ECON Inquizitive Ch. 10
Based on the following graph, how much should the monopolist charge for its product?
~$30 [The price is found by identifying the quantity where MR=MC and then going up to the demand curve and across to the price axis. From this the monopolist can expect a total profit of ($30 - $23) × 40 = $280]
Calculate the amount of consumer surplus transferred to the monopolist in the monopoly situation shown.
~$300 [This is the part of the lost consumer surplus that is transferred to the monopolist: ($13 - $10) × 100 = $300]
Which of the following traits describe a competitive market, and which describe a monopoly?
Competitive Market ~many firms [Competition among sellers requires that there be more than one seller] ~seller has no market power [In a competitive market, each firm is a price taker] ~price equals seller's marginal revenue [In a competitive market, a seller is not free to charge more than it has to] ~cannot earn long-run economic profits [Any prospect of long-run profits will be undermined by new competitors entering the market] Monopoly ~one firm [There is limited choice for consumers] ~seller has significant market power [Price control is in the hands of the company] ~price is greater than seller's marginal revenue [This makes the monopolist less than efficient from the consumer's point of view] ~may earn long-run economic profits [A monopolist is able to maintain price (P) above marginal cost (MC)] *[Monopolies have great control over the market, which is generally to the detriment of the consumers]
Match the appropriate barrier to entry with the correct scenario.
A company buys up all of the world's copper mines ~control of resources [The firm is trying to become the sole owner of copper mines] A family-owned hardware store tries to break into the market ~problems raising capital [Family-owned businesses have a hard time competing with large, nationwide hardware stores] A large rail shipping company lays down new railroad tracks in an area ~economies of scale [Laying down new railroad tracks is very expensive, but the firm will reduce its average total costs by shipping to more customers] A law student passes the state bar exam ~licensing [A person must qualify for the legal right to practice law by passing the bar exam]
In most cases, markets are considered more efficient and better off when monopolies are broken up. Why is it hard for governments to do this?
Correct Answer(s) ~Monopolies often have laws to protect them [Laws that support monopolies, such as trade barriers, are created through lobbying and are strongly supported by the monopolists themselves] ~Monopolists have a lot of money to fend off antitrust lawsuits [A monopolist would rather change or avoid a law that would split the monopoly apart than comply and lose profits] ~Sometimes keeping a monopoly intact is the best option when it lowers production costs [Economies of scale sometimes necessitate a monopoly] Incorrect Answer(s) ~Competitive firms cause just as many problems for consumers [A competitive market is generally more beneficial for consumers] ~If a monopoly splits up, a new one will form from the resulting competitive firms [A natural monopoly will be unlikely to form, since it will be difficult for one of the new firms to gain control over most of the market] ~Monopolies produce more social welfare than competitive markets, so breaking them up would have large consequences [Monopolies are usually inefficient for consumers and harmful to the economy] *[Monopolists generally prefer to remain in a monopoly position, to keep their profits high]
A small-town monopolist determines that lowering prices will bring in more customers. Following the price drop, however, the firm discovers that even though the number of customers increased as hoped, the firm's total profit is falling. What could have gone wrong?
Correct Answer(s) ~The new price and output level are at a point where MR < MC [The firm has increased output to the right of point Q] ~The loss in revenue due to the price effect exceeds the gain in revenue due to the output effect [If this happens, marginal revenue is negative: each additional unit sold by dropping the price a little further actually means less total revenue than before] Incorrect Answer(s) ~With the increase in customers, MR is now greater than MC [Lowered prices and greater volume tend to reduce MR. Eventually, it drops below MC] ~At lower price levels, demand is very elastic, so the price effect is minimized [It is at higher price levels that demand tends to be more elastic]
According to the graphs of the possible outcomes of a competitive firm and a monopoly in the same market, which of the following is a correct statement?
Correct Answer(s) ~When firms merge into a monopoly, the market price will rise [A monopoly would choose to produce where MR = MC] ~Competitive firms and monopolies attempt to maximize profits [While both seek profits, only monopolies are able to maintain them because of the barriers to entry from competition] Incorrect Answer(s) ~When firms merge into a monopoly, the market output will rise [A monopoly would restrict output and increase the price it charged] ~In a competitive industry, firms do not have a MC function [In a competitive market, the supply represents the summation of MC functions of all the firms in the market] ~Multiple monopolies in this market would reduce the output even more than shown [If you have more than one firm, then it would no longer be considered a monopoly]
What are some problems a monopoly may cause?
