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Monopoly16

CHECKPOINTS

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Problem 1

Problem 2

Problem 1

Problem 2

Problem 3

Problem 4

Problem 1

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Problem 4

Problem 1

Problem 2

Problem 2

Problem 1

Problem 2

Problem 3

Checkpoint 16.1 Checkpoint 16.3

Checkpoint 16.5Checkpoint 16.2

Checkpoint 16.4

In the News

Problem 3

In the News

In the News

In the News

In the News

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Practice Problem 1In which of the six cases might monopoly arise?

a. Coca-Cola cuts its price below that of Pepsi-Cola in an attempt to increase its market share.

b. A single firm, protected by a barrier to entry, produces a personal service that has no close substitutes.

c. A barrier to entry exists, but the good has some close substitutes.

d. A firm offers discounts to students and seniors.

CHECKPOINT 16.1

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In which of the six cases might monopoly arise?

e. A firm can sell any quantity it chooses at the going price.

f. A firm experiences economies of scale even when it produces the quantity that meets the entire market demand.

CHECKPOINT 16.1

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SolutionMonopoly arises when a single firm produces a good or service that has no close substitutes and a barrier to entry exists.

Monopoly arises in b and f.

In a, there is more than one firm.

In c, the good has some close substitutes.

In d, a monopoly might be able to price discriminate, but other types of firms (for example, art museums and pizza producers) price discriminate and they are not monopolies.

CHECKPOINT 16.1

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In e, the demand for the good that the firm produces is perfectly elastic and there is no limit to what the firm could sell if it wished.

Such a firm is in perfect competition.

CHECKPOINT 16.1

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Practice Problem 2Of the six cases: Which are natural monopolies? Which are legal monopolies? Which can price discriminate?

a. Coca-Cola cuts its price below that of Pepsi-Cola in an attempt to increase its market share.

b. A single firm, protected by a barrier to entry, produces a personal service that has no close substitutes.

c. A barrier to entry exists, but the good has some close substitutes.

d. A firm offers discounts to students and seniors.

CHECKPOINT 16.1

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Of the six cases: Which are natural monopolies? Which are legal monopolies? Which can price discriminate?

e. A firm can sell any quantity it chooses at the going price.

f. A firm experiences economies of scale even when it produces the quantity that meets the entire market demand.

CHECKPOINT 16.1

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SolutionNatural monopoly exists when one firm can meet the entire market demand at a lower price than two or more firms could.

So f is a natural monopoly, but b could be also.

Legal monopoly exists when the granting of a right creates barrier to entry.

b might be a legal monopoly.

Monopoly b could price discriminate because a personal service cannot be resold.

CHECKPOINT 16.1

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Study Plan Problem A single firm, protected by a barrier to entry, produces a personal service that has no close substitutes is an example of ______.

CHECKPOINT 16.1

A. either a natural monopoly or a legal monopoly that can price discriminate

B. either a natural monopoly or a legal monopoly that cannot price discriminate

C. a natural monopoly that can price discriminate D. a legal monopoly that can price discriminate E. a natural monopoly that cannot price discriminate

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Study Plan Problem The government issues Tiger Woods, Inc. an exclusive license to produce golf balls. Tiger Woods, Inc. is an example of ______.

CHECKPOINT 16.1

A. a natural monopoly that can price discriminate B. either a natural monopoly or a legal monopoly that can

price discriminate C. a natural monopoly that cannot price discriminate D. either a natural monopoly or a legal monopoly that can

price discriminate E. a legal monopoly that cannot price discriminate

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Practice Problem 3Deal raise monopoly concerns A deal between United Continental and Air Canada looks like an “effective merger” of all of their Canadian and U.S. operations. The deal would create a monopoly on 10 major high demand, transborder routes and substantially reduce competition on nine others. Prices would be higher and choice restricted.

Source: CBC News, June 27, 2011

What type of monopoly would be created on the 10 major, high demand routes? With higher prices and restricted choice, what would be the barrier to entry?

CHECKPOINT 16.1

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SolutionThis deal would create a legal monopoly on 10 major high demand transborder routes.

