曼昆经济学曼昆《经济学原理》习题答案ch15

288 ( Chapter 15/Monopoly Chapter 15/Monopoly ( 289 Chapter 15 Monopoly WHAT’S NEW IN THE THIRD EDITION: A new summary table comparing perfect competition and monopoly has been added. There is also a new In the News box on "Why People Pay More than Dogs.” LEARNING OBJECTIVES: By the end of this chapter, students should understand: · why some markets have only one seller. · how a monopoly determines the quantity to produce and the price to charge. · how the monopoly’s decisions affect economic well-being. · the various public policies aimed at solving the problem of monopoly. · why monopolies try to charge different prices to different customers. CONTEXT AND PURPOSE: Chapter 15 is the third chapter in a five-chapter sequence dealing with firm behavior and the organization of industry. Chapter 13 developed the cost curves on which firm behavior is based. These cost curves were employed in Chapter 14 to show how a competitive firm responds to changes in market conditions. In Chapter 15, these cost curves are again employed, this time to show how a monopolistic firm chooses the quantity to produce and the price to charge. Chapters 16 and 17 will address the decisions made by oligopolistic and monopolistically competitive firms. A monopolist is the sole seller of a product without close substitutes. As such, it has market power because it can influence the price of its output. That is, a monopolist is a price maker as opposed to a price taker. The purpose of Chapter 15 is to examine the production and pricing decisions of monopolists, the social implications of their market power, and the ways in which governments might respond to the problems caused by monopolists. KEY POINTS: 1. A monopoly is a firm that is the sole seller in its market. A monopoly arises when a single firm owns a key resource, when the government gives a firm the exclusive right to produce a good, or when a single firm can supply the entire market at a smaller cost than many firms could. 2. Because a monopoly is the sole producer in its market, it faces a downward-sloping demand curve for its product. When a monopoly increases production by one unit, it causes the price of its good to fall, which reduces the amount of revenue earned on all units produced. As a result, a monopoly’s marginal revenue is always below the price of its good. 3. Like a competitive firm, a monopoly firm maximizes profit by producing the quantity at which marginal revenue equals marginal cost. The monopoly then chooses the price at which that quantity is demanded. Unlike a competitive firm, a monopoly firm’s price exceeds its marginal revenue, so its price exceeds marginal cost. 4. A monopolist’s profit-maximizing level of output is below the level that maximizes the sum of consumer and producer surplus. That is, when the monopoly charges a price above marginal cost, some consumers who value the good more than its cost of production do not buy it. As a result, monopoly causes deadweight losses similar to the deadweight losses caused by taxes. 5. Policymakers can respond to the inefficiency of monopoly behavior in four ways. They can use the antitrust laws to try to make the industry more competitive. They can regulate the prices that the monopoly charges. They can turn the monopolist into a government-run enterprise. Or, if the market failure is deemed small compared to the inevitable imperfections of policies, they can do nothing at all. 6. Monopolists often can raise their profits by charging different prices for the same good based on the buyer’s willingness to pay. This practice of price discrimination can raise economic welfare by getting the good to some consumers who otherwise would not buy it. In the extreme case of perfect price discrimination, the deadweight losses of monopoly are completely eliminated. More generally, when price discrimination is imperfect, it can either raise or lower welfare compared to the outcome with a single monopoly price. CHAPTER OUTLINE: I. A competitive firm is a price taker; a monopoly firm is a price maker. II. Why Monopolies Arise A. Definition of monopoly: a firm that is the sole seller of a product without close substitutes. B. The fundamental cause of monopoly is barriers to entry. 1. Monopoly Resources a. A monopoly could have sole ownership or control of a key resource that is used in the production of the good. b. Case Study: The DeBeers Diamond Monopoly—this firm controls about 80 percent of the diamonds in the world. 2. Government-Created Monopolies a. Monopolies can arise because the government grants one person or one firm the exclusive right to sell some good or service. b. Patents are issued by the government to give firms the exclusive right to produce a product for 20 years. 3. Natural Monopolies a. Definition of natural monopoly: a monopoly that arises because a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms. b. A natural monopoly occurs when there are economies of scale, implying that average total cost falls as the firm's scale becomes larger. III. How Monopolies Make Production and Pricing Decisions A. Monopoly Versus Competition 1. The key difference between a competitive firm and a monopoly is the monopoly's ability to control price. 