Correct Answer(s) ~limited choice [One company means only one consumer option] ~deadweight loss [Consumer prices are higher than in a competitive market, and production is lower] ~political lobbying [Rent seeking leads to stagnation of innovation for companies] ~inefficient output [Price making leads to inefficient output and higher prices] Incorrect Answer(s) ~limited demand [The law of demand still holds in monopoly scenarios] ~increased consumer surplus [When a monopolist operates at their profit-maximizing output, consumer surplus is transferred to the monopolist] *[From a consumer's point of view, monopolies generally cause more problems than they fix]
Monopolists are price makers. Which of the following explains why this does not apply to competitive markets?
Explanation ~Even if one or more firms in a competitive market go out of business, other competitors will appear [Barriers to entry are one of the conditions of a monopoly. If new firms can enter, this is clearly not a monopoly market] ~Other sellers sell products that are similar if not identical [A monopolist sells a product for which no substitutes are available from other sellers] ~A competitive firm's product makes up only a small portion of the market's total product [A monopolist is the only seller in the market; therefore, it has some control over the price it charges] Not an Explanation ~Price controls prevent firms in a competitive market from pricing their products as they think best [Firms in a competitive market have to "take" the price set by the law of supply and demand. The price is usually not set by government price controls]
Based on the given information, which of the following are places where a monopoly is more likely to spring up?
Likely To Have a Monopoly ~a port city where owning a dock requires a government license [Government-enforced licenses help create monopolies, as licensing requirements create barriers to entry and reduce competition] ~a desert town with a single well, and no ability to drill more [The single water source creates a high barrier to entry. Control of essential resources creates an extremely effective barrier to entry] Not Likely To Have a Monopoly ~a large town with a single furniture store [Even though there is only one, the barriers to entry are still low, which allows other furniture stores to enter and compete in this market] ~a city where there is only one drive-thru coffee shop for morning commuters [Coffee has several substitutes, including making it at home. There is likely no reason another coffee shop is restricted from opening in this city either] *[The keys to establishing a monopoly are a unique product and high barriers to entry]
A small town in Wyoming has three doctors but only one veterinarian. Apply the appropriate label to each characteristic of a small-town veterinarian that tends to make him a monopolist.
Medical treatment for animals differs from humans ~unique service without close substitutes [Pets and livestock need a vet. There doctors cannot offer a substitute for this service] He is known and liked by all the locals and has negotiated long-term service contracts with the local ranchers ~barrier to entry [Any newly arrived vet would find it a challenge to win customers away from the vet everyone already knows and the long-term contracts would reduce the number of potential clients, at least for a while] He is the only vet in town ~sole seller ["One seller" is a key characteristic of a monopoly] *[In addition to the characteristics mentioned, the vet is also a price maker]
Which of the following methods would help society deal with a monopoly?
Method ~Regulate the socially efficient price and subsidize any loss to the firm [It is possible, but easier said than done. A regulated price of P = MC is socially efficient, but if the regulators get it wrong, the monopoly could operate inefficiently despite offering a lower price] ~Prevent the firm from buying all possible competitors in the market [Instead of breaking up a monopoly, antitrust laws attempt to prevent several firms from becoming one to start] Not a Method ~Require the firm to lower the costs so the market price will fall [All firms typically have the incentive to maintain low costs in pursuit profits, so this would have little impact on a monopoly] ~Increase tariffs on monopoly firms in other countries [By making competing goods from other countries more expensive, tariffs would likely increase the monopoly power of the firm, reducing the possibility of new substitutes] ~Shut down the firm [With no firm in the market, all consumer surplus and producer surplus would be lost] *[Dealing with the issues that arise from a monopoly does not have a simple solution. Each monopoly market can have unique characteristics. Breaking up a natural monopoly is not an efficient solution, while regulating a price correctly with a changing market demand may be near impossible. The "fix" may make things worse. Attempting to reduce some of the loss to society from a monopoly's existence may have to be acceptable sometimes]
Which of the following are examples of natural barriers to entry?
