Section 11

Perfect price discrimination

Perfect price discrimination takes place when a monopolist charges each consumer his or her willingness to pay—the maximum that the consumer is willing to pay.

b. The only two airlines that currently fly to Alaska need government approval to merge. Other airlines wish to fly to Alaska but need government-allocated landing slots to do so.

The government should approve the merger only if it fos- ters competition by transferring some of the company's landing slots to another, competing airline.

b. A monopolist causes inefficiency because there are consumers who are willing to pay a price greater than or equal to marginal cost but less than the monopoly price.

True. If a monopolist sold to all customers willing to pay an amount greater than or equal to marginal cost, all mutually beneficial transactions would occur and there would be no deadweight loss.

c. Under price discrimination, a customer with highly elastic demand will pay a lower price than a customer with inelastic demand.

True. Under price discrimination consumers are charged prices that depend on their price elasticity of demand. A consumer with highly elastic demand will pay a lower price than a consumer with inelastic demand.

A price discriminating monopolist will charge a higher price to consumers with a. a more inelastic demand. b. a less inelastic demand. c. higher income. d. lower willingness to pay. e. less experience in the market.

A

Compared to the short-run industry supply curve, the long-run industry supply curve will be more a. elastic. b. inelastic. c. steeply sloped. d. profitable. e. accurate.

A

Which of the following markets is an example of a regulated natural monopoly? a. local cable TV b. gasoline c. cell phone service d. organic tomatoes e. diamonds

A

single-price monopolist

A single-price monopolist charges all consumers the same price.

d. Give an example of price discrimination.

An example is different prices for movie tickets charged for people of different age

b. The wages paid to workers in the industry go up for an extended period of time.

An increase in wages generates an increase in the aver- age variable and the average total cost of production at every output level. In the short run, firms incur losses at the current output level, and so in the long run some firms will exit the industry. (If the average vari- able cost rises sufficiently, some firms may even shut down in the short run.) As firms exit, supply decreases, price rises, and losses are reduced. Exit will cease once losses return to zero.

Which of the following is most likely to be higher for a regulated natural monopoly than for an unregulated natural monopoly? a. product variety b. quantity c. price d. profit e. deadweight loss

B

In the long run, a perfectly competitive firm will earn a. a negative market return. b. a positive profit. c. a loss. d. a normal profit. e. excess profit.

D

Which of the following characteristics is necessary in order for a firm to price discriminate? a. free entry and exit b. differentiated product c. many sellers d. some control over price e. horizontal demand curved

D

Which of the following is correct for a perfectly competitive firm? I. The marginal revenue curve is the demand curve. II. The firm maximizes profit when price equals marginal cost. III. The market demand curve is horizontal. a. I only b. II only c. III only d. I and II only e. I, II, and III

D

a. Define price discrimination.

Price discrimination is the practice of charging different prices to different customers for the same product.

Price regulation

Price regulation limits the price that a monopolist is allowed to charge.

c. A permanent change in consumer tastes increases demand for the good.

Price will rise as a result of the increased demand, lead- ing to a short-run increase in profits at the current out- put level. In the long run, firms will enter the industry, generating an increase in supply, a fall in price, and a fall in profits. Once profits are driven back to zero, entry will cease.

a. the demand schedule (Hint: the average revenue at each quantity indicates the price at which that quantity would be demanded.)

The demand schedule is found by determining the price at which each quantity would be demanded. This price is the average revenue, found at each output level by dividing the total revenue by the number of emeralds produced. For example, the price when 3 emeralds are produced is $252/3 = $84. The price at the various out- put levels is then used to construct the demand schedule in the accompanying table.

Price-taking firm's optimal output rule

says that a price-taking firm's profit is maximized by producing the quantity of output at which the market price is equal to the marginal cost of the last unit produced.