With higher prices, the monopoly might make positive economic profits, which would be an incentive for other airlines to offer service on these routes.

The barrier would be the granting of landing slots and boarding gates.

CHECKPOINT 16.1

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Practice Problem 1Minnie’s Mineral Springs is a single-price monopoly.

The table shows the demand schedule for Minnie’s spring water (columns 1 and 2), and the firm’s total cost scheduled (columns 3 and 4).

Calculate Minnie’s total revenue and marginal revenue schedules.

CHECKPOINT 16.2

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SolutionTotal revenue equals price multiplied by quantity sold.

Marginal revenue equals the change in total revenue when the quantity sold increases by one unit.

CHECKPOINT 16.2

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Practice Problem 2Minnie’s Mineral Springs is a single-price monopoly.

The table shows the demand schedule for Minnie’s spring water and the firm’s total cost scheduled.

Draw the demand curve and Minnie’s marginal revenue curve.

CHECKPOINT 16.2

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SolutionThe figure shows the market demand curve for spring water and Minnie’s marginal revenue curve.

CHECKPOINT 16.2

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Practice Problem 3Minnie’s Mineral Springs is a single-price monopoly.

The table shows the demand schedule for Minnie’s spring water and the firm’s total cost scheduled.

Calculate Minnie’s profit-maximizing output, price, and economic profit.

CHECKPOINT 16.2

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SolutionA monopoly maximizes economic profit by producing the quantity at which MR = MC.

Marginal cost, MC, is the change in total cost when the quantity produced increases by 1 bottle. See table.

CHECKPOINT 16.2

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Minnie’s maximizes its economic profit by producing 3 bottles an hour at the intersection of the MR curve and the MC curve.

The profit-maximizing price is $7 a bottle.

Economic profit equals total revenue ($21) minus total cost ($7), which is $14 an hour.

CHECKPOINT 16.2

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Practice Problem 4Minnie’s Mineral Springs is a single-price monopoly.

The figure illustrates the demand for Minnie’s spring water and Minnie’s marginal revenue and marginal cost.

If Minnie’s is hit with a conservation tax of $14 an hour, what are Minnie’s new profit-maximizing output, price, and economic profit?

CHECKPOINT 16.2

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SolutionWith a conservation tax of $14 an hour, Minnie’s fixed cost increases, but marginal cost doesn’t change.

So Minnie’s profit-maximizing output remains at 3 bottles an hour and the price is unchanged at $7 a bottle.

Economic profit is zero.

CHECKPOINT 16.2

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Practice Problem 5Comcast offers faster home broadband in some U.S. cities

Comcast, the largest U.S. internet-service provider, introduced a new home-broadband package called Extreme 105, which can download files many times faster than most connections

Source: CNN, April 14, 2011

How does Comcast determine the price of its broadband service?

CHECKPOINT 16.2

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SolutionComcast is the only supplier of broadband service in many cities.

Comcast undertakes a marketing survey to estimate the demand for its new faster service.

Comcast knows its production costs, so to calculate its total costs it adds its marketing costs.

Then Comcast calculates its profit-maximizing quantity of service.

CHECKPOINT 16.2

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From its estimated demand for the service, Comcast calculates the highest price at which it expects it can sell the profit-maximizing quantity of the service.

CHECKPOINT 16.2

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Practice Problem 1The Township Gazette is the only source of news is a small isolated community.

The figure shows the marginal cost of printing the Township Gazette and the market for it.

If the Township Gazette is a single-price monopoly, how many copies are printed each day and what is the price?

CHECKPOINT 16.3

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SolutionThe newspaper maximizes profit by producing 150 copies a day, where marginal revenue equals marginal cost.

The profit-maximizing price is 70¢ a copy.

CHECKPOINT 16.3

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Practice Problem 2The Township Gazette is the only source of news is a small isolated community.

The figure shows the marginal cost of printing the Township Gazette and the market for it.

What is the efficient number of copies and what is the price at which the efficient number of copies could be sold?

CHECKPOINT 16.3

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SolutionThe efficient quantity of copies is 250, where demand (marginal benefit) equals marginal cost.