Natural Barrier to Entry ~Over time, a firm takes control of 85% of the world's supply of a chemical used in the production of plastic [Resource control is a form of natural barrier] ~Smaller companies with smaller production processes have higher per unit costs than larger companies [This is a description of economies of scale at work] ~Lenders are hesitant to provide funding for new firms that will compete with a large, well-established firm [Problems raising capital are one form of natural barrier] Not a Natural Barrier to Entry ~A local government gives a construction company the exclusive right to build all the town's future buildings [Licensing-related barriers are government-created, not natural] ~BioCorp develops a new skin cancer drug for which they receive a patent [Patents are a government-created barrier to entry, not a natural one] *[Natural barriers are barriers that arise through the dynamic involving private firms, without any particular government action]
Perfectly competitive firms and monopolies have different price and output structures, but both types of firms operate using the profit-maximizing rule. Drag the following labels to the appropriate places on the graph to show each firm's profit-maximizing output and price
P2 ~price monopoly [Monopoly firms charge the price that is equal to the demand curve at the profit-maximizing quantity of output] P3 ~price competitive [For perfectly competitive firms, MR is constant at P for each firm and the price is determined by the demand, so the intersection of MC and the demand is where MR = MC] Q2 ~quantity monopoly [Firms produce a quantity where MR = MC] Q3 ~quantity competitive [Firms produce a quantity where MR = MC. The perfectly competitive firm's marginal revenue is equal to the demand curve]
What are the pros and cons of patents and copyrights for society?
Pros ~They serve as a form of property rights, which creates incentives to innovate [When a society has stronger property rights, people have more of a reason to develop new ideas and goods, leading to more variety in the market] ~They generate high profits, giving firms money to invest in research and development of new products [Since patents and copyrights provide the exclusive right to sell a product, they earn a lot of money that they can put into designing new products] ~They expire after a period of time, allowing competitors to develop lower-priced versions in the long run [In the long run, there will be more sellers of the product, and the price will fall] Cons ~They may have unintended consequences, leading to black market behavior [People may find ways to get the product illegally in order to avoid high sale prices] ~They keep sale prices high, which may prevent some consumers from having access to the products [Because patents and copyrights create a high degree of monopoly power, some consumers may not be able to afford the product]
Match each label to the situation it describes.
The total surplus in a market is lower than it could be ~deadweight loss [Some of the loss is on the producer side, and some is on the consumer side. Who ends up worse overall depends on the situation] The government caps the prices a company can charge ~regulation [Governments do this in order to limit monopolies] A monopoly sells products grouped together rather than separately ~bundling [Consumers, in order to buy the product they want, must also buy other products they may be less interested in] A group seeks to restrict the number of government-issued licenses ~rent seeking [A monopolist would seek to have the government restrict entry into its market] *[Limited choice, inefficient output, and rent seeking are all problems caused by monopolies]
Which of the following statements are true regarding tariffs?
True Regarding Tariffs ~Tariffs impose high barriers to entry [Tariffs are an artificial barrier to entry created by governments] ~Tariffs bolster the power of monopolies by reducing competition [With less competition, domestic companies have less incentive to improve their product or lower their prices] Not True Regarding Tariffs ~Tariffs allow for gains from trade with other countries [The opposite is true. Tariffs limit possible gains from international trade] ~Tariffs lessen the influence of domestic companies [Protecting domestic companies is the economic reason for tariffs] *[Tariffs and similar trade barriers are beneficial for monopolists, which is why many of them engage in rent seeking]
If a pharmaceutical company holds a patent to a successful COVID-19 vaccine, which of the following statements would be true of that company?
True Statements ~It is the only seller of the vaccine it produces [Patents provide pharmaceutical companies with an incentive to make large investments into finding successful vaccines. U.S. patents limit government intervention and competition for up to twenty-one years] ~It will produce less than a perfectly competitive firm [A monopolist will produce at a less-than-efficient level compared to a firm in a competitive market] Not True Statements ~It is operating as an illegal monopoly [Monopolies do exist for various reasons and are not always illegal. In fact, some are intentionally created by licensing and patents] ~It holds no market power [Monopolies created by patents are able to command higher prices than a perfectly competitive firm] ~It would be described as a natural monopoly [In order to be a monopoly, a company must have a unique good, and competition must be limited by barriers to entry. Barriers to entry can be one of two types. A patent or copyright is an example of a government-created barrier. On the other hand, when barriers exist or happen within a market, they are referred to as natural barriers. For example, in industries like airlines where there are huge startup costs, the high cost can greatly limit other firms' ability to enter the market. A natural monopoly also happens when there are economies to scale, as this makes it easier for larger companies to drive smaller companies out of the market due to the larger companies' lower unit costs]
A city has several small taxicab companies that compete against one another in the market. Eventually, these small companies agree to merge and take over the market as a monopoly. Which areas on the graphs below represent loss to consumers as a result of the newly formed monopoly?