2. The demand curves that each of these types of firms faces is different as well. a. A competitive firm faces a perfectly elastic demand at the market price. The firm can sell all that it wants to at this price. b. A monopoly faces the market demand curve because it is the only seller in the market. If a monopoly wants to sell more output, it must lower the price of its product. B. A Monopoly's Revenue 1. Example: sole producer of water. Quantity Price Total Revenue Average Revenue Marginal Revenue 0 $ 11 $ 0 ---- ---- 1 10 10 $ 10 $ 10 2 9 18 9 8 3 8 24 8 6 4 7 28 7 4 5 6 30 6 2 6 5 30 5 0 7 4 28 4 -2 8 3 24 3 -4 2. A monopoly's marginal revenue will always be less than the price of the good (other than at the first unit sold). a. If the monopolist sells one more unit, his total revenue (P  Q) will rise because Q is getting larger. This is called the output effect. b. If the monopolist sells one more unit, he must lower price. This means that his total revenue (P  Q) will fall because P is getting smaller. This is called the price effect. c. Note that, for a competitive firm, there is no price effect. 3. When graphing the firm's demand and marginal revenue curve, they always start at the same point (because P = MR for the first unit sold); for every other level of output, marginal revenue lies below the demand curve (because MR < P). C. Profit Maximization 1. The monopolist's profit-maximizing quantity of output occurs where marginal revenue is equal to marginal cost. a. If the firm's marginal revenue is greater than marginal cost, profit can be increased by raising the level of output. b. If the firm's marginal revenue is less than marginal cost, profit can be increased by lowering the level of output. 2. Even though MR = MC is the profit-maximizing rule for both competitive firms and monopolies, there is one important difference. a. In competitive firms, P = MR; at the profit-maximizing level of output, P = MC. b. In a monopoly, P > MR; at the profit-maximizing level of output, P > MC. 3. The monopolist's price is determined by the demand curve (which shows us the willingness to pay of consumers). D. FYI: Why a Monopoly Does Not Have a Supply Curve 1. A supply curve tells us the quantity that a firm chooses to supply at any given price. 2. But a monopoly firm is a price maker; the firm sets the price at the same time it chooses the quantity to supply. 3. It is the market demand curve that tells us how much the monopolist will supply because the shape of the demand curve determines the shape of the marginal revenue curve (which in turn determines the profit-maximizing level of output). E. A Monopoly's Profit 1. Again, we can find profit using the following: Profit = TR – TC. 2. Because TR = P  Q and TC = ATC  Q, we can rewrite this equation: Profit = (P – ATC)  Q. F. Case Study: Monopoly Drugs Versus Generic Drugs 1. The market for pharmaceutical drugs takes on both monopoly characteristics and competitive characteristics. 2. When a firm discovers a new drug, patent laws give the firm a monopoly on the sale of that drug. However, the patent eventually expires and any firm can make the drug, which causes the market to become competitive. 3. Analysis of the pharmaceutical industry has shown us that prices of drugs fall after patents expire and new firms begin production of that drug. IV. The Welfare Cost of Monopoly A. The Deadweight Loss 1. The socially efficient quantity of output is found where the demand curve and the marginal cost curve intersect. This is where total surplus is maximized. 2. Because the monopolist sets marginal revenue equal to marginal cost to determine its output level, it will produce less than the socially efficient quantity of output. 3. The price that a monopolist charges is also above marginal cost. Although some potential customers value the good at more than its marginal cost but less than the monopolist’s price, they do not purchase the good even though from a societal standpoint that is inefficient. 4. The deadweight loss can be seen on the graph as the area between the demand and marginal cost curves for the units between the monopoly quantity and the efficient quantity. B. The Monopoly's Profit: A Social Cost? 1. Welfare in a market includes the welfare of both consumers and producers. 2. The transfer of surplus from consumers to producers is therefore not a social loss. 3. The deadweight loss from monopoly stems from the fact that monopolies produce less than the socially efficient level of output. 4. If the monopoly incurs costs to maintain (or create) its monopoly power, those costs would also be included in deadweight loss. V. Public Policies toward Monopolies A. Increasing Competition with Antitrust Laws 1. Antitrust laws are a collection of statutes that give the government the authority to control markets and promote competition. a. The Sherman Antitrust Act was passed in 1890 to lower the market power of the large and powerful "trusts” that were viewed as dominating the economy at that time. b. The Clayton Act was passed in 1914; it strengthened the government's ability to curb monopoly power and authorized private lawsuits. 