Econ 200
What are 3 conditions that characterize a perfectly competitive market?
1. Many buyers and sellers 2. Identical products 3. Free entry and exit of firms in the long run (both buyers and sellers are "price-takers", they have no market power)
What are some of the problems associated with regulating the price charged by a natural monopoly?
As previously mentioned, deciding the price a natural monopoly should charge is difficult because the natural monopoly is unable to charge the socially efficient price at P=MC because for a natural monopoly, MC<ATC. In order to allow firms to charge this price, they must subsidize the firm, which creates a deadweight loss for the government. If a natural monopoly is charged P=ATC, where economic profit is zero, there no incentive to reduce costs because as costs decrease, as does price.
What is a barrier to entry?
A barrier to entry is something that promotes a monopoly in its ability to prevent other firms to be able to enter a market.
What constitutes a firm's long-run supply curve? Explain
A competitive firm's long-run supply curve is the section of the Marginal Cost curve which is above the Long Run Average Total Cost curve. It is along the Marginal Cost curve for the same reason as in the short term, as P= MR = MC (when profit-maximizing in a perfectly competitive market)
Is it necessarily inefficient for airlines to charge different prices to different cus-tomers? Why or why not?
Because it is not Perfect Price Discrimination, it is unsure if it is inefficient. It depends on what the Deadweight Loss of the single price monopoly is compared with that of the price discrimination. If there is a smaller deadweight loss after discrimination, it is efficient.
What is efficient scale?
Efficient scale is a firm's level of production that has the lowest Average Total Cost
Airlines often charge different customers based on their willingness to pay. List some of the ways airlines divide their customers according to their willingness to pay.
One way airlines divide customers is to charge lower prices for those willing to stay overnight on a Saturday, an option business flyers will not choose. This allows airlines to divide customers on their willingness to pay.
If Wal-Mart had the same number of customers during its daytime hours as you observed during its nighttime hours, do you think it would continue to operate? Explain.
Wal-Mart would probably not continue to operate, as its revenue would not be high enough to cover its Average Total Cost.
Is perfect price discrimination efficient? Explain. Who receives the surplus?
Yes. Perfect price discrimination allows for each customer to be charged the price they are each willing to pay, so there are no losses from trade. This way, though the monopolist receives all surplus, it is not wasted.
Suppose the price for a firm's output is above the average variable cost of production but below the average total cost of production. Will the firm shut down in the short run? Explain. Will the firm exit the market in the long run? Explain.
The firm will not shut down in the short run. This is because in the short-run Fixed Costs are not considered in deciding to shutdown, as they are a sunk cost. So, as long as the firm produces above the Average Variable Cost of production, it doesn't matter that they are producing under the Average Total Cost because in the short-run it merely represents the addition of the Fixed Cost. In the long-run, because there are no Fixed Costs or Variable Costs, we take both into consideration when determining its value against revenue. Thus, the firm will exit if it is producing below Average Total Cost.
What are the four ways that policymakers can respond to the problem of monopoly?
The four ways policymakers can respond are: 1)Anti-trust Laws Laws which ban some anti-competitive practices, such as mergers between companies, which would give the new combined company a disproportionate share of the market power. 2) Regulations The government may attempt to regulate the price at which a monopoly can produce, such as P=MC or P=ATC, however this rarely works as firms will not produce at P=MC because they will be at a loss, and at P=ATC, there will be no incentive to cut costs.
Under what conditions would the long-run market supply curve be upward sloping?
The long-run market supply curve is upward sloping in 2 cases: 1) Costs for each firm differ If each firms have a different cost to enter, lower cost firms will enter first. As Price rises, more firms who have higher costs will enter, increasing market supply. 2) If costs rise as firms enter Entry of new firms increases the price of a limited input. Because of this, an increase in the quantity demanded for a product increases a producer's costs, in turn driving up price. The result is a long-run market supply curve that is upward sloping.
If a natural monopoly is forced through regulation to charge a price equal to its marginal cost, will the outcome be efficient? Why or why not?
The outcome will be inefficient because the firm will exit the market. Because Price is greater than Marginal Revenue for a monopoly, and Marginal Revenue is equal to Marginal Cost when profit maximizing, (Represented by the inequality P>MR=MC) And because ATC is constantly declining for a natural monopoly, MC will be less than ATC, and when a firm produces less than ATC, a firm will exit the market in the long-run.
What are the three sources of barriers to entry that allow a monopoly to remain the sole seller in a market?
3 sources of barriers to entry are: 1) Monopoly of resources: A key resource required for production is owned by a single firm, for which there is no close substitute. This is rare, but DeBeers diamond company owns as much as 80 percent of all diamond mines, so it exerts substantial influence over the market price of diamonds. 2) Government regulation: The government gives a single firm the exclusive right to produce some good or service Example: Copyrights and patents are granted for 20 years to drug companies and authors to protect their original ideas. This occurs to encourage creative activity. 3)Natural monopoly: A single firm is able to produce a good or service to an entire market at a lower cost than could two or more firms. It occurs when Average Total Cost is continually declining. Example: A bridge that is never congested has a natural monopoly because there is large fixed cost to build the bridge, but negligible marginal cost of additional users. So, Average Total Cost falls in the long run, creating a natural monopoly.
