BB 107(spring) Tutorial 10 PDF

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BB 107

Tutorial 10

Part A: MCQ 1. In moving down the elastic segment of the monopolist's demand curve, total revenue is: A. Increasing, and marginal revenue is negative. B. Decreasing, and marginal revenue is positive. C. Decreasing, and marginal revenue is negative. D. Increasing, and marginal revenue is positive. Answer: D 2. Suppose that a monopolist calculates that at present output and sales levels, marginal revenue is $1.00 and marginal cost is $2.00. He or she could maximize profits or minimize losses by: A. Decreasing price and increasing output. B. Increasing price and decreasing output. C. Decreasing price and leaving output unchanged. D. Decreasing output and leaving price unchanged. Answer: B 3. Which of the following is not a barrier to entry? A. Patents. B. X-inefficiency. C. Economies of scale. D. Ownership of essential resources. Answer: B 4. Many people believe that monopolies charge any price they want to without affecting sales. Instead, the output level for a profit-maximizing monopoly is determined by: A. Marginal cost = demand. B. Marginal revenue = demand. C. Average total cost = demand. D. Marginal cost = marginal revenue. Answer: D 5. Allocative inefficiency due to unregulated monopoly is characterized by the condition: A. P = MC. B. P = MR. C. P > MC. D. P > AVC. Answer: C

2 6. If a monopolist produces 100 units of output at a market price of $5 per unit with marginal revenue per unit equaling $4, we would expect that if the monopolist's good was provided under pure competition, quantity would be: A. Higher than 100 units, price lower than $5, and MR = price. B. Lower than 100 units, price greater than $5, and MR = price. C. Higher than 100 units, price greater than $5, and MR = price. D. Lower than 100 units, price lower than $5, and MR = price. Answer: A 7. X-inefficiency is said to occur when a firm's: A. Average costs of producing any output are greater than the minimum possible average costs. B. Marginal costs of producing any output are greater than the minimum possible total costs. C. Total costs of producing any output are greater than the minimum possible average costs. D. Short-run costs of producing any output are greater than the long-run costs. Answer: A 8. Other things equal, a price discriminating monopolist will: A. Realize a smaller economic profit than a nondiscriminating monopolist. B. Produce a larger output than a nondiscriminating monopolist. C. Produce the same output as a nondiscriminating monopolist. D. Produce a smaller output than a nondiscriminating monopolist. Answer: B 9. Price discrimination refers to: A. Selling a given product for different prices at two different points in time. B. Any price above that which is equal to a minimum average total cost. C. The selling of a given product at different prices that do not reflect cost differences. D. The difference between the prices a purely competitive seller and a purely monopolistic seller would charge. Answer: C

Part B: Short Answer 1. “No firm is completely sheltered from rivals; all firms compete for consumer dollars. If that is so, then pure monopoly does not exist.” Do you agree? Explain. How might you use Chapter 4’s concept of cross elasticity of demand to judge whether monopoly exists? Answer: Though it is true that “all firms compete for the dollars of consumers,” it is playing on words to hold that pure monopoly does not exist. If you wish to send a

3 first-class letter, it is the postal service or nothing. Of course, if the postal service raises its rate to $10 to get a letter across town in two days, you will use a courier, or the phone, or you will fax it. But within sensible limits, say a doubling of the postal rate, there is no alternative to the postal service at anything like it at a comparable price. The same case can be made concerning the pure monopoly enjoyed by the local electricity company in any town. If you want electric lights, you have to deal with a single company. It is a pure monopoly in that regard, even though you can switch to oil or natural gas for heating. Of course, you can use oil, natural gas, or kerosene for lighting too—but these are hardly convenient options. The concept of cross elasticity of demand can be used to measure the presence of close substitutes for the product of a monopoly firm. If the cross elasticity of demand is greater than one, then the demand that the monopoly faces is elastic with respect to substitute products, and the firm has less control over its product price than if the cross elasticity of demand were inelastic. In other words, the monopoly faces competition from producers of substitute products.

2. Given the table below, Total Revenue (TR)

Marginal Revenue (MR)

Total Cost

Price (P)

Quantity Demanded (Q)

$7.00

0

6

6.50

1

8

6.00

2

11

5.50

3

14

5.00

4

17

4.50

5

19

4.00

6

23

3.50

7

24

3.00

8

25

2.50

9

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(a) fill up the empty columns. (b) What output would the monopolist firm produce?

Answer: To calculate Total Revenue multiply price (P) by Quantity Demanded (Q): TR = P x Q.

4 To calculate Marginal Revenue find the change in total revenue for each unit demanded: MR = Δ TR = TR (i+1) - TR(i). See table below. Price (P)

Quantity Demanded (Q)

Total Revenue (TR)

Marginal Revenue (MR)

Total Cost

$7.00

0

$0

NA

6

6.50

1

6.50

$6.50

8

6.00

2

12.00

5.50

11

5.50

3

16.50

4.50

14

5.00

4

20.00

3.50

17

4.50

5

22.50

2.50

19

4.00

6

24.00

1.50

23

3.50

7

24.50

0.50

24

3.00

8

24.00

-0.50

25

2.50

9

22.50

-1.50

27

3. Explain verbally and graphically how price (rate) regulation may improve the performance of monopolies. In your answer distinguish between (a) socially optimal (marginal ‐cost) pricing and (b) fair‐return (average‐total‐cost) pricing. What is the “dilemma of regulation”?

Answer: Monopolies that are natural monopolies are normally subject to regulation. Because of extensive economies of scale, marginal cost is less than average total cost throughout the range of output. An unregulated monopolist would produce at Q m when MC = MR and enjoy an economic profit. Society would be better off with a larger quantity. Output level Q r would be socially optimal because MC = Price and allocative efficiency would be achieved. However, the firm would lose money producing at Qr since ATC exceeds the price. In order for the firm to survive, public subsidies out of tax revenue would be necessary. Another option for regulators is to allow a fair-return price that would allow the firm to break even economically (cover all costs including a normal profit). Setting price equal to ATC would deliver Q f output and only partially solve the underallocation of resources. Despite this dilemma regulation can improve on the results of monopoly from the social point of view. Price regulation (even at the fair-return price) can simultaneously reduce price, increase output, and reduce the economic profits of monopolies.

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4. It has been proposed that natural monopolists should be allowed to determine their profit‐maximizing outputs and prices and then government should tax their profits away and distribute them to consumers in proportion to their purchases from the monopoly. Is this proposal as socially desirable as requiring monopolists to equate price with marginal cost or average total cost? LO5

Answer: No, the proposal does not consider that the output of the natural monopolist would still be at the suboptimal level where P > MC. Too little would be produced and there would be an underallocation of resources. Theoretically, it would be more desirable to force the natural monopolist to charge a price equal to marginal cost and subsidize any losses. Even setting price equal to ATC would be an improvement over this proposal. This fair-return pricing would allow for a normal profit and ensure greater production than the proposal would....