2. Antitrust laws allow the government to prevent mergers and break up large, dominating companies. 3. Antitrust laws also impose costs on society. Some mergers may provide synergies, which occur when the costs of operations fall because of joint operations. B. Regulation 1. Regulation is often used when the government is dealing with a natural monopoly. 2. Most often, regulation involves government limits on the price of the product. 3. While we might believe that the government can eliminate the deadweight loss from monopoly by setting the monopolist's price equal to its marginal cost, this is often difficult to do. a. If the firm is a natural monopoly, its average total cost curve will be declining because of its economies of scale. b. When average total cost is falling, marginal cost must be lower than average total cost. c. Therefore, if the government sets price equal to marginal cost, the price will be below average total cost and the firm will earn a loss, causing the firm to eventually leave the market. 4. Therefore, governments may choose to set the price of the monopolist's product equal to its average total cost. This gives the monopoly zero profit, but assures that it will remain in the market. a. Note that there is still a deadweight loss in this situation because the level of output will be lower than the socially efficient level of output. b. Average-cost pricing also provides no incentive for the monopolist to reduce costs. C. Public Ownership 1. Rather than regulating a monopoly run by a private firm, the government can run the monopoly itself. 2. However, economists generally prefer private ownership of natural monopolies than public ownership. a. Private owners have an incentive to keep costs down to earn higher profits. b. If government bureaucrats do a bad job running a monopoly, the political system is the taxpayers only recourse. D. Do Nothing 1. Sometimes the costs of government regulation outweigh the benefits. 2. Therefore, some economists believe that it is best for the government to leave monopolies alone. E. In the News: Public Transport and Private Enterprise 1. In New York, thousands of illegal drivers of buses and taxi cabs provide transportation services that are often cheaper and preferred to the government-provided (or licensed) services. 2. This is an article from The New York Times Magazine describing this situation. VI. Price Discrimination A. Definition of price discrimination: the business practice of selling the same good at different prices to different customers. B. A Parable about Pricing 1. Example: Readalot Publishing Company 2. The firm pays an author $2 million for the right to publish a book. (Assume that the cost of printing the book is zero.) 3. The firm knows that there are two types of readers. a. There are 100,000 die-hard fans of the author willing to pay up to $30 for the book. b. There are 400,000 other readers who will be willing to pay up to $5 for the book. 4. So how should the firm set its price? a. If the firm sets its price equal to $30, it will sell 100,000 copies of the book, receive total revenue of $3 million, and earn $1 million in profit. b. If the firm sets its price equal to $5, it will sell 500,000 copies, receive total revenue of $2.5 million, and earn only $500,000 in profit. c. It will choose to set its price at $30 and sell 100,000 books. Note that there is a deadweight loss from this decision because there are 400,000 other customers willing to pay $5, more than the marginal cost of producing the book ($0). 5. However, if there was a way to guarantee that the readers willing to pay $30 could not buy a copy of the book from those willing to pay $5 (if they lived far away from one another), the company could make even more profit by selling 100,000 copies to the die-hard fans at $30 each, and then selling 400,000 copies to the other readers for $5 each. a. The total revenue from selling 100,000 copies at $30 each is $3 million. b. The total revenue from selling 400,000 copies at $5 each is $2 million. c. Since the firm's costs are $2 million, profit will be $3 million. C. The Moral of the Story 1. By charging different prices to different customers, a monopoly firm can increase its profit. 2. To price discriminate, a firm must be able to separate customers by their willingness to pay. 3. Arbitrage (the process of buying a good in one market at a low price and then selling it in another market at a higher price) will limit a monopolist's ability to price discriminate. 4. Price discrimination can increase economic welfare. Producer surplus rises (because price exceeds marginal cost for all of the units sold) while consumer surplus is unchanged (because price is equal to the consumers’ willingness to pay). D. The Analytics of Price Discrimination 1. Perfect price discrimination describes a situation where a monopolist knows exactly the willingness to pay of each customer and can charge each customer a different price. 2. Without price discrimination, a firm produces an output level that is lower than the socially efficient level. 