left graph ~N/A right graph ~top yellow triangle [This is part of lost consumer surplus and also part of total deadweight loss] ~red rectangle b/w PM & PC [This is lost consumer surplus that has become part of producer surplus] *[Monopolies generally produce more profit for the monopolist at the expense of consumers]
Because suppliers in natural monopolies, such as public utilities, enjoy economies of scale, they can work with lower production costs than can a large number of smaller companies. At the same time, monopolists may charge very high prices, and as a result, the government often regulates these firms. Match each regulatory environment to the graph depicting the resulting level of production.
left graph ~prices regulated by the marginal cost pricing rule [The price equals the marginal cost, and that determines the quantity demanded] middle graph ~N/A right graph ~no price regulation [The difference between the price and the average total cost is the profit per unit]
How was each monopoly situation successfully eliminated? Note that all labels may not be used.
market regulation ~Air India [After the airspace over India was opened up to private corporations, new companies entered the market] government breakup ~AT&T [AT&T's monopoly was eliminated in 1982. AT&T now has to compete in the market, which has led to the expansion of services and lower prices] natural market forces ~Microsoft [New technologies have made the operating system market much more competitive] *[Monopolies are not generally desirable, but in cases where economies of scale are an important consideration, the government may choose to regulate them rather than mandate a breakup]
Label the functions of the monopoly firm and the profit-maximizing output and profit on the graph.
orange slope ~MC [The marginal costs will eventually increase with output and intersect the ATC curve] green slope ~ATC [While likely much larger in output, the average cost and output relationship of a typical monopoly tend to resemble that of competitive firms] red slope ~MR [Because of the price and output effect, the MR curve has a steeper slope than the demand function for a monopoly] vertical gray line ~firm's output [The profit-maximizing firm produces where MR = MC] horizontal gray line ~profit-maximizing price [The monopoly firm will charge a price on the demand function that corresponds to the ideal output] *[A monopoly firm maximizes profit just like a competitive firm, but given its singular position in a market, it can charge a price above the marginal cost with no concern for competitors]
Middletown, U.S.A., has been dealing with several monopoly firms, making it difficult for new firms to enter. Match each company to the best description of the particular "barrier to entry" it is benefitting from.
patents and copyright law ~Burt's Brass Band gets a royalty from every download of a song [New music is covered under copyright laws to encourage the creation of ideas, art, and other less physically intangible output] control of resources ~Lucinda's Lake Condos owns all the property around Middletown Lake, the only lake for 200 miles [If you like water, to rent a lake house without a lake is a poor substitute] economies of scale ~Wanda's Water Park adds a new water slide or ride each year to the already large park, and can do it fairly cheaply due to volume discounts from the firm that produces the slides [Each time a new water slide is added, it lowers per unit costs of running the park. A new firm would likely be smaller and have higher costs per unit] problems raising capital ~Marvin's Mining Company runs 100 different pieces of large equipment and trucks in daily operations [This sounds very expensive! To enter, a new firm would have to borrow the resources to compete with Marvin, which is unlikely to happen] licensing ~Larry's Lawn Care has exclusive rights to mow the grass for all city government property in town for the next 5 years [Other lawn care services are restricted from competing for this work because of the government contract] *[If a monopoly exists, there is likely a reason new firms are unable to compete. These barriers to entry are the reasons other firms cannot capture the benefits of entering the market]
Drag the labels to the appropriate positions on the monopoly graph to show the firm's profit-maximizing combination.
top dotted horizontal gray line ~price [The price charged by the firm is equal to the firm's demand curve at the profit-maximizing quantity] middle dotted horizontal gray line ~average total cost [The firm's average total cost is equal to its ATC curve at the profit-maximizing quantity] area near y axis ~economic profit [The firm's economic profit is equal to the (price minus the average total cost) times the quantity of units sold at the profit-maximizing quantity] vertical dotted gray line ~quantity [The profit-maximizing quantity is where the firm's MC = MR]
Calculate the deadweight loss associated with the monopoly situation shown.
