Transcript
366Miller• Economics Today, Nineteenth Edition
Chapter 24Monopoly365
Answers to Questions for Critical Analysis
A Tombstone law Is a Grave Barrier to Entry in New Jersey (p. 538)
Who gained from passage of the New Jersey law? Explain briefly.
The passage of the New Jersey law would prevent private religious groups from becoming new sellers of cemetery tombstones and mausoleums. The Monument Builders Association of New Jersey would gain from the reduction in potential market competition as a result.
Want to Raise Prices of Heart Drugs? Create a Monopoly Seller (p. 545)
What do you suppose happened to the profit-maximizing quantities of heart drugs produced and sold by the new pharmaceutical monopoly?
The new pharmaceutical monopoly would reduce its quantity of heart drugs produced in order to maximize its profit.
Can Firms Use “Big Data” and Complicated Pricing to “Gouge” Consumers? (p.548)
What essential economic conditions must be satisfied for firms to succeed in utilizing big data techniques to engage in price discrimination that increases their profits?
For firms to succeed in utilizing big data techniques to engage in price discrimination, they must face a down-sloping demand curve; they must be able to identify buyers with different elasticities of demand; and they must be able to prevent resale of their products.
You Are There
A Legal Barrier to Entry Prevents Lemonade Sales by Two Young Sisters
(pp. 550–551)
1. How does the act of forbidding competitors such as Andria and Zoey from selling cold drinks on the street affect the prices that legally licensed sellers can obtain for their cold drinks?
With more competitors selling cold drinks on the street, the prices that legally licensed sellers can obtain for their cold drinks will fall.
2. What is the effect of Overton’s barrier to entry on the total quantity of cold drinks sold by the city’s food-and-beverage retailing industry?
A barrier to enter Overton’s food-and-beverage retailing industry effectively reduces the total quantity of cold drinks sold in that industry.
Issues and Applications
Why a French Dealer of Illegal Drugs Provides Loyalty Discount Cards
(pp. 550–551)
1. Why do you suppose that the Marseilles drug dealer also seeks to prevent customers from reselling drugs to other buyers?
The practice of price discrimination will be less successful in maximizing the drug dealer’s total profits if customers can resell the Marseilles drugs to other buyers, and so there will be fewer buyers paying for the full price.
2. Is there any economic difference between a customer-loyalty-card program offered by a legitimate drugstore and the program established by the Marseilles drug dealer?
There is no economic difference between a customer-loyalty-care program offered by a legitimate drugstore and the program established by the Marseilles drug dealer. Both programs seek to separate customers with different demand elasticities.
Research Project
1. For contemplate various reasons, including price discrimination, that businesses sometimes offer lower prices to certain groups of people, see the Web Links in MyEconLab.
2. To a detailed discussion about how a profit-maximizing monopoly can determine the
appropriate discount to offer to bearers of coupons or loyalty cards, see the Web Links in MyEconLab.
Appendix G—Consumer Surplus and the Deadweight Loss Resulting from Monopoly
Consumer Surplus in a Perfectly Competitive Market (See Figure G-1.)
How Society Loses from Monopoly
A. Implications of Monopoly for Consumer Surplus: The monopolist transfers a portion of the competitive level of consumer surplus to itself in the form of profits. (See Figure G-2.)
B. Deadweight Loss: The portion of consumer surplus that no one in society is able to obtain in a situation of monopoly. (See Figure G-2.)
Answers to Problems
24-1. The following table depicts the daily output, price, and costs of a monopoly dry cleaner located near the campus of a remote college town.
Output
(suits cleaned) Price per Suit
($) Total Costs ($)
0 8.00 3.00
1 7.50 6.00
2 7.00 8.50
3 6.50 10.50
4 6.00 11.50
5 5.50 13.50
6 5.00 16.00
7 4.50 19.00
8 4.00 24.00
a. Compute revenues and profits at each output rate.
b. What is the profit-maximizing rate of output?
c. Calculate the dry cleaner’s marginal revenue and marginal cost at each output level. What is the profit-maximizing level of output?
a. The total revenue and total profits of the dry cleaner are as follows.