What constitutes a competitive firm's short-run supply curve? Explain.
A competitive firm's short-run supply curve is the section of the Marginal Cost curve which is above the Average Variable Cost curve. Because profit is maximized at Marginal Revenue = Marginal Cost, and because Price = Marginal Revenue for a perfectly competitive firm, Price is therefore also equal to Marginal Cost when profits are maximized, and its movement along the MC determines the Quantity supplied.
What is the necessary condition for a monopolist to be able to price discriminate?
A monopolist can only price discriminate if it possesses market power. Otherwise, such as in a competitive market, there is no incentive to change prices as both buyers and sellers are price-takers.
Why does a monopolist produce less than the socially efficient quantity of output?
A monopolist seeks to maximize profit, so it will produce a quantity where MR=MC. The socially efficient quantity occurs at the intersection of the demand curve (price) and MC. Because in monopoly MR is less than Price (MR<P), the intersection of MR and MC must be less than that of the intersection with demand (Price)
What is a monopoly?
A monopoly is a firm that is the sole seller of a product without close substitutes. As a result, it has market power and is able to decide price for a given product.
What is a sunk cost?
A sunk cost is a cost which has already been committed, and which cannot be recovered. Its cost should not be considered in decision making, as nothing can be done about its expenditure. An example of this in our analysis of economics is when determining whether or not a firm will shutdown in the short-run: Because Fixed Costs (such as rent) will be incurred regardless of the production, they are not included in the determination of a shutdown, only that of Variable Costs, as they will change with production.
You walk into a Wal-Mart stor at 2:00 a.m. with a friend to buy some VCR tapes. Your friend says, "I can't believe that these stores stay open all night. Only one out of fifteen checkout lines is open. There can't be more than ten shoppers in this store. It just doesn't makes sense for this store to be open all night." Explain to your friend what conditions must be true for it to be the advantage of Wal-Mart to stay open all night?
If Wal-Mart is able to stay open all night, it must be true that the revenue it receives is more that its Average Variable Costs. Otherwise, it would not be open those hours.
Why is the short-run market supply curve upward sloping while the standard long-run market supply curve perfectly elastic?
In the short-run, market supply curves upwards because it represents the sum of quantities supplied by each of the individual firms active in the market (a specific number because there is no entry or exit in the short-run). In the long-run, market supply is perfectly elastic because firms are allowed to enter and exit the market freely. Over time, profit generated or lost from an increase or decrease in demand will incentivize firms to enter or exit the market. An increase in firms drives down price to the minimum of Average Total Cost where profits are again zero. A decrease in firms cuts losses for those which remain, raising price back to the minimum of Average Total Cost as well.
Why must the long-run equilibrium in a competitive market (with free entry and exit) have all firms operating at their efficient scale?
Long-run equilibrium must have all firms in a competitive market operating at their efficient scale (lowest ATC) so that Marginal Cost can intersect the minimum of the Average Total Cost curve, equaling Price. It is at this point that profit = 0.
Is the increase in profits generated by this type of price discrimination a social cost? Explain.
No, Increasing profits from price discrimination represents an increase in producer surplus, which increases total surplus.
Does a monopolist charge the highest possible price for its output? Why or why not? How does a monopolist choose the price it will charge for its product?
No, a monopolists Price is dependent on the market demand curve, as a monopoly is the only firm in a market, and it represents the price that buyers are willing to pay. Because the market demand curve is constantly declining, so does price. The price is then determined by finding the profit-maximizing quantity where MR=MC, and then finding the price buyers are willing to pay for that quantity (demand curve)
Are the costs of rent, equipment, fixtures, salaries of management, and so on relevant when Wal-Mart makes the decision whether to stay open all night? Why or why not?
No, rent, equipment, fixtures, and salary pay are Fixed Costs, which are not included in their decision because they will be paid regardless of whether or not they are open during that time. They are considered sunk costs.
Should antitrust laws be utilized to stop all mergers? Why or why not?
No, there are certain synergistic benefits to merging which aim not to reduce competition but to reduce costs through more efficient joint production. The government must decide if the synergistic benefits outweigh the costs of reducing competition.
Are the monopolist's profits part of the social cost of monopoly? Explain.
No. As long as all benefits from trade are gained, profits accumulated (measured in consumer surplus or producer surplus) do not change total surplus.
If a firm is producing a level of output where marginal revenue exceeds marginal cost, would it improve profits by increasing output, decreasing output, or keeping output unchanged? Why?
This firm should decrease its output to improve profit. This is because the revenue gained from adding one unit is greater than its costs, and total profit= revenue - cost, so profit increases. This occurs until MR = MC, until profit =0.
You go to your campus bookstore and see a coffee mug emblazoned with your uni- versity's shield. It costs $5 and you value it at $8, so you buy it. On the way to your car, you drop it and it breaks into pieces. Should you buy another one or should you go home because the total expenditure now exceeds the $8 value that you place on it? Why?
This is an example of a sunk cost. The benefit of the mug ($8) still exceeds the opportunity cost ($5 for the second mug). The cost of the broken mug is not considered.
If a firm is in a competitive market, what happens to its total revenue if it doubles its output? Why?
Total revenue is proportional to output, so if a firm doubles its total revenue, its output doubles as well.