3. If a firm perfectly price discriminates, each customer who values the good at more than its marginal cost will purchase the good and be charged his or her willingness to pay. a. There is no deadweight loss in this situation. b. Because consumers pay a price exactly equal to their willingness to pay, all surplus in this market will be producer surplus. E. Examples of Price Discrimination 1. Movie Tickets 2. Airline Prices 3. Discount Coupons 4. Financial Aid 5. Quantity Discounts F. In the News: Why People Pay More than Dogs 1. Drugs sold for humans generally sell at a higher price than those sold for animals. Drugs in rich countries tend to cost more than drugs in poor countries. 2. This is an article written by economist Hal Varian explaining the concept of price discrimination and describing why it may be beneficial to society in some cases. VII. The Prevalence of Monopoly A. Monopoly firms behave very differently from competitive firms. B. Table 2 summarizes the key similarities and differences between monopoly and competitive markets. SOLUTIONS TO TEXT PROBLEMS: Quick Quizzes 1. A market might have a monopoly because: (1) a key resource is owned by a single firm; (2) the government gives a single firm the exclusive right to produce some good; and (3) the costs of production make a single producer more efficient than a large number of producers. Examples of monopolies include: (1) the water producer in a small town, which owns a key resource, the one well in town; (2) pharmaceutical companies who are given a patent on a new drug by the government; and (3) a bridge, which is a natural monopoly because (if the bridge is uncongested) having just one bridge is efficient. Many other examples are possible. 2. A monopolist chooses the amount of output to produce by finding the quantity at which marginal revenue equals marginal cost. It finds the price to charge by finding the point on the demand curve at that quantity. 3. A monopolist produces a quantity of output that’s less than the quantity of output that maximizes total surplus because it produces the quantity at which marginal cost equals marginal revenue rather than the quantity at which marginal cost equals price. 4. Policymakers can respond to the inefficiencies caused by monopolies in one of four ways: (1) by trying to make monopolized industries more competitive; (2) by regulating the behavior of the monopolies; (3) by turning some private monopolies into public enterprises; and (4) by doing nothing at all. Antitrust laws prohibit mergers of large companies and prevent them from coordinating their activities in ways that make markets less competitive, but such laws may keep companies from merging to gain from synergies. Some monopolies, especially natural monopolies, are regulated by the government, but it is hard to keep a monopoly in business, achieve marginal-cost pricing, and give the monopolist incentive to reduce costs. Private monopolies can be taken over by the government, but the companies are not likely to be well run. Sometimes doing nothing at all may seem to be the best solution, but there are clearly deadweight losses from monopoly that society will have to bear. 5. Examples of price discrimination include: (1) movie tickets, for which children and senior citizens get lower prices; (2) airline prices, which are different for business and leisure travelers; (3) discount coupons, which lead to different prices for people who value their time in different ways; (4) financial aid, which offers college tuition at lower prices to poor students and higher prices to wealthy students; and (5) quantity discounts, which offer lower prices for higher quantities, capturing more of a buyer’s willingness to pay. Many other examples are possible. Perfect price discrimination reduces consumer surplus, increases producer surplus by the same amount, and has no effect on total surplus, compared to a competitive market. Compared to a monopoly that charges a single price, perfect price discrimination reduces consumer surplus, increases producer surplus, and increases total surplus, since there is no deadweight loss. Questions for Review 1. An example of a government-created monopoly comes from the existence of patent and copyright laws. Both allow firms or individuals to be monopolies for extended periods of time—20 years for patents, forever for copyrights. But this monopoly power is good, because without it, no one would write a book (because anyone could print copies of it, so the author would get no income) and no firm would invest in research and development to invent new products or drugs (since any other company could produce or sell them, and the firm would get no profit from its investment). 2. 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. As a market grows it may evolve from a natural monopoly to a competitive market. 3. A monopolist's marginal revenue is less than the price of its product because: (1) its demand curve is the market demand curve, so (2) to increase the amount sold, the monopolist must lower the price of its good for every unit it sells. (3) This cut in prices reduces revenue on the units it was already selling. A monopolist's marginal revenue can be negative because to get purchasers to buy an additional unit of the good, the firm must reduce its price on all units of the good. The fact that it sells a greater quantity increases revenue, but the decline in price decreases revenue. The overall effect depends on the elasticity of the demand curve. If the demand curve is inelastic, marginal revenue will be negative. 