Output (suits cleaned) Price per Suit
($) Total Costs ($) Total Revenue ($) Total Profit ($)
0 8.00 3.00 0 –3.00
1 7.50 6.00 7.50 1.50
2 7.00 8.50 14.00 5.50
3 6.50 10.50 19.50 9.00
4 6.00 11.50 24.00 12.50
5 5.50 13.50 27.50 14.00
6 5.00 16.00 30.00 14.00
7 4.50 19.00 31.50 12.50
8 4.00 24.00 32.00 8.00
b. The profit-maximizing rate of output is between 5 and 6 units.
c. The marginal cost and marginal revenue of the dry cleaner are as follows. The profit-maximizing rate of output is 6 units.
Output (suits cleaned) Price per Suit
($) Total Costs ($) Total Revenue ($) Total Profit ($) Marginal Cost
($ per unit) Marginal Revenue ($ per unit)
0 8.00 3.00 0 –3.00 — —
1 7.50 6.00 7.50 1.50 3.00 7.50
2 7.00 8.50 14.00 5.50 2.50 6.50
3 6.50 10.50 19.50 9.00 2.00 5.50
4 6.00 11.50 24.00 12.50 1.00 4.50
5 5.50 13.50 27.50 14.00 2.00 3.50
6 5.00 16.00 30.00 14.00 2.50 2.50
7 4.50 19.00 31.50 12.50 3.00 1.50
8 4.00 24.00 32.00 8.00 4.00 0.50
24-2. A manager of a monopoly firm notices that the firm is producing output at a rate at which average total cost is falling but is not at its minimum feasible point. The manager argues that surely the firm must not be maximizing its economic profits. Is this argument correct?
This statement is not correct. Profit maximization occurs at the output rate at which marginal revenue equals marginal cost. This rate of output may well occur at a point above and to the left of the point of minimum average total cost.
24-3. Use the following graph to answer the questions that follow.
a. What is the monopolist’s profit-maximizing output?
b. At the profit-maximizing output rate, what are average total cost and average revenue?
c. At the profit-maximizing output rate, what are the monopolist’s total cost and total revenue?
d. What is the maximum profit?
e. Suppose that the marginal cost and average total cost curves in the diagram also illustrate the horizontal summation of the firms in a perfectly competitive industry in the long run. What would the equilibrium price and output be if the market were perfectly competitive? Explain the economic cost to society of allowing a monopoly to exist.
a. The profit-maximizing output rate is 5,000 units.
b. Average total cost is $5 per unit. Average revenue is $6 per unit.
c. Total costs equal $5 per unit 5,000 units = $25,000. Total revenue equals $6 per unit 5,000 units = $30,000.
d. ($6 per unit – $5 per unit) 5,000 units = $5,000.
e. In a perfectly competitive market, price would equal marginal cost at $4.50 unit, at which the quantity is 8,000 units. Because the monopolist produces less and charges a higher price than under perfect competition, price exceeds marginal cost at the profit-maximizing level of output. The difference between the price and marginal cost is the per-unit cost to society of a monopolized industry.
24-4. The marginal revenue curve of a monopoly crosses its marginal cost curve at $30 per unit and an output of 2 million units. The price that consumers are willing to pay for this output is $40 per unit. If it produces this output, the firm’s average total cost is $43 per unit, and its average fixed cost is $8 per unit. What is the profit-maximizing (loss- minimizing) output? What are the firm’s economic profits (or economic losses)?
The firm’s loss-minimizing output is 2 million units, and its short-run economic losses equal
($40 per unit - $43 per unit) 2 million units = -$6 million.
24-5. A monopolist’s maximized rate of economic profits is $5,000 per week. Its weekly output is 500 units, and at this output rate, the firm’s marginal cost is $15 per unit. The price at which it sells each unit is $40 per unit. At these profit and output rates, what are the firm’s average total cost and marginal revenue?
The monopolist’s total revenues equal 500 units per week $40 per unit = $20,000 per week. Thus, its total costs equal total revenues – economic profits = $20,000 per week - $5,000 per week = $15,000 per week. Average total cost equals the ratio of total costs to the output rate, or $15,000/500 units = $30 per unit. The firm has maximized profits by producing to the point at which marginal cost, which is $15 per unit, equals marginal revenue, so marginal revenue is $15 per unit.
24-6. Currently, a monopolist’s profit-maximizing output is 200 units per week. It sells its output at a price of $60 per unit and collects $30 per unit in revenues from the sale of the last unit produced each week. The firm’s total costs each week are $9,000. Given this information, what are the firm’s maximized weekly economic profits and its marginal cost?
