EA Midterm 3
One source of inefficiency in monopolistic competition is that
since price is above marginal cost, some units are not produced that buyers value in excess of the cost of production and this causes a deadweight loss. - In monopolistic competition, the market price is greater than the marginal cost of production. This generates deadweight loss because some units will not be produced where the value to the buyer is greater than the cost of production.
What is a monopoly?
- A monopoly is a firm that is the sole seller of a product without close substitutes. The fundamental cause of monopoly is the presence of barriers to entry - Too much market power may invite govt regulation if a firm has over 25% market share
Which of the following is not a barrier to entry in a monopolized market? Likewise, what are the four sources to barriers of entry?
- A single firm being very large would not be a source of barriers to entry - They are: Ownership of a key resource.The government gives a single firm the exclusive right to produce some good. Costs of production make a single producer more efficient than a large number of producers. A firm is able to gain control of other firms in the market and thus grow in size.
What is price discrimination and what is arbitrage?
- Price discrimination is selling the same good at different prices to different customers, even though the costs for producing for the two customers are the same Two important effects of price discrimination:It can increase the monopolist's profits. It can reduce deadweight loss - Arbitrage will limit a monopolist's ability to price discriminate. Arbitrage is the process of buying a good in one market at a low price and then selling it in another market at a higher price.
What point do monopolists choose as profit-maximizing?
- The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity, and then the demand curve shows the price consistent with this quantity -Profits are maximised where marginal revenue (MR) equals marginal cost (MC). If MR>MC, then the monopolist should increase production to increase profits. If MR<MC, then the monopolist should decrease production to increase profits. When MR=MC, profits cannot be increased. The price that this quantity is sold for is determined by the demand curve.
Discuss the costs and benefits to society of advertising
Critics of advertising argue that: Firms advertise in order to manipulate people's tastes. It impedes competition by implying that products are more different than they really are. Defenders argue that advertising: provides information to consumers increases competition by offering a greater variety of products and prices. The willingness of a firm to spend advertising dollars can be a signal to consumers about the quality of the product being offered.
Which of the following firms is most likely to spend a large percentage of their revenue on advertising?
Firms that sell highly differentiated consumer goods spend a lot on advertising. - Firms that sell industrial products typically spend very little on advertising. -Firms that sell homogeneous products spend nothing at all. -When firms sell differentiated products and charge prices above marginal cost, each firm has an incentive to advertise in order to attract more buyers to its particular product.
A firm whose average total cost continually declines at least to the quantity that could supply the entire market is known as a
Natural Monopoly. An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms. A natural monopoly occurs when there are economies of scale, implying that average total cost falls as the firm's scale becomes larger.
Which of the follow statements about price discrimination is not true?
Not true: Perfect price discrimination generates a deadweight loss. True: - Price discrimination increases a monopolist's profits. - Price discrimination can raise economic welfare. - Price discrimination requires that the seller be able to separate buyers according to their willingness to pay. - For a monopolist to engage in price discrimination, buyers must be unable to engage in arbitrage. - Under perfect price discrimination, each consumer is charged their willingness to pay and there is no deadweight loss. Every consumer who values the product for more than it costs to produce will purchase the product and all mutually beneficial trades take place. However, all derived surplus in the market goes to the monopoly producer.
Which of the following is not a characteristic of a monopolistically competitive market?
Not: long-run economic profits Are: free entry and exit, many sellers, differentiated products In a monopolistically competitive market, there are many sellers, products are differentiated, and there is free entry and exit. Because there is free entry and exit, economic profits in the long-run are driven to zero (because firms keep entering whenever economic profit can be made).
What is deadweight loss in the monopoly? (Be able to identify on a graph)
See below in the graph the black doted line triangle which shows the deadweight loss in the example. The deadweight loss refers to the welfare losses as there are some transactions that do not take place due to the higher price. Recall that in the case of monopoly -as here in this example- the monopolist due to the market power (s)he holds can set the price above the MC (mark-up).
Chart given. Compute total revenue, total cost and profit at each quantity. What quantity would a profit-maximising publisher choose? What price would it charge?
TR = P x Q TC = FC + VC VC = Q x MC (Because MC is constant in this example.) Profit = TR - TC The profit maximizing quantity is Qmaxprofit= 500,000 at the point where MR=MC. The corresponding price that the publisher will charge is P = €50.
How does marginal revenue compare to the price? Explain.
The MR is always below the price which is P=AR. A monopolist's marginal revenue is always less than the price of its good. The demand curve is downward sloping. When a monopoly drops the price to sell one more unit, the revenue received from previously sold units also decreases. When a monopoly increases the amount it sells, it has two effects on total revenue (P ´ Q). The output effect—more output is sold, so Q is higher & TR increases. The price effect—price falls, so P is lower & TR decreases
On a graph be able to identify consumer and producer surplus
The consumer surplus (CS on the graph) is the triangular area below the demand curve and above the dotted line showing the price and by the vertical axis. The deadweight loss (DWL on the graph) is the triangle shaped below the demand curve, above the MC curve and to the right of the dotted line showing the quantity produced.
Discuss what is meant by contestable markets and explain how firms may deviate from profit maximising behaviour?
The key characteristic of a perfectly contestable market (the benchmark to explain firms' behaviours) was that firms were influenced by the threat of new entrants into a market. The more highly contestable a market is, the lower the barriers to entry. We have seen how, in monopolistically competitive markets, despite the fact that each firm has some monopoly control over its product, the ease of entry and exit means that in the long run profits can be competed away as new firms enter the market. This threat of new entrants may make firms behave in a way that departs from what was assumed to be the traditional goal of firms - to maximize profits. Firms may deliberately limit profits made to discourage new entrants. Profits might be limited by what is termed entry limit pricing. This refers to a situation where a firm will keep prices lower than they could be in order to deter new entrants. Similarly, firms may also practise predatory or destroyer pricing whereby the price is held below average cost for a period to try and force out competitors or prevent new firms from entering the market. Incumbent firms may be in a position to do this because they may have been able to gain some advantages of economies of scale which new entrants may not be able to exploit.
The inefficiency associated with monopoly is due to
The monopolist produces less than the socially efficient QUANTITY of output. The deadweight loss caused by a monopoly is similar to the deadweight loss caused by a tax. ! The difference between the two cases is that the government gets the revenue from a tax, whereas a private firm gets the monopoly profit
If regulators break up a natural monopoly into many smaller firms, the cost of production
Will rise. If many firms produce a small amount of output, the average cost of production will be greater than when a single firm serves the entire market. This is because the average total cost curve for a natural monopoly is downward sloping.
The use of the word "monopoly" in the name of the market structure called "monopolistic competition" refers to the fact that
a monopolistically competitive firm faces a downward-sloping demand curve for its differentiated product and so does a monopolist. - In monopolistically competitive markets, products are differentiated. This means that consumers are willing to pay a higher price for a variety produced by a particular firm. The demand curve for the firm's product is downward sloping, just as it is for a monopolist.