4. Figure 1 shows the demand, marginal-revenue, and marginal-cost curves for a monopolist. The intersection of the marginal-revenue and marginal-cost curves determines the profit-maximizing level of output, Qm. The demand curve then shows the profit-maximizing price, Pm. Figure 1 5. The level of output that maximizes total surplus in Figure 1 is where the demand curve intersects the marginal-cost curve, Qc. The deadweight loss from monopoly is the triangular area between Qc and Qm that is above the marginal-cost curve and below the demand curve. It represents deadweight loss, since society loses total surplus because of monopoly, equal to the value of the good (measured by the height of the demand curve) less the cost of production (given by the height of the marginal-cost curve), for the quantities between Qm and Qc. 6. The government has the power to regulate mergers between firms because of antitrust laws. Firms might want to merge to increase operating efficiency and reduce costs, something that is good for society, or to gain monopoly power, which is bad for society. 7. When regulators tell a natural monopoly that it must set price equal to marginal cost, two problems arise. The first is that, because a natural monopoly has a constant marginal cost that is less than average cost, setting price equal to marginal cost means that the price is less than average cost, so the firm will lose money. The firm would then exit the industry unless the government subsidized it. However, getting revenue for such a subsidy would cause the government to raise other taxes, increasing the deadweight loss. The second problem of using costs to set price is that it gives the monopoly no incentive to reduce costs. 8. One example of price discrimination is in publishing books. Publishers charge a much higher price for hardback books than for paperback books—far higher than the difference in production costs. Publishers do this because die-hard fans will pay more for a hardback book when the book is first released. Those who don't value the book as highly will wait for the paperback version to come out. The publisher makes greater profit this way than if it charged just one price. A second example is the pricing of movie tickets. Theaters give discounts to children and senior citizens because they have a lower willingness to pay for a ticket. Charging different prices helps the theater increase its profit above what it would be if it charged just one price. Problems and Applications 1. The following table shows revenue, costs, and profits, where quantities are in thousands, and total revenue, total cost, and profit are in millions of dollars: Price Quantity (1,000s) Total Revenue Marginal Revenue Total Cost Profit $ 100 0 $ 0 ---- $ 2 $ -2 90 100 9 $ 9 3 6 80 200 16 7 4 12 70 300 21 5 5 16 60 400 24 3 6 18 50 500 25 1 7 18 40 600 24 -1 8 16 30 700 21 -3 9 12 20 800 16 -5 10 6 10 900 9 -7 11 -2 0 1,000 0 -9 12 -12 a. A profit-maximizing publisher would choose a quantity of 400,000 at a price of $60 or a quantity of 500,000 at a price of $50; both combinations would lead to profits of $18 million. b. Marginal revenue is always less than price. Price falls when quantity rises because the demand curve slopes downward, but marginal revenue falls even more than price because the firm loses revenue on all the units of the good sold when it lowers the price. c. Figure 2 shows the marginal-revenue, marginal-cost, and demand curves. The marginal-revenue and marginal-cost curves cross between quantities of 400,000 and 500,000. This signifies that the firm maximizes profits in that region. Figure 2 d. The area of deadweight loss is marked “DWL” in the figure. Deadweight loss means that the total surplus in the economy is less than it would be if the market were competitive, since the monopolist produces less than the socially efficient level of output. e. If the author were paid $3 million instead of $2 million, the publisher wouldn’t change the price, since there would be no change in marginal cost or marginal revenue. The only thing that would be affected would be the firm’s profit, which would fall. f. To maximize economic efficiency, the publisher would set the price at $10 per book, since that’s the marginal cost of the book. At that price, the publisher would have negative profits equal to the amount paid to the author. Figure 3 2. Figure 3 illustrates a natural monopolist setting price, PATC, equal to average total cost. The equilibrium quantity is QATC. Marginal cost pricing would yield the price PMC and quantity QMC. For quantities between QATC and QMC, the benefit to consumers (measured by the demand curve) exceeds the cost of production (measured by the marginal cost curve). This means that the deadweight loss from setting price equal to average total cost is the triangular area shown in the figure. 