are illegal under United States law. IV. The firm determines its price and output. (A) I and II only (B) I and III only (C) I, II, and III only (D) I, II, and IV only (E) I, II, III, and IV (D) Unregulated monopolies are allowed to exist under U.S. law and are quite common where demand does not support additional firms. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Monopoly Book Section: An Introduction to Pure Monopoly 2. Why are monopoly firms price makers? (A) Monopolies produce at a lower cost than perfectly competitive firms. (B) Monopolies enjoy barriers to entry. (C) Monopolies face a perfectly elastic demand curve. (D) Monopolies are more efficient than perfectly competitive firms. (E) Monopolies produce goods that competitive firms cannot produce. (B) Because a monopoly can restrict entry, the firm can reduce its output and thereby increase market price. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Monopoly Book Section: Barriers to Entry 3. The monopolist's demand curve is (A) downward-sloping (B) elastic between all points (C) inelastic between all points (D) vertical (E) horizontal (A) The monopolist faces a downward-sloping demand curve because the firm must lower prices to sell more. Demand is elastic where marginal revenue is positive and inelastic where marginal revenue is negative. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Monopoly Book Section: Monopoly Demand 4. The monopolist's marginal revenue curve is lower than the demand curve because the firm (A) must accept the price set by the industry (B) achieves efficiency when revenues are lower than prices (C) must lower the price of all of its products in order to sell more (D) becomes less efficient as output increases (E) faces constantly increasing costs of production as output increases (C) Because the monopoly must lower its price to sell more products, it must lower the price for all units, including the first units produced. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Monopoly Book Section: Marginal Revenue Is Less than Price 5. Why do unregulated monopolists not produce in the inelastic portion of the demand curve? (A) The marginal revenue is negative, causing total revenue to decrease. (B) That output will not bring about allocative efficiency. (C) The marginal revenue is lower than the price, causing price to fall. (D) The marginal cost is lower than the marginal revenue in that range. (E) Inelastic demand indicates consumers will not buy the additional output. (A) When marginal revenue is negative, it reduces total revenue. Because the marginal cost is increasing, the firm cannot maximize profit in that range. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Profit Maximization Book Section: The Monopolist Sets Prices in the Elastic Region of Demand Use the profit-maximizing monopoly graph below to answer questions 6-9. 6. This monopoly firm is (A) earning an economic profit (B) earning a normal profit, but not an economic profit (C) earning short-run profit, but will earn no economic profit in the long run (D) experiencing a loss, but should remain in business in the short run (E) experiencing a loss and should shut down (A) This firm is earning an economic profit because price is higher than ATC. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Microeconomics: Profit Maximization Book Section: MR=MC Rule 7. The deadweight loss associated with reducing output for the monopoly is the (A) triangle to the left of MC = D, on the Q1 line from P1 to P4 (B) triangle below MC = D, on the P3 line from Q2 to Q4 (C) rectangle between P1 and P3, from the left axis to the Q1 line (D) rectangle between P1 and P4, from the left axis to the Q1 line (E) triangle below the demand curve, on the P3 line from Q1 to Q4 (A) The deadweight loss represents the lost consumer and producer surplus associated with the firm's decision to reduce its output. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Inefficiency of Monopoly Book Section: Price, Output, and Efficiency 8. To reach allocative efficiency, government would set a price ceiling at (A) P1 (B) P2 (C) P3 (D) P4 (E) MR = ATC (B) The firm achieves allocative efficiency where MC = D. If the government sets the price ceiling at that point, the firm's marginal revenue becomes that price and the firm produces where MC = MR to maximize profit and achieve allocative efficiency at the same point. Difficulty: Medium Style: Application AP Economics Curricular Requirement Microeconomics: Regulation Book Section: Socially Optimal Price: P = MC 9. At what output would this firm achieve productive efficiency? (A) Q1 (B) Q2 (C) Q3 (D) Q4 (E) Monopolies cannot achieve productive efficiency. (B) Productive efficiency is achieved where marginal cost crosses ATC at its lowest point. This is the point at which the firm produces at its lowest average cost per unit. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Inefficiency of Monopoly Book Section: Price, Output, and Efficiency 10. Why do monopolies not produce at the point of productive efficiency? (A) The monopoly focuses on achieving allocative efficiency. (B) The firm reduces output in order to raise the price. (C) The firm maximizes profit by producing where ATC = D. (D) The monopoly focuses on minimizing the marginal cost. (E) Monopolies cannot achieve productive efficiency. (B) The monopoly maximizes profit by reducing output and raising the price, so the firm does not produce at its productively efficient output. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Inefficiency of Monopoly Book Section: Price, Output, and Efficiency 11. Which statement is true for a monopoly but not true for a perfectly competitive firm? (A) The firm maximizes profit where marginal revenue equals marginal cost. (B) The firm's marginal revenue equals the product price. (C) The firm achieves allocative efficiency at the same output where it maximizes profit. (D) The firm produces where MC = MR = ATC. (E) The firm sustains long-run economic profit. (E) The monopoly can earn long-run economic profit because barriers to entry prevent other firms from entering the market. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Firm Behavior and Market Structure Book Section: Price, Output, and Efficiency 12. Price discrimination occurs when a firm’s decision to charge different prices is based on (A) changes in the average total cost (B) changes in the marginal cost (C) changes in the marginal revenue (D) the excise tax rate the government sets (E) customers' sensitivity to the higher price (E) In order to increase its total revenue, a price-discriminating monopolist charges a higher price for customers who are not sensitive to the higher price and lower prices to customers who are sensitive to the price. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Price Discrimination Book Section: Price Discrimination 13. A profit-maximizing natural monopoly with positive economic profits has which of the following characteristics? I. Price is set higher than marginal revenue. II. Marginal cost equals marginal revenue. III. Average total cost equals average revenue. IV. Market demand intersects ATC where ATC is declining. (A) I and II only (B) I and III only (C) I, II, and III only (D) I, II, and IV only (E) I, II, III, and IV (D) A profit-maximizing natural monopoly with positive economic profits will set output where MR=MC. This results in price being higher than MR due to the downward-sloping firm demand curve. Average revenue (AR) at profit-maximizing output will be higher than average total cost (ATC). By definition, a natural monopoly occurs when the market demand intersects long-run ATC in the range at which the monopoly’s long-run ATC curve is declining. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Natural Monopoly Book Section: Economies of Scale Use the following table for a monopoly firm to answer questions 14–16. Total Product (Q) Total Cost (TC) ($) Average Total Cost (ATC) ($) Average Variable Cost (AVC) ($) Marginal Cost ($) Total Revenue (TR) ($) Average Revenue ($) Marginal Revenue (MR) ($) 0 100.00 0 1 190.00 190.00 90.00 162.00 162.00 2 270.00 135.00 85.00 304.00 152.00 3 340.00 133.33 80.00 426.00 142.00 4 400.00 100.00 75.00 528.00 132.00 5 470.00 94.00 74.00 610.00 122.00 6 550.00 91.67 75.00 672.00 112.00 7 640.00 91.43 77.14 714.00 102.00 8 750.00 93.75 81.25 736.00 92.00 9 880.00 97.78 86.67 738.00 82.00 10 1030.00 103.00 93.00 720.00 72.00 14. This firm has set its price at $162.00. If this firm were to maximize its profit, it should (A) increase price and decrease quantity, given that the price elasticity of demand is elastic (B) decrease price and increase quantity, given that the price elasticity of demand is elastic (C) increase price and decrease quantity, given that the price elasticity of demand is inelastic (D) decrease price and increase quantity, given that the price elasticity of demand is inelastic (E) decrease price and hold quantity constant, given that the price elasticity of demand is elastic (B) At a price of $122.00, this firm will produce 5 units and MR>MC ($82>$70). By increasing output and lowering price, the firm’s total revenue will increase and its marginal revenue will decrease. The firm would maximize its profit at $140. Difficulty: Hard Style: Applied AP Economics Curricular Requirement Microeconomics: Profit Maximization Book Section: The Monopolist Sets Prices in the Elastic Region of Demand 15. To maximize profit, this firm will (A) offer three units at a price of $142.00 (B) offer four units at a price of $132.00 (C) offer five units at a price of $122.00 (D) offer six units at a price of $112.00 (E) offer seven units at a price of $102.00 (C) This firm will maximize its profit at an output where MC and MR intersect. At that quantity, the firm’s demand curve (AR=D) indicates a market price of $122.00. Difficulty: Medium Style: Applied AP Economics Curricular Requirement Microeconomics: Profit Maximization Book Section: Output and Price Determination 16. Which of the following misconceptions concerning monopolist pricing are illustrated by the table above? I. Monopolists will charge the highest price possible. II. Monopolists seek maximum total profit. III. Monopolists seek maximum per-unit profit. (A) I only (B) II only (C) I and II only (D) I and III only (E) I, II, and III (D) Monopolists will not charge the highest price possible. The profit-maximizing monopolist produces the output where MR=MC and charges a price on the demand curve. Any higher price would result in lower total profit. Thus, the monopolist does not charge the highest possible price, but the profit-maximizing price. Secondly, the monopolist would rather sell 5 units at a profit of $28 per unit for a total profit of $140 than 4 units at a profit of $32 per unit for a total profit of only $128. Difficulty: Medium Style: Applied AP Economics Curricular Requirement Microeconomics: Profit Maximization Book Section: Misconceptions Concerning Monopoly Pricing Use the monopoly graph below to answer questions 17-18. 