Which of the following statements is true of a monopoly as compared to a perfectly competitive market with the same costs? I. Consumer surplus is smaller. II. Profit is smaller. III. Deadweight loss is smaller. a. I only b. II only c. III only d. I and II only e. I, II, and III

A

a. A technological advance lowers the fixed cost of production of every firm in the industry.

A fall in the fixed cost of production generates a fall in the average total cost of production and, in the short run, an increase in each firm's profit at the current output level. So in the long run new firms will enter the industry. The increase in supply drives down price and profits. Once profits are driven back to zero, entry will cease.

shut-down price

A firm will cease production in the short run if the market price falls below the shut-down price, which is equal to minimum average variable cost.

long-run market equilibrium

A market is in long-run market equilibrium when the quantity supplied equals the quantity demanded, given that sufficient time has elapsed for entry into and exit from the industry to occur.

Suppose a monopolist mistakenly believes that her or his marginal revenue is always equal to the market price. Assuming constant marginal cost and no fixed cost, draw a diagram comparing the level of profit, consumer surplus, total surplus, and deadweight loss for this misguided monopolist compared to a smart monopolist.

As shown in the accompanying diagram, a "smart" profit-maximizing monopolist produces QM, the output level at which MR = MC. A monopolist who mistakenly believes that P = MR produces the output level at which P = MC (when, in fact, P > MR, and at the true profit- maximizing level of output, P > MR = MC). This misguid- ed monopolist will produce the output level QC, where the demand curve crosses the marginal cost curve—the same output level that would be produced if the industry were perfectly competitive. It will charge the price PC , which is equal to marginal cost, and make zero profit. The entire shaded area is equal to the consumer surplus, which is also equal to total surplus in this case (since the monopolist receives zero producer surplus). There is no deadweight loss because every consumer who is willing to pay as much as or more than marginal cost gets the good. A smart monopolist, however, will produce the output level QM and charge the price PM. Profit for the smart monopolist is represented by the green area, consumer surplus corresponds to the blue area, and total surplus is equal to the sum of the green and blue areas. The yellow area is the deadweight loss generated by the monopolist.

Which of the following is true of a natural monopoly? a. It experiences diseconomies of scale. b. ATC is lower if there is a single firm in the market. c. It occurs in a market that relies on natural resources for its production. d. There are decreasing returns to scale in the industry. e. The government must provide the good or service to achieve efficiency.

B

Which of the following will happen in response if perfectly competitive firms are earning positive economic profit? a. Firms will exit the industry. b. The short-run industry supply curve will shift right. c. The short-run industry supply curve will shift left. d. Firm output will increase. e. Market price will increase.

B

With perfect competition, efficiency is generally attained in a. the short run but not the long run. b. the long run but not the short run. c. both the short run and the long run. d. neither the short run nor the long run. e. specific firms only.

B

With perfect price discrimination, consumer surplus a. is maximized. b. equals zero. c. is increased. d. cannot be determined. e. is the area below the demand curve above MC.

B

At prices that motivate the firm to produce at all, the short-run supply curve for a perfect competitor corresponds to which curve? a. the ATC curve b. the AVC curve c. the MC curve d. the AFC curve e. the MR curve

C

If a firm has a total cost of $200, its profit-maximizing level of output is 10 units, and it is breaking even (that is, earning a normal profit), what is the market price? a. $200 b. $100 c. $20 d. $10 e. $2

C

Price discrimination a. is the opposite of volume discounts. b. is a practice limited to movie theaters and the airline industry. c. can lead to increased efficiency in the market. d. rarely occurs in the real world. e. helps to increase the profits of perfect competitors.

C

What is the firm's profit if the price of its product is $5 and it produces 500 units of output at a total cost of $1,000? a. $5,000 b. $2,500 c. $1,500 d. −$1,500 e. −$2,500

C

Which of the following government actions is the most common for a natural monopoly in the United States? a. prevent its formation b. break it up using antitrust laws c. use price regulation d. public ownership e. elimination of the market

C

a. Internet service in Anytown, OH, is provided by cable. Customers feel they are being overcharged, but the cable company claims it must charge prices that let it recover the costs of laying cable.