~$120 [The net result is a loss in value of ½(140 - 100)($13 - $7) = $120. Consumers lose more than the producer gains. The DWL is part consumer and producer surplus, but the monopoly adds 300 to the producer surplus (13 - 10) × 100, which is more than the loss of 60, (10 - 7) × 40]
The following is a table showing the quantity of customers to the price of a product that a monopolist is selling. Based on this information, at what price does the monopolist first see negative marginal revenue? Q: 0, 100, 200, 300, 400 P: $60, $45, $30, $15, $0
~$15 [Here the total revenue has dropped from $6,000 (at P = $30) to 300 × $15 = $4,500. The additional units hurt the bottom line]
Lisette's laptop needs a unique battery, and a local computer parts company is the only place that sells it. Given the demand function table below, what is the marginal revenue if the parts company chooses to drop the price of the battery from $50 to $40? Quantity (Q) 0, 500, 1000, 1500, 2000, 2500, 3000, 3500, 4000, 4500, 5000 Price (P) 100, 90, 80, 70, 60, 50, 40, 30, 20, 10, 0 Total revenue (TR) 0, 45000, 80000, -, -, -, -, -, 80000, 45000, 0 Marginal revenue (MR) X, 45000, 35000, -, -, -, -, -, -25000, -35000, -45000
~-$5,000 [By dropping the price from $50 to $40, the total revenue decreases by $5,000 ($120,000 - $125,000). The price effect lowers revenue because less revenue is made on each unit. The output effect raises revenue by selling more. Here, the price effect is larger than the output effect and marginal revenue turns negative at $40] *[(TR) 105000, 120000, 125000, 120000, 105000 | (MR) 25000, 15000, 5000, -5000, -15000]
Which of the following is a/are monopolist(s)?
~a large company that has bought out all the competition [Doing this gets rid of any competition that could interfere with a monopoly]
Fill in the blanks to complete the passage about monopolies. Monopolists want to protect their market position by - potential competitors. A common tactic is to lobby for -, such as -. Such lobbying is a form of -: use of political means to secure a - position.
~denying entry to ~trade restrictions ~import tariffs ~rent seeking ~monopoly *[Rent seeking is a monopolist's use of the political system to maintain monopoly rights]
Place in order the steps we can use to calculate a monopolist's profit using a graph.
~determine the marginal revenue curve from the market demand ~find the quantity where the firm maximizes profits by finding where marginal revenue equals marginal cost ~trace the profit-maximizing quantity to the demand curve to determine the price ~calculate the difference between the price and average total cost, and multiply by the profit-maximizing output [Once a firm has found the marginal revenue curve, it can find the intersection between MR and MC to determine the maximizing quantity, and from there can decide how much to charge based on the demand curve]
Perfectly competitive and monopoly firms are complete opposites. The monopoly demand curve is -, while the perfectly competitive firm's demand curve is -. This is because a monopoly is the only producer in an industry, so the monopoly firm's - curve is the same as the market demand curve, while the perfectly competitive firm produces in a market with - competitors.
~downward sloping ~horizontal ~demand ~many *[In perfect competition, one firm competes with a large number of other firms in the market. The firm's demand curve is not the same as the market's demand curve. In a monopoly, the one firm is the sole provider of a good, so the firm is the only one in the market, and the firm demand curve is the same as the market demand curve]
Fill in the blanks to complete the passage. Natural monopolies can develop due to -. In this case, breaking up a monopolist may lead to higher - due to inefficiency. Instead, governments can seek to remove the output inefficiency of a monopoly by capping prices at a level beneficial for - but not for -.
~economies of scale ~prices ~society ~the monopolist *[Natural monopolies can be difficult to break up without creating an inefficient situation for consumers]
A monopoly has complete control over the market price of a product, and therefore always makes a profit.
~false [If people do not have a need for a product, they are less likely to buy it, even if it is the only available product of that type]
The lack of competition in a monopoly leads to a horizontal demand curve, as shown, for the market as a whole.