3. Mail delivery has an always-declining average-total-cost curve, since there are large fixed costs for equipment. The marginal cost of delivering a letter is very small. However, the costs are higher in isolated rural areas than they are in densely populated urban areas, since transportation costs differ. Over time, increased automation has reduced marginal cost and increased fixed costs, so the average-total-cost curve has become steeper at small quantities and flatter at high quantities. 4. If the price of tap water rises, the demand for bottled water increases. This is shown in Figure 4 as a shift to the right in the demand curve from D1 to D2. The corresponding marginal-revenue curves are MR1 and MR2. The profit-maximizing level of output is where marginal cost equals marginal revenue. Prior to the increase in the price of tap water, the profit-maximizing level of output is Q1; after the price increase, it rises to Q2. The profit-maximizing price is shown on the demand curve: it is P1 before the price of tap water rises, and it rises to P2 after. Average cost is AC1 before the price of tap water rises and AC2 after. Profit increases from (P1 - AC1) x Q1 to (P2 - AC2) x Q2. Figure 4 5. a. Figure 5 illustrates the market for groceries when there are many competing supermarkets with constant marginal cost. Output is QC, price is PC, consumer surplus is area A, producer surplus is zero, and total surplus is area A. Figure 5 b. If the supermarkets merge, Figure 6 illustrates the new situation. Quantity declines from QC to QM and price rises to PM. Area A in Figure 5 is equal to area B + C + D + E + F in Figure 6. Consumer surplus is now area B + C, producer surplus is area D + E, and total surplus is area B + C + D + E. Consumers transfer the amount of area D + E to producers and the deadweight loss is area F. Figure 6 6. a. The following table shows total revenue and marginal revenue for each price and quantity sold: Price Quantity Total Revenue Marginal Revenue Total Cost Profit 24 10,000 $ 240,000 ---- $ 50,000 $ 190,000 22 20,000 440,000 $ 20 100,000 340,000 20 30,000 600,000 16 150,000 450,000 18 40,000 720,000 12 200,000 520,000 16 50,000 800,000 8 250,000 550,000 14 60,000 840,000 4 300,000 540,000 b. Profits are maximized at a price of $16 and quantity of 50,000. At that point, profit is $550,000. c. As Johnny's agent, you should recommend that he demand $550,000 from them, so he instead of the record company receives all of the profit. 7. IBM's monopoly power will be constrained to the extent that people can substitute other computers for mainframes. So the government might have looked at the demand curve facing IBM, or the divergence between IBM's price and marginal cost, to get some idea of how severe the monopoly problem was. 8. a. The table below shows total revenue and marginal revenue for the bridge. The profit-maximizing price would be where revenue is maximized, which will occur where marginal revenue equals zero, since marginal cost equals zero. This occurs at a price of $4 and quantity of 400. The efficient level of output is 800, since that's where price equals marginal cost equals zero. The profit-maximizing quantity is lower than the efficient quantity because the firm is a monopolist. Price Quantity Total Revenue Marginal Revenue $ 8 0 $ 0 ---- 7 100 700 $ 7 6 200 1,200 5 5 300 1,500 3 4 400 1,600 1 3 500 1,500 -1 2 600 1,200 -3 1 700 700 -5 0 800 0 -7 b. The company should not build the bridge because its profits are negative. The most revenue it can earn is $1,600,000 and the cost is $2,000,000, so it would lose $400,000. Figure 7 c. If the government were to build the bridge, it should set price equal to marginal cost to be efficient. But marginal cost is zero, so the government should not charge people to use the bridge. d. Yes, the government should build the bridge, because it would increase society's total surplus. As shown in Figure 7, total surplus has area 1/2 x 8 x 800,000 = $3,200,000, which exceeds the cost of building the bridge. 9. a. Figure 8 illustrates the drug company's situation. They will produce quantity Q1 at price P1. Profits are equal to (P1 - AC1) x Q1. Figure 8 b. The tax on the drug increases both marginal cost and average cost by the amount of the tax. As a result, as shown in Figure 9, quantity is reduced to Q2, price rises to P2, and average cost plus tax rises to AC2. Figure 9 c. The tax definitely reduces profits. After all, the firm could have produced quantity Q2 at price P2 before the tax was imposed, but it chose not to because this level did not maximize profit before the tax occurred. d. A tax of $10,000 regardless of how many bottles of the drug are produced would result in the quantity produced at Q1 and the price at P1 in Figure 8 because such a tax does not affect marginal cost or marginal revenue. It does, however, raise average cost; in fact, profits decline by exactly $10,000. 