Cable Internet service is a natural monopoly. So the gov- ernment should intervene if it believes that the current price exceeds average total cost, which includes the cost of laying the cable. In this case it should impose a price ceil- ing equal to average total cost. If the price does not exceed average total cost, the government should donothing.

A firm is profitable if a. TR < TC. b. AR < ATC. c. MC < ATC. d. ATC < P. e. ATC > MC.

D

A firm should continue to produce in the short run as long as price is at least equal to a. MR. b. MC. c. minimum ATC. d. minimum AVC. e. AFC.

D

A perfectly competitive firm will maximize profit at the quantity at which the firm's marginal revenue equals... a. price. b. average revenue. c. total cost. d. marginal cost. e. demand.

D

How does a monopoly differ from a perfectly competitive industry with the same costs? I. It produces a smaller quantity. II. It charges a higher price. III. It earns normal profits in the long run. a. I only b. II only c. III only d. I and II only e. I, II, and III

D

Which of the following is a technique used by price discriminating monopolists? I. advance purchase restrictions II. two-part tariffs III. volume discounts a. I only b. II only c. III only d. I and II only e. I, II, and III

E

Which of the following is generally true for perfect competition? I. There is free entry and exit. II. Long-run market equilibrium is efficient. III. Firms maximize profits at the output level where P = MC. a. I only b. II only c. III only d. I and II only e. I, II, and III

E

b. A price-discriminating monopolist creates more inefficiency than a single-price monopolist because it captures more of the consumer surplus.

False. Although a price-discriminating monopolist does indeed capture more of the consumer surplus, less ineffi- ciency is created: more mutually beneficial transactions occur because the monopolist makes more sales to cus- tomers with a low willingness to pay for the good.

a. Society's welfare is lower under monopoly because some consumer surplus is transformed into profit for the monopolist.

False. Although some consumer surplus is indeed trans- formed into monopoly profit, this is not the source of inefficiency. As can be seen from Figure 62.1, panel (b), the inefficiency arises from the fact that some of the consumer surplus is transformed into deadweight loss (the yellow area), which is a complete loss not captured by consumers, producers, or anyone else.

a. A single-price monopolist sells to some customers that would not find the product affordable if purchasing from a price-discriminating monopolist.

False. The opposite is true. A price-discriminating monop- olist will sell to some customers that would not find the product affordable if purchasing from a single-price monopolist—namely, customers with a high price elastici- ty of demand who are willing to pay only a relatively low price for the good.

b. Why do firms price discriminate?

Firms price discriminate to increase their profits.

e. What additional information is needed to determine Emerald, Inc.'s profit-maximizing output?

In order to determine Emerald, Inc.'s profit-maximizing output level, you must know its marginal cost at each output level. Its profit-maximizing output level is the one at which marginal revenue is equal to mar- ginal cost.

c. In which market structures can firms price discriminate? Explain why.

In order to price discriminate, firms must be in the monopoly, oligopoly, or monopolistic competition market structure. Because rather than being price-takers, firms in these market structures have some degree of market power, which gives them the ability to charge more than one price.

public ownership

In public ownership of a monopoly, the good is supplied by the government or by a firm owned by the government.

price discrimination

Sellers engage in price discrimination when they charge different prices to different consumers for the same good.

break-even price

The break-even price of a price-taking firm is the market price at which it earns zero profits.

industry supply curve

The industry supply curve shows the relationship between the price of a good and the total output of the industry as a whole.

long-run industry supply curve

The long-run industry supply curve shows how the quantity supplied responds to the price once producers have had time to enter or exit the industry.

If a firm has a total cost of $500 at a quantity of 50 units, and it is at that quantity that average total cost is minimized for the firm, what is the lowest price that would allow the firm to break even (that is, earn a normal profit)? Explain.

