L15: Monopoly

Which methods allow the government to estimate the demand curve?

* Contingent valuation * Revealed preference The government can estimate the demand curve by asking consumers how much they value the good (contingent valuation) or studying the behaviors of consumers (revealed preference). Asking the monopolist will yield information about the supply curve, but not the demand curve. Optimal price regulation is the setting of efficient price ceiling not how to determine the demand curve.

What are ways that the government can reduce the deadweight loss from monopolies discussed in the lecture?

* Introducing competition * Regulation The government can regulate monopolies like the optimal price regulation discussed in the previous video or they can introduce competition in order to give consumers more options. Patents create monopolies rather than helping decrease the deadweight loss from them. Taxes are not typically used in the regulation of monopolies.

What are properties of a natural monopoly?

* One firm has lower average cost than any other for any relevant quantity * The monopoly arises due to cost advantages * Average cost is declining within the relevant range of quantities

What happened when the government deregulated airlines in 1978?

* Prices decreased * More routes were offered * Flight amenities decreased * Consumer surplus increased When the government deregulated airlines, it turned out that airlines were a mostly contestable market. More companies entered the market. These companies drove down prices and increased the number of routes offered (increased quantity) just as theory would predict. Since airlines could compete on price, airlines reduced their number of amenities in order to reduce their prices. Before airlines could not compete on price, so they competed by providing more amenities. We know that this tradeoff between price and amenities increased social welfare, because if consumers demanded more amenities, then a popular airline would emerge that offered these additional amenities at a higher price. Since none of the major airlines offer such additional amenities, we can conclude that most consumers value the lower prices more than the additional amenities.

What is the effect of optimal monopoly price regulation relative to a monopoly market with no regulation? (What happens to producer surplus, consumer surplus, deadweight loss?)

* Producer surplus decreases * Consumer surplus increases * Deadweight loss decreases Optimal monopoly price regulation induces the monopolist to produce the efficient quantity, because there is no poisoning effect. There is no poisoning effect, because the monopolist does not have the option to raise the price above the efficient price. Producing the efficient quantity and offering it at the efficient price will decrease deadweight loss. Consumers will be better off because more transactions will occur at a lower price. The producer will be worse off, because they will not be able to use their market power to restrict quantity and raise price in order to extract additional producer surplus.

How can governments introduce competition into public schools' local monopoly on education?

* Provide vouchers to parents * Allow public school choice * Fund charter schools Providing vouchers would allow parents to use their government educational dollars on any institution, which would eliminate the cost advantage that public schools enjoy. Public school choice would also increase competition by forcing each local public school to compete with schools from across the city. Creating charter schools would also provide a competitor to the public schools that would not have a cost disadvantage. While improving public school education might be a good policy, this would not increase competition.

What are downsides to providing vouchers to parents to spend on education?

* The government must regulate private schools to ensure achievement of basic educational goals * Vouchers subsidize educational spending of the rich As Professor Gruber mentioned, the government would need to regulate the private schools that parents spent their vouchers on to ensure they were achieving basic educational goals. (He gave the example of a clown school as a school that would not be achieving these goals) The vouchers would also be given to rich parents that would have sent their kids to private school anyway, which would simply be a gift to the rich. Vouchers would increase competition, but this would be a benefit of the system rather than a downside.

What are the purposes of patents?

* They provide firms with a temporary monopoly on an invention. * The promote innovation. Course Week 6: Applying the Competitive Model; Monopoly Lecture 15: Monopoly (2/2) Government-Sanctioned Monopoly — Quiz PreviousNext video Natural Monopoly Completedproblem Natural Monopoly — Quiz video Government-Sanctioned Monopoly Completedproblem Government-Sanctioned Monopoly — Quiz video Benefits of Regulating Monopolies Completedproblem Benefits of Regulating Monopolies — Quiz video Problems with Regulating Monopolies Completedproblem Problems with Regulating Monopolies — Quiz Completedvideo Increasing Competition: Education Completedproblem Increasing Competition: Education — Quiz video Contestable Markets: Airlines Completedproblem Contestable Markets: Airlines — Quiz Completedother Handout Government-Sanctioned Monopoly — Quiz Bookmark this page Lecture Exercise 15.2.1 1/1 point (graded) Patents are intended to... (Select each correct answer.) ...create efficient competitive markets ...provide firms with a temporary monopoly on an invention ...create natural monopolies ...promote innovation correct Explanation The government gives patents to firms that invent new products. The patents provide firms with a temporary monopoly on the new product. Giving patents promotes innovation, because inventors reap monopoly profits while they have their temporary monopoly instead of being immediately undercut by competitors. Patents do not create natural monopolies, but instead, create monopolies through government action.

In optimal monopoly price regulation, the government...

..sets a price ceiling at the competitive market equilibrium price. The government sets a price ceiling at the competitive market equilibrium price in order to prevent the monopolist from marking up the good. Setting a price floor would not prevent markups. Quantity restrictions and taxes are not price regulations.

Define a contestable market.

A monopoly market with the threat of entry. A contestable market is a monopoly market with a threat of entry. The threat of entry is because there is a relatively small barrier to entry. This restricts the market power of the monopolist because if they raise their price too high then another firm will be incentivized to enter the market.

What are patents' effect on social welfare?

Ambiguous. Patents have an ambiguous effect on social welfare. Patents promote innovation, which increases social welfare, but patents also create inefficient monopolies that reduce social welfare. Whether patents increase or decrease social welfare depends on which of these two effects dominates.

Which of the following could be a case of a natural monopoly? A. The producers of an HIV drug, because they have a patent B. Water utilities, because of the cost of laying down pipes C. A rock quarry where no other rock quarries are nearby D. McDonald's with respect to hamburgers, because they sell more hamburgers than any other company

B, C. The monopoly of HIV producers arises from government regulation (patent laws) rather than cost advantages, so it is not a natural monopoly. The large fixed costs of laying down pipes and the low marginal cost of providing water may make it unprofitable for a second firm to enter the water market, so it may be natural monopoly. A rock quarry with no other rock quarries nearby could have a natural cost advantage over any relevant quantity, which would make it a natural monopoly. Since other companies produce hamburgers and compete with McDonald's, McDonald's is not a monopoly.

Suppose marginal cost is everywhere increasing. What will happen if the government sets the price ceiling below the marginal cost of the first unit?

The market for the good will disappear. If the price ceiling is below the marginal cost of the first unit, then the monopolist will lose money by producing the good, so it will shut down and the market for the good will disappear. This will increase deadweight loss, because beneficial transactions will not occur.

In order to do optimal monopoly price regulation, the government needs to know...

The supply and demand curve. The government needs to know the demand curve and supply curve in order to determine what the efficient price ceiling will be. The current price and quantity are irrelevant to their decision if they know the demand curve and the supply curve.