~false [In a monopoly, the demand curve for a single firm is the same as market demand, because the monopolist is the only firm. The law of demand describes a downward-sloping market demand curve because of the inverse relationship between price and quantity demanded. The market demand is the firm's demand in the monopoly market]
Due to the frequent occurrence of illegal file sharing and pirating, copyright holders in the music and movie business always lose more than they gain from the copyright protections.
~false [Some copyright holders will be harmed by illegal downloading. However, copyright laws allow legal action to be taken against theft and without that, no one has the incentive to pay. This would discourage the production of new material, such as movies and music. Since we continue to have new songs and movies each year, the creators must see a gain from our current copyright laws]
If a cable company is a monopolist in a certain town, then it can restrict the bundles of channels it offers, and therefore force consumers into making limited choices.
~true [If the price is too high, or the choices too limited, consumers may not buy the bundle if it is nonessential. However, their choices are limited to "buy" and "don't buy."]
The graphs show the price effect (pink) and output effect (pale green) when a certain monopolist changes the price that it charges. Based on the price effect and output effect, which two of these price changes would be beneficial to the monopolist?
~graph A [The price effect is -$30,000 and the output effect is +$60,000] ~graph D [The price effect is +$50,000 and the output effect is -$40,000] *[The net gain (or loss) is found by adding the price effect and output effect]
Fill in the blanks to complete the paragraph describing the emergence of monopolies. When old, large companies become monopolists, this - always deliberate. Entry into a market can become difficult due to a lack of funding for - companies. Also, - make it hard for a small, new firm to operate as efficiently as a large, established one.
~is not ~new ~economies of scale *[Another factor contributing to monopolies is the fact that often, when a successful new company is founded, it is bought by a larger, entrenched company]
Fill in the blanks to complete the statement about how some monopolies are formed because they can drive out rivals with lower costs and prices. Large public water and sewer companies often become - monopolies because they benefit from economies of scale. Although the company faces high start-up costs, the firm experiences - average - as it expands and adds more customers. Smaller competitors would experience - average costs and would be less -.
~natural ~falling ~costs ~higher ~efficient *[For a natural monopoly, the average costs decline over a large output so it is more efficient to have one firm in the market. A new firm would find it difficult to compete with an established firm. A competing firm would also reduce the output for the first firm, thereby increasing average cost]
Fill in the blanks to complete the following paragraph about prices and revenue. A monopolist follows the same - rule as a firm in a competitive market: produce until marginal cost equals marginal revenue, but the monopoly firm must decide what price to charge. As prices go -, the monopolist gains more customers. At the same time, this - the revenue from each individual customer, including the existing ones. However, up to a certain point the increased sales volume - the revenue loss from the price decrease.
~profit-maximizing ~down ~lowers ~outweighs *[Monopolists still have to listen to consumer demand and thus have only partial control over what prices they set]
Which of the following statements is correct?
~regulating a monopoly can lower the market price but also leads to cost inefficiencies [Without the correct incentives, cost inefficiencies will develop]
A monopoly has the following pricing and revenue structure. If the firm's marginal cost per customer is $30, and the firm wants to follow the profit-maximizing rule, what would be the firm's quantity of customers and price charged per customer?
~the quantity of customers is 4,000 and the price is $60 [The marginal cost per customer is $30, so the marginal cost per 1,000 customers is $30,000. The profit-maximizing rule says that firms will produce where MR = MC. The MR for 4,000 customers is $30,000, and the price charged to 4,000 customers is $60 each]
Consider the following graph for a monopoly. Regardless of the firm's marginal cost of production, it will never increase its production to serve more than 5,000 customers.
~true [At 5,000 customers, the firm's marginal revenue is zero, which represents the point where the firm's total revenue is maximized. When marginal revenue becomes negative, as it would if the firm were to produce for more than 5,000 customers, the firm's total revenue would fall, and it could not maximize profit]
Place the businesses in order from the least to the greatest amount of market power.
~vegetable stands at a very large local farmer's market ~few restaurants in a small town ~a pharmaceutical company that has been granted a patent for a lifesaving vaccine [Firms that have something unique to sell have a high degree of monopoly power (price-setting ability) because there is little to no competition if customers do not consider the good to have close substitutes]