The efficient quantity would be could be sold for 50¢ a copy.

CHECKPOINT 16.3

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Practice Problem 3The Township Gazette is the only source of news is a small isolated community.

The figure shows the marginal cost of printing the Township Gazette and the market for it.

Is the number of copies printed the efficient quantity? Explain your answer.

CHECKPOINT 16.3

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SolutionThe number of copies printed (150 a day) is not efficient because the marginal benefit of the 150th copy (70¢ a copy) exceeds marginal cost of producing it (40¢ a copy).

CHECKPOINT 16.3

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Practice Problem 4The Township Gazette is the only source of news is a small isolated community.

The figure shows the marginal cost of printing the Township Gazette and the market for it.

Show the consumer surplus that is redistributed to the Township Gazette and the deadweight loss that arises from the monopoly.

CHECKPOINT 16.3

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SolutionIn the figure, the blue rectangle shows the consumer surplus transferred from the consumers to the Township Gazette.

The gray triangle shows the deadweight loss.

CHECKPOINT 16.3

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Practice Problem 5Ticketmaster’s near monopoly challenged as technology changes

In the 1990s, to see Michael Jordan or Garth Brooks live you had to buy the ticket through Ticketmaster, or from a scalper. Today, Ticketmaster no longer controls the sale of tickets to sports and music events, and more changes are coming. Concert promoter Live Nation, Ticketmaster’s biggest client, will sell its own tickets. Also, sports and music events tickets are now sold through Internet auction markets.

CHECKPOINT 16.3

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How will the increased competition in the sale of tickets affect the service fee component of the price and the efficiency of the market?

Will scalpers survive?

CHECKPOINT 16.3

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SolutionThe price you pay for a ticket to an event is made up of the price of the event plus a service fee.

As a monopoly, Ticketmaster charged the profit-maximizing fee.

As the monopoly weakens and competition increases, sellers will still charge the profit-maximizing fee, but the fee will be lower.

The ticket-selling market will be more efficient. Scalpers will have to compete with resale auctions and might have a hard time surviving.

CHECKPOINT 16.3

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Practice Problem 1Village, a small isolated town, has one doctor.

For a 30-minute consultation, the doctor charges a rich person twice as much as much as a poor person.

Does the doctor practice price discrimination?

Is the doctor using resources efficiently?

Does the doctor’s pricing scheme redistribute consumer surplus? If so, explain how.

CHECKPOINT 16.4

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SolutionThe doctor practices price discrimination because rich people and poor people play a different price for the same service: a 30-minute consultation.

The doctor provides the profit-maximizing number of consultations and charges rich people more than poor people.

As a monopoly, the total number of consultations is less than that at which marginal benefit equals the marginal cost of providing the medical service.

CHECKPOINT 16.4

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Because marginal benefit does not equal marginal cost, the doctor is not using resources efficiently.

With price discrimination, the doctor takes some of the consumer surplus.

So some consumer surplus is redistributed to the doctor as profit.

CHECKPOINT 16.4

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Practice Problem 2Village, a small isolated town, has one doctor.

For a 30-minute consultation, the doctor charges a rich person twice as much as much as a poor person.

If the doctor decided to charge everyone the maximum price that he or she would be willing to pay, what would be the consumer surplus?

Would the market for medical service in Village be efficient?

CHECKPOINT 16.4

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SolutionThe doctor decides to practice perfect price discrimination.

With perfect price discrimination, marginal revenue equals price.

To maximize economic price, the doctor increases the number of consultations to make the lowest price charged equal to the marginal cost of providing the service.

CHECKPOINT 16.4

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The doctor takes the entire consumer surplus, so consumer surplus is zero.

Marginal benefit equals price so resources are being used efficiently.

CHECKPOINT 16.4

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Practice Problem 3Feast on these great dining dealsEntrées at Patina in Los Angeles start at $40, but the four-course fixed menu is $59. And pair that with the waived corkage fee on Tuesdays. At Michael Mina, San Francisco, enjoy a three-course, prix-fixe lunch for $49 or pay up to $65 when ordering the same items individually at dinner.