10. Larry wants to sell as many drinks as possible without losing money, so he wants to set quantity where price (demand) equals average cost, which occurs at quantity QL and price PL in Figure 10. Curly wants to bring in as much revenue as possible, which occurs where marginal revenue equals zero, at quantity QC and price PC. Moe wants to maximize profits, which occurs where marginal cost equals marginal revenue, at quantity QM and price PM. Figure 10 11. a. Long-distance phone service was originally a natural monopoly because installation of phone lines across the country meant that one firm's costs were much lower than if two or more firms did the same thing. b. With communications satellites, the cost is no different if one firm supplies them or if many firms do so. So the industry evolved from a natural monopoly to a competitive market. c. It is efficient to have competition in long-distance phone service and regulated monopolies in local phone service because local phone service remains a natural monopoly (being based on land lines) while long-distance service is a competitive market (being based on satellites). 12. a. The patent gives the company a monopoly, as shown in Figure 11. At a quantity of QM and price of PM, consumer surplus is area A + B, producer surplus is area C + D, and total surplus is area A + B + C + D. Figure 11 b. If the firm can perfectly price discriminate, it will produce quantity QC and extract all the consumer surplus. Consumer surplus is zero and producer surplus is A + B + C + D + E, as is total surplus. Deadweight loss is reduced from area E to zero. There is a transfer of surplus from consumers to producers of area A + B. 13. A monopolist always produces a quantity at which the demand curve is elastic. If the firm produced a quantity for which the demand curve were inelastic, then if the firm raised its price, quantity would fall by a smaller percentage than the rise in price, so revenue would increase. Since costs would decrease at a lower quantity, the firm would have higher revenue and lower costs, so profit would be higher. Thus the firm should keep raising its price until profits are maximized, which must happen on an elastic portion of the demand curve. Another way to see this is to note that on an inelastic portion of the demand curve, marginal revenue is negative. Increasing quantity requires a greater percentage reduction in price, so revenue declines. Since a firm maximizes profit where marginal cost equals marginal revenue, and marginal cost is never negative, the profit-maximizing quantity can never occur where marginal revenue is negative, so can never be on an inelastic portion of the demand curve. 14. Though Britney Spears has a monopoly on her own singing, there are many other singers in the market. If Spears were to raise her price too much, people would substitute to other singers. So there is no need for the government to regulate the price of her concerts. 15. Because the marginal cost of the music was virtually zero, Napster enhanced economic efficiency because those individuals who valued the music more than zero but less than the selling price were able to consume it. However, in the long run, musicians and record companies would have no incentive to release new music because everyone could own a copy of it without paying for it. The courts eventually shut Napster down because they believed that this access violated copyright laws. 16. a. Figure 12 shows the cost, demand, and marginal-revenue curves for the monopolist. Without price discrimination, the monopolist would charge price PM and produce quantity QM. Figure 15-12 b. The monopolist's profit consists of the two areas labeled X, consumer surplus is the two areas labeled Y, and the deadweight loss is the area labeled Z. c. If the monopolist can perfectly price discriminate, it produces quantity QC, and has profit equal to X + Y + Z. d. The monopolist's profit increases from X to X + Y + Z, an increase in the amount Y + Z. The change in total surplus is area Z. The rise in monopolist's profit is greater than the change in total surplus, since monopolist's profit increases both by the amount of deadweight loss (Z) and by the transfer from consumers to the monopolist (Y). e. A monopolist would pay the fixed cost that allows it to discriminate as long as Y + Z (the increase in profits) exceeds C (the fixed cost). f. A benevolent social planner who cared about maximizing total surplus would want the monopolist to price discriminate only if Z (the deadweight loss from monopoly) exceeded C (the fixed cost) since total surplus rises by Z - C. g. The monopolist has a greater incentive to price discriminate (it will do so if Y + Z > C) than the social planner would allow (she would allow it only if Z > C). Thus if Z < C but Y + Z > C, the monopolist will price discriminate even though it is not in society's best interest. 