The firm’s total revenues are $60 per unit 200 units per week = $12,000 per week. Thus, its weekly economic profits equal $12,000 – $9,000 = $3,000. Its marginal revenue, which is $30 per unit, is equal to marginal cost when the firm maximizes profits, so marginal cost is equal to $30 per unit.
24-7. Consider the revenue and cost conditions for a monopolist that are depicted in the figure at the top of the next page.
a. If price exceeds AVC, what is this producer’s profit-maximizing (or loss-minimizing) output?
b. What are the firm’s economic profits (or losses)?
a. The monopoly maximizes economic profits or minimizes economic losses by producing to the point at which marginal revenue is equal to marginal cost, which is 1 million units of output per month.
b. The profit-maximizing or loss-minimizing price of 1 million units per month is $30 per unit, so total revenues equal $30 million per month. The average total cost of producing 1 million units per month is $33 per unit, so total costs equal $33 million per month. Hence, in the short run, producing 1 million units minimizes the monopoly’s loss at $3 million per month.
24-8. For each of the following examples, explain how and why a monopoly would try to price discriminate.
a. Air transport for businesspeople and tourists
b. Serving food on weekdays to businesspeople and retired people. (Hint: Which group has more flexibility during a weekday to adjust to a price change and, hence, a higher price elasticity of demand?)
c. A theater that shows the same movie to large families and to individuals and couples. (Hint: For which set of people will the overall expense of a movie be a larger part of their budget, so that demand is more elastic?)
a. The businessperson’s desire for air travel is less flexible than that of a retired individual. The businessperson’s demand, therefore, is likely to be more inelastic. The price discriminating firm should charge the businessperson a higher price and the retired individual a lower price.
b. The businessperson is likely to have less flexibility in timing when choosing where to eat on a weekday than a retired individual, so the businessperson’s demand will be more inelastic than the retired person. The price discriminating firm should charge the businessperson a higher price and the retired person a lower price.
c. The cost of a movie for a family of four is a larger part of the family budget than for a couple only. The family’s demand for a movie will be more elastic than the couple’s demand. The price discriminating firm should, therefore, charge a lower average price to the family and a higher average price to the couple. It can do this by admitting children at reduced ticket prices.
24-9. A monopolist’s revenues vary directly with price. Is it maximizing its economic profits? Why or why not? (Hint: Recall that the relationship between revenues and price depends on price elasticity of demand.)
If price varies positively with total revenue, then the monopolist is operating on the inelastic portion of the demand curve. This corresponds to the range where marginal revenue is negative. The monopolist cannot, therefore, be at the point where its profits are maximized. In other words, the monopolist is not producing where marginal cost equals marginal revenue.
24-10. A new competitor enters the industry and competes with a second firm, which had been a monopolist. The second firm finds that although demand is not perfectly elastic, it is now more elastic. What will happen to the second firm’s marginal revenue curve and to its profit-maximizing price?
Because demand is more elastic, the marginal revenue curve is also more elastic. It is likely that the price the monopolist can change has fallen.
24-11. A monopolist’s marginal cost curve has shifted upward. What is likely to happen to the monopolist’s price, output rate, and economic profits?
Because marginal cost has risen, the monopolist will be operating at a lower rate of output and charging a higher price. Economic profits are likely to decline because even though the price is higher, its output will be more than proportionately lower.
24-12. Demand has fallen. What is likely to happen to the monopolist’s price, output rate, and economic profits?
When demand decreases, the demand curve and corresponding marginal revenue curve both shift leftward. Thus the marginal revenue curve shifts to the left along the marginal cost curve, indicating a reduction in the profit-maximizing output rate. The leftward shift in demand means a reduced willingness to pay at any given quantity, so at the lower quantity the profit-maximizing price is likely to be lower, as is the maximum amount of economic profits.
24-13. Suppose that in Figure 24-4, the monopolist knows that if it were to reduce the price of its product to $5.40 per unit, the quantity demanded-and hence its output-would rise to 13 units per week. What would be the marginal revenue that the monopolist would derive from producing and selling a 13th unit?
Total revenues from production and sale of 13 units would equal $5.40 per unit times 13 units, or $70.20. Column (3) of panel (a) indicates that total revenues for 12 units equal $67.20, so marginal revenue from production and sale of the 13th unit would be $3 per unit.