Source: USA Today, July 29, 2011

Are Patina and Michael Mina price discriminating? Explain your answer.

CHECKPOINT 16.4

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SolutionA restaurant meal cannot be resold, so price discrimination is possible.

Offering a four-course fixed menu at a lower price than the sum of the prices of the individual items is price discrimination.

Diners who want fewer than four courses and want to be more selective about what they eat pay more.

CHECKPOINT 16.4

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Waiving the corkage fee on Tuesdays is not price discrimination.

Demand is lower on Tuesdays, so the profit-maximizing price is lower.

Waiving the corkage fee is a way of price cutting without reprinting the menu.

CHECKPOINT 16.4

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Practice Problem 1An unregulated natural monopoly bottles Elixir. The monopoly’s total fixed cost is $150,000, and its marginal cost is 10 cents a bottle. The figure illustrates the demand for Elixir.

How many bottles of Elixir does the monopoly sell and what is the price of a bottle of Elixir?

Is the monopoly’s use of resources efficient?

CHECKPOINT 16.5

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SolutionThe monopoly will produce 1 million bottles a year—the quantity at which marginal revenue equals marginal cost.

The price is 30 cents a bottle— the highest price at which the monopoly can sell the 1 million bottles a year.

CHECKPOINT 16.5

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The monopoly’s use of resources is inefficient.

If resource use were efficient, the monopoly would produce the quantity at which marginal benefit (price) equals marginal cost: 2 million bottles a year.

CHECKPOINT 16.5

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Practice Problem 2An unregulated natural monopoly bottles Elixir. The monopoly’s total fixed cost is $150,000, and its marginal cost is 10 cents a bottle.

If the government introduces a marginal cost pricing rule.

What is the price of Elixir, the quantity sold, and the monopoly’s economic profit?

CHECKPOINT 16.5

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SolutionWith a marginal cost pricing rule, the price is set equal to marginal cost (10 cents a bottle) and 2 million bottles a year are sold.

The monopoly incurs an economic loss equal to its total fixed costs of $150,000 a year.

The monopoly would need a subsidy to keep it in business.

CHECKPOINT 16.5

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Practice Problem 3An unregulated natural monopoly bottles Elixir. The monopoly’s total fixed cost is $150,000, and its marginal cost is 10 cents a bottle.

If the government introduces an average cost pricing rule.

What is the price of Elixir, the quantity sold, and the monopoly’s economic profit?

CHECKPOINT 16.5

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SolutionWith an average cost pricing rule, the firm produces the quantity at which price equals average total cost.

ATC = AFC + AVC.

AVC equals marginal cost and is 10 cents a bottles.

AFC equals $150,000 divided by the quantity produced.

CHECKPOINT 16.5

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With an average cost pricing rule, the firm produces the quantity at which price equals average total cost.

ATC = AFC + AVC.

AVC equals marginal cost and is 10 cents a bottles.

AFC equals $150,000 divided by the quantity produced. For example, at 1 million bottles, AFC is 15 cents.

CHECKPOINT 16.5

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If 1.5 million bottles are produced, AFC is 10 cents a bottle.

That is, 1.5 million bottles are produced:

ATC = 10 cents + 10 cents= 20 cents

The monopoly can sell 1.5 million bottles at 20 cents a bottle.

So the monopoly produces 1.5 million bottles a year and makes zero economic profit.

CHECKPOINT 16.5

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Practice Problem 4Mexicans protest the plan to end the state oil monopoly

Thousands of protesters have demonstrated to fight the plan to open Mexico’s state oil monopoly to private investment. In Mexico, the government sets the price, currently $2.48 a gallon, while the U.S. average is $3.37 a gallon. The government taxes the state monopoly’s profit 90 percent.

Source: USA Today, April 13, 2008

Describe how the Mexican government regulates the domestic oil market.

CHECKPOINT 16.5

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SolutionThe price is not set equal to marginal cost (marginal cost pricing) because the oil company does not receive a subsidy.

The price is not set equal to average total cost (average cost pricing) because the oil company does not break even.

The government operates a price cap regulation and the company pays a profit tax of 90 percent.

CHECKPOINT 16.5