150 MONOPOLY Figure 1 Figure 2 Table 1 ALTERNATIVE CLASSROOM EXAMPLE: The Whatsa Widget Company has a monopoly in the sale of widgets. The demand the firm faces can be shown by the following schedule: Quantity� Price� Total Revenue� Marginal Revenue� � 0� $ 15� $ 0� ----� � 1� 14� 14� $ 14� � 2� 13� 26� 12� � 3� 12� 36� 10� � 4� 11� 44� 8� � 5� 10� 50� 6� � Students often have trouble with this. Go through the table making sure that they understand the calculation of both total revenue and marginal revenue as output increases. Emphasize that the monopolist is setting one price and sticking to it rather than having the ability to set the price and lower it little by little as he wishes to sell more. � EMBED MS_ClipArt_Gallery ��� Figure 3 At this point, you may want to discuss the price elasticity of demand again. Remind students that demand tends to be elastic along the upper left-hand portion of the demand curve. Thus, a decrease in price causes total revenue to increase (so that marginal revenue is greater than zero). Further down the demand curve, the demand is inelastic. In this region, a decrease in price results in a drop in total revenue (implying that marginal revenue is now less than zero). � EMBED MS_ClipArt_Gallery ��� ALTERNATIVE CLASSROOM EXAMPLE: The costs for the Whatsa Widget Company can be represented by the following schedule: Quantity� Total Cost� Marginal Cost� � 0� $ 8� ----� � 1� 11� $ 3� � 2� 16� 5� � 3� 26� 10� � 4� 39� 13� � 5� 57� 18� � Using the earlier information regarding the demand for widgets, have the students find the profit-maximizing level of output (where marginal revenue is equal to marginal cost). Use the information on total revenue and total cost to calculate the level of maximum profit. Figure 4 After having seen profit-maximization for a perfectly competitive firm, students generally do not have difficulty understanding that a monopolist will maximize profit where marginal revenue equals marginal cost. However, students do have trouble remembering to use the demand curve to find the monopolist’s price. Thus, be careful to review this point several times. � EMBED MS_ClipArt_Gallery ��� Figure 5 Figure 6 Figure 7 Remind students that total surplus is the area between the demand curve and the marginal cost curve. It should be clear that surplus is not realized for quantities of output between the monopoly output and the socially efficient output. � EMBED MS_ClipArt_Gallery ��� Figure 8 � EMBED MS_ClipArt_Gallery ��� Point out to students that this is similar to the analysis of taxes in Chapter 8. Here, the monopolist places a wedge between price and marginal cost and the quantity sold ends up being short of the optimum level. � Local phone and electric companies are good examples of regulated monopoly firms. � EMBED MS_ClipArt_Gallery ��� Figure 9 Activity 1 — Price Discrimination and Time Travel Type: In-class demonstration Topics: Price discrimination, consumer surplus Materials needed: None Time: 10 minutes Class limitations: Works in any size class Purpose This example illustrates how a price discriminating monopolist can earn even higher profits than a monopolist charging a single price. The example uses an imaginary time machine to look at monopoly profits and consumer surplus. The cases of competition, monopoly, and price discriminating monopoly are examined. Instructions Use student names in the demand for time travel shown below. Steve wants to travel back in time to see the dinosaurs; he is willing to pay as much as $200 to use the time machine Joyce wants to relive this entire semester; she is willing to pay up to $150 to use the time machine. Chip can’t wait for the semester to end; he is willing to pay as much as $125 to use the time machine Dawn just wants to get through this class period; she is willing to pay up to $100 to use the time machine. The demand curve for time travel is: Price Quantity $200 1 150 2 125 3 100 4 For simplicity, let the marginal cost of time travel be constant at $100. If Time Travel was a competitive industry, price would equal marginal cost ($100) and 4 trips would be sold. Assume that Time Travel is a patented product, giving the firm complete monopoly control. The monopolist will equate marginal cost and marginal revenue to find the profit maximizing quantity. For a single price monopolist the total revenue is simply price ( quantity. Price Quantity Total Revenue Marginal Revenue $200 1 200 200 150 2 300 100 125 3 375 75 100 4 400 25 The single price monopolist will operate where MC = MR. Marginal cost is constant at 100, so the monopolist will sell 2 trips at a price of $150. Profits = 300 – 200 = 100. Now examine the case of price discrimination. The price discriminating monopolist will charge each consumer his or her maximum willingness to pay. Total revenue becomes the sum of the various prices charged to the different consumers. In this case, Steve pays $200; Joyce pays $150; Chip pays 125; Dawn pays $100. Price Quantity Total Revenue Marginal Revenue $200 1 200 200 200,150 2 350 150 200,150,125 3 475 125 200,150,125,100 4 575 100 The price discriminating monopolist will also operate where MC = MR. Marginal cost is still constant at 100, but now the marginal revenue is the full amount of price paid by the additional consumer. The price discriminating monopolist will sell 4 trips. Each consumer will pay a different price. Profits are even higher than the ordinary monopoly profits. Profit = 575 – 400 = $175. Points for Discussion The price discriminating monopolist produces more than the ordinary monopolist and earns higher profit. This monopolist was able to perfectly price discriminate, eliminating all consumer surplus. Price discrimination depends on three factors: monopoly power, the identification of consumers’ willingness-to-pay, and the ability to prevent resale. If Dawn could buy a trip from the firm for $100 and resell it to Steve for $200, the price discrimination would break down. Figure 10 Table 2 287