24-14. Consider the information from Problem 24-13. If the total costs of producing 13 units were equal to $72.70 per week, would the marginal revenue of producing the 13th unit (your answer to Problem 24-13) be greater or less than the marginal cost of producing that unit? How would the firm’s weekly economic profits be affected if the firm were to produce the 13th unit?
The marginal cost of producing 13 units would equal the difference between $72.70 and $57.70 in total costs if it were to produce 12 units, or $15 per unit. This $15-per-unit marginal cost would exceed the $3-per-unit marginal revenue by $12 per unit and hence would reduce the firm’s profits by $12 per week.
24-15. Take a look a Figure 24-5. Suppose that Q1 is equal to 25 units of output per time period. If the vertical distance to point A is $10 per unit and the vertical distance to point B is $4 per unit, then by how much does producing the 25th unit of output affect the firm’s economic profits?
The vertical distance to point A, $10 per unit, is the marginal revenue received as a result of producing and selling the 25th unit, and the vertical distance to point B, $4 per unit, is the marginal cost incurred in doing so. Consequently, producing the 25th unit adds the difference, $6, to the firm’s economic profits during this time period.
24-16. Take a look a Figure 24-5. Suppose that Q2 is equal to 35 units of output per time period. If the vertical distance to point C is $6 per unit and the vertical distance to point B is $3 per unit, then by how much does producing the 35th unit of output affect the firm’s economic profit?
The vertical distance to point C, $6 per unit, is the marginal cost incurred in producing and selling the 35th unit, and the vertical distance to point F, $3 per unit, is the marginal revenue received from doing so. Consequently, producing the 35th unit reduces the firm’s economic profits during this time period by $3.
24-17. Take a look a Figure 24-6. Suppose that Qm is 9.5 units per week, that Pm is $6.10 per unit and that the average total cost of producing the 9.5 units is $4.26 per unit. What is the dollar amount of maximized monopoly profits displayed by the green area?
The monopolists weekly economic profits equal the multiplication of the difference between price and average total cost ($6.10 per unit - $4.26 per unit = $1.84) times 9.5 units, or $17.48.
24-18. Suppose that initially the data in Problem 24-17 apply, but then an increase in fixed costs occurs. As a result, the ATC curve in Figure 24-6 shifts upward, As a result, the average total cost of producing 9.5 units of output rises to $5 per unit. Does the monopolist’s profit-maximizing weekly output rise, fall, or remain the same? What is the new amount of maximized weekly economic profits?
A change in fixed costs leaves marginal cost unaffected, so the marginal cost curve remains in its current position. The profit-maximizing output rate at which MR = MC stays at 9.5 units per week, and the monopolist’s price remains at $6.10 per unit. Multiplying the new difference between price and average total cost ($6.10 per unit - $5 per unit = $1.10) by 9.5 units per week yields weekly profits of $10.45.
Selected References
Brozen, Yale, “Is Government the Source of Monopoly?” The Intercollegiate Review, Winter 1968–69.
The Competitive Economy, Morristown, NJ: General Learning Press, 1975.
Coase, R. H., “Durability and Monopoly,” Journal of Law and Economics, Vol. XV, No. 1, April 1972, pp. 143–149.
Hicks, J. R., “The Theory of Monopoly,” Econometrics, Vol. 3, 1935, pp. 1–20; reprinted. in American Economic Association, Readings in Price Theory, Homewood, IL: Irwin, 1952.
Liebeler, Wesley J., “Market Power and Competitive Superiority in Concentrated Industries,” UCLA Law Review 25, 1978.
Mansfield, Edwin, Monopoly Power and Economic Performance, 3rd ed., New York: Norton, 1974.
Miller, Roger LeRoy and Roger Meiners, Intermediate Microeconomics: Theory, Issues, and Applications, 4th ed., New York: McGraw-Hill, 1987.
Stigler, George J., “The Tactics of Economic Reform,” Selected Papers of the Graduate School of Business, No. 13, University of Chicago, 1970.
“The Economists and the Problem of Monopoly,” American Economic Review, Vol. 72, May 1982,
pp. 1–11.
Wenders, John, “Entry and Monopoly Pricing,” Journal of Political Economy, October 1967,
pp. 755–760.