The lowest price that would allow the firm to break even is $10, for the minimum average total cost is $500/50 = $10, and price must at least equal minimum average total cost in order for the firm to break even.

b. the marginal revenue schedule

The marginal revenue schedule is found by calculating the change in total revenue as output increases by one unit. For example, the marginal revenue generated by increasing output from 2 to 3 emeralds is ($252 − $186) = $66.

d. the price effect component of marginal revenue at each output level

The price effect component of marginal revenue is the decline in total revenue caused by the fall in price when one more unit is sold. For example, as shown in the table, when only 2 emeralds are sold, each emerald sells at a price of $93. However, when Emerald, Inc. sells an additional emerald, the price must fall by $9 to $84. So the price effect component in going from 2 to 3 emeralds is (−$9) × 2 = −$18. That's because 2 emeralds can only be sold at a price of $84 when 3 emeralds in total are sold, although they could have been sold at a price of $93 when only 2 in total were sold.

c. the quantity effect component of marginal revenue at each output level

The quantity effect component of marginal revenue is the additional revenue generated by selling one more unit of the good at the market price. For example, as shown in the accompanying table, at 3 emeralds, the market price is $84; so, when going from 2 to 3 emeralds the quantity effect is equal to $84.

short-run individual supply curve

The short-run individual supply curve shows how an individual firm's profit- maximizing level of output depends on the market price, taking fixed cost as given.

short-run industry supply curve

The short-run industry supply curve shows how the quantity supplied by an industry depends on the market price, given a fixed number of firms.

d. The price of a key input rises due to a long-term shortage of that input.

The shortage of a key input causes that input's price to increase, resulting in an increase in average variable and average total cost for producers. Firms incur losses in the short run, and some firms will exit the industry in the long run. The fall in supply generates an increase in price and decreased losses. Exit will cease when the losses for remaining firms have returned to zero.

short-run market equilibrium

There is a short-run market equilibrium when the quantity supplied equals the quantity demanded, taking the number of producers as given.

c. Food manufacturers place discount coupons for their merchandise in newspapers.

This is a case of price discrimination. Consumers with a high price elasticity of demand will pay a lower price by collecting and using discount coupons. Consumers with a low price elasticity of demand will not use coupons.

b. Restaurants have senior citizen discounts.

This is a case of price discrimination. Senior citizens have a higher price elasticity of demand for restaurant meals (their demand for restaurant meals is more responsive to price changes) than other patrons. Restaurants lower the price to high-elasticity consumers (senior citizens). Consumers with low price elasticity of demand will pay the full price.

The state of Maine has a very active lobster industry, which harvests lobsters during the summer months. During the rest of the year, lobsters can be obtained by restaurants from producers in other parts of the world, but at a much higher price. Maine is also full of "lobster shacks," roadside restaurants serving lobster dishes that are open only during the summer. Supposing that the market demand for lobster dishes remains the same throughout the year, explain why it is optimal for lobster shacks to operate only during the summer.

This is an example of a temporary shut-down by a firm when the market price lies below the shut-down price, the minimum average variable cost. The market price is the price of a lobster meal and the variable cost is the cost of the lobster, employee wages, and other expenses that increase as more meals are served. In this example, however, it is the average variable cost curve rather than the market price that shifts over time, due to sea- sonal changes in the cost of lobsters. Maine lobster shacks have relatively low average variable cost during the summer, when cheap Maine lobsters are available; during the rest of the year, their average variable cost is relatively high due to the high cost of imported lob- sters. So the lobster shacks are open for business during the summer, when their minimum average variable cost lies below price; but they close during the rest of the year, when the price lies below their minimum average variable cost.

a. Damaged merchandise is marked down.

This is not a case of price discrimination because the product itself is different and all consumers, regardless of their price elasticities of demand, value the damaged mer- chandise less than undamaged merchandise. So the price must be lowered to sell the merchandise.

d. Airline tickets cost more during the summer peak flying season.

This is not a case of price discrimination; it is simply a case of supply and demand.