17. The consumer surplus generated by this profit-maximizing monopolist is area bounded by the points: (A) P, P1, b (B) P1, P3, a, b (C) P, P2, d, b (D) P, P2, c (E) P, P3, a, b (A) The consumer surplus is equal to the area bounded by the monopolist price (P1) and the demand curve (D). Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Consumer Surplus, Producer Surplus, and Allocative Efficiency Book Section: Price, Output, and Efficiency 18. The efficiency loss generated by this profit-maximizing monopolist is area bounded by the points (A) b, d, c (B) d, a, c (C) P1, b, a, P3 (D) P1, b, c, a, P3 (E) b, a, c (E) Monopoly firms create economic inefficiency (deadweight loss) because they produce less output and charge a higher price than a purely competitive industry would (where MC=D). Difficulty: Medium Style: Applied AP Economics Curricular Requirement Microeconomics: Inefficiency of Monopoly Book Section: Price, Output, and Efficiency Use the graph below to answer questions 19-21. 19. Assume that this firm is an unregulated monopoly. At what price and quantity would this firm produce to maximize profit? (A) P1, Q1 (B) P5, Q1 (C) P3, Q2 (D) P4, Q2 (E) P4, Q3 (A) The firm maximizes output by producing at the quantity where MR=MC (Q1) and then sets the price on the demand curve above that point (P1). Difficulty: Easy Style: Applied AP Economics Curricular Requirement Microeconomics: Profit Maximization Book Section: Output and Price Determination 20. What would the fair return price and quantity be for a regulated monopoly? (A) P1, Q1 (B) P2, Q1 (C) P3, Q2 (D) P4, Q3 (E) P5, Q1 (C) The fair return price would be set where ATC=D, allowing the monopolist to earn normal profit but denying the monopolist positive economic profit. In this case the fair return price would be set at P3, so the firm would produce Q2 products. Difficulty: Medium Style: Applied AP Economics Curricular Requirement Microeconomics: Regulation Book Section: Fair-Return Price: P = ATC 21. What would the socially optimal price and quantity be for a regulated monopoly? (A) P1, Q1 (B) P2, Q1 (C) P3, Q2 (D) P4, Q3 (E) P5, Q1 (D) The socially optimal price and quantity would be set where MC=D, which is the allocatively efficient output level. If that price were below ATC, this firm would have to be subsidized to operate in the long run. Difficulty: Medium Style: Applied AP Economics Curricular Requirement Microeconomics: Regulation Book Section: Socially Optimal Price: P = MC 22. Sources of market power for a monopoly include I. economies of scale II. patents and licenses III. ownership or control of essential resources (A) I only (B) II only (C) II and III only (D) I and III only (E) I, II, and III (E) Monopolists may use all of these barriers to entry to prevent new firms from entering the industry. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Sources of Market Power Book Section: Barriers to Entry 23. Antitrust laws in the United States are designed to (A) prevent any firm from becoming a monopoly (B) limit the actions of long-lasting monopolies that engage in anti-competitive behavior (C) set price ceilings for products produced by utility companies and other natural monopolies (D) regulate the quality and price of all products produced by monopolies (E) provide an orderly means for oligopolies to merge into monopolies (B) Monopolies can form for a variety of reasons, and geographic and natural monopolies are common. But when a monopoly engages in abusive behavior that harms competition and consumers, the government can use antitrust laws to prohibit the behavior and even break up monopolies. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Microeconomics: Antitrust Policy Book Section: Assessment and Policy Options 24. A monopoly maximizes total revenue at the output where (A) marginal revenue equals marginal cost (B) demand equals zero (C) marginal cost equals average total cost (D) marginal revenue equals zero (E) marginal cost equals demand (D) When marginal revenue equals zero, any additional output will create negative marginal revenue, taking away from total revenue. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Microeconomics: Monopoly Book Section: The Monopolist Sets Prices in the Elastic Region of Demand 25. A natural monopoly’s barrier to entry is (A) economies of scale (B) a patent (C) a copyright (D) a government license to operate (E) heavy use of advertising (A) A natural monopoly occurs when the long-run average total cost continues to fall as the plant size increases over a very large range of output. The larger the firm becomes, the more efficient it becomes, and smaller firms with higher production costs cannot successfully compete. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Natural Monopoly Book Section: Economies of Scale Free-Response Questions 1. Perfectly competitive and monopoly industries differ in several important ways. (a) Using correctly labeled side-by-side graphs of a perfectly competitive industry and a typical firm that is earning short-run economic profit, show each of the following. (i) The price and output for the industry (ii) The price and output for the individual firm (iii) The area of economic profit (b) Using a correctly labeled graph of a profit-maximizing monopoly, show each of the following. (i) The price and output for the firm (ii) The area of economic profit 2. Assume that Chai Pharmaceuticals holds a patent for an important medication which prevents competing firms from producing that medication. Chai Pharmaceuticals is a profit-maximizing firm earning an economic profit. (a) Using a correctly labeled graph for Chai Pharmaceuticals, showing each of the following. (i) The output (ii) The price (iii) The area of economic profit (iv) The area of deadweight loss (b) Explain what deadweight loss represents. (c) Is Chai Pharmaceuticals producing at a productively efficient output? Explain. (d) Is Chai Pharmaceuticals producing at an allocatively efficient output? Explain. 3. The graph below illustrates the costs and revenues for Cisco's Widgets, a profit-maximizing monopoly that does not price discriminate. Assume Cisco’s Widgets is a profit-maximizing monopoly producer of widgets. (a) Using the labeling in the graph, identify each of the following. (i) The output at which profit is maximized (ii) The output at which total revenue is maximized (iii) The output that is socially optimal (b) Assume that the per-unit (variable) cost of materials used to produce Widgets rises. (i) What will happen to the price of Widgets? (ii) What will happen to the output of Widgets? (iii) What will happen to the profit for Cisco's Widgets? (c) Assume that the government wants to encourage the firm to produce at the socially optimal output. Using the labeling in the graph, answer the following questions. (i) At what price should the government set a price ceiling to encourage socially optimal output? (ii) At the socially optimal output, is this firm earning an economic profit or experiencing a loss? Explain. Free-Response Explanations 1. 9 points (5 + 4) (a) 5 points: 1 point is earned for correctly identifying industry price and output. 1 point is earned for showing a horizontal demand curve for the firm, set at the price determined by the industry. 1 point is earned for identifying price on the firm's horizontal demand curve. 1 point is earned for setting output where MC = MR. 1 point is earned for identifying the area of profit. (b) 4 points: 1 point is earned for a correctly labeled monopoly graph with a downward-sloping demand curve and the marginal revenue curve below the demand curve. 1 point is earned for setting output where MC = MR. 1 point is earned for setting price on the demand curve above where MC = MR. 1 point is earned for identifying the area of profit. Difficulty: Medium Style: Applied AP Economics Curricular Requirement Microeconomics: Firm Behavior and Market Structure Book Section: Output and Price Determination 2. 10 points (5 + 1 + 2 + 2) (a) 5 points: 1 point is earned for a correctly labeled graph with a downward-sloping demand curve and marginal revenue lower than demand. 1 point is earned for setting output where MC = MR. 1 point is earned for setting price on the demand curve above the MC = MR output. 1 point is earned for identifying the area of economic profit. 1 point is earned for identifying the area of deadweight loss. (b) 1 point: 1 point is earned for stating that deadweight loss represents the area of consumer and producer surplus lost due to the monopoly restricting output. (c) 2 points: 1 point is earned for stating that the firm is not producing at productive efficiency. 1 point is earned for explaining that the firm is producing where MC = MR, not where MC = ATC; with the restricted output, ATC is not at its minimum. (d) 2 points: 1 point is earned for stating that the firm is not producing at allocative efficiency. 1 point is earned for explaining that the firm is producing where MC = MR, not where MC = P; with the restricted output, price is greater than the marginal cost. Difficulty: Medium Style: Applied AP Economics Curricular Requirement Microeconomics: Monopoly Book Section: Economic Effects of Monopoly 3. 9 points (3 + 3 + 3) (a) 3 points: 1 point is earned for stating that profit is maximized at Q1 (where MC=MR). 1 point is earned for stating that total revenue is maximized at Q3 (where MR=0). 1 point is earned for stating that socially optimal output is at Q3 (where MC=D). (b) 3 points: 1 point is earned for stating that the price of Widgets will increase. 1 point is earned for stating that the output for Widgets will decrease. 1 point is earned for stating that the profit for Cisco's Widgets will decrease. (c) 3 points: 1 point is earned for stating that the government should set the price ceiling at P2. 1 point is earned for stating that the firm is earning an economic profit at that output. 1 point is earned for explaining that the firm's profit results from the price being higher than the average total cost at that output. Difficulty: Medium Style: Applied AP Economics Curricular Requirement Microeconomics: Monopoly Book Section: Regulated Monopoly