ECON 101: Principles of Microeconomics Discussion Section Week 12 TA: Kanit Kuevibulvanich

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1 Important Concepts: Monopoly ECON 101: Principles of Microeconomics Discussion Section Week 12 Comparison of Perfectly Competitive Market and Monopoly Market Perfect Competition Monopoly Number of Participants Many sellers, many buyers One seller, many buyers Product Differentiated product with no close Homogeneous product Characteristics substitutes Entry-Exit Free entry and exit into market Natural or created barriers to entry Technology Same technology; perfect information Possibly exclusive technology or limited of consumers and producers flow of information to consumers Profit Max. Rule Demand Curve for a Firm Pricing Power of a Firm Problems 1. A monopoly faces a market demand curve given by P = 42 Q. Its marginal cost curve is given by MC = Q. a. What is the equation for the marginal revenue? Show this on a graph. b. Find the profit-maximizing level of production for this monopolist. c. What price will the monopolist charge? d. What price and quantity would be socially optimal? e. What is this monopolist s total revenue? f. Graph the producer surplus, the consumer surplus, and the deadweight loss for the market with the monopolist. 2. True or False: A monopolist can always make a positive profit. 3. True or False: A firm in perfectly competitive market will always earn zero economic profit. 4. Suppose a monopolistic local utility company faces a demand curve given by P = 120 4Q. Total cost for this firm is given by TC = Q, and MC is fixed at $4 per unit. a. Does the technology of a firm represent economies of scale? b. What is the fixed cost? Does this indicate high barriers to entry? c. What is the socially optimal level of production and price? d. Suppose this industry operates as a monopoly. Find the equilibrium price and quantity. e. The government, bowing to public pressure to regulate monopolies, decides to force firms to charge their marginal cost just like they would in perfect competition. How much will the monopolist produce? What is the profit for this monopolist? f. Suppose the government instead chooses to force the monopolist to charge a price equal to their average total cost, this monopolist will supply 25 units. What will be their profits? 1

2 Practice Questions for Midterm 2 1) Demand-supply and International Trade Montrovia is a small, closed economy that produces tires. The domestic demand and domestic supply of tires in Montrovia is given by the following equations where P is the price per unit and Q is the quantity of tires: Domestic Demand: P = 500 (5/1000)Q Domestic Supply: P = (1/600)Q You are also told that the world price for tires is $150 per tire. Suppose Montrovia opens its tire market to international trade while simultaneously the government of Montrovia implements a tariff that raises the price per tire to $180. Holding everything else constant, the amount of tariff revenue the government earns from this tariff will equal? a. $480,000 b. $16,000 c. $2,880,000 d. $1,800,000 2) Elasticity Which of the following statements is false? a. If Andrew s income elasticity of demand for good X is equal to zero, Andrew s demand for good X would not be affected if he suddenly loses his job. b. For Mary, honey is a substitute for sugar. Then, her cross-price elasticity of demand for honey and sugar must be positive. c. The Internet has made it easier for people to search for a large number of products on websites like ebay and Amazon. This should result in a higher price elasticity of demand for many goods. d. For John, apples are an inferior good. Then, his income elasticity of demand for apples must be positive. 3) Elasticity and Taxation The market for telephones is in equilibrium when the government decides to levy an excise tax of $5 per telephone on consumers. If at the initial equilibrium point consumer demand is inelastic and producer supply is unit elastic, which of the following could describe the tax incidence? a. Consumers pay 100% of the tax incidence. b. Consumers pay 20% and producers pay 80% of the tax incidence. c. Consumers pay 80% and producers pay 20% of the tax incidence. d. Consumers pay 0% of the tax incidence. 4) Real and Nominal Each year on her birthday, Amber buys herself one piece of cheesecake. Suppose Amber notices that this year she has to pay less in the store for her cheesecake than she had to last year. Furthermore, she heard on the news that this year the overall price level in the country has gone up as compared to last year. What can you conclude about the real price of cheesecake? a. The real price of cheesecake is higher this year than it was last year. b. The real price of cheesecake is lower this year than it was last year. c. The real price of cheesecake is the same this year as it was last year. d. There is not enough information to answer this question. 2

3 5) Consumer Theory (with crossover to Elasticity) Use the following diagram to answer the next question. Y Direction of higher utility IC 1 IC 2 IC 3 IC 4 What can you conclude about goods X and Y from the above diagram? a. The cross-price elasticity of demand for goods X and Y is equal to positive infinity. b. The income-elasticity of demand for good Y is positive. c. The cross-price elasticity of demand for goods X and Y is equal to zero. d. The cross-price elasticity of demand for goods X and Y is equal to negative infinity. 6) Consumer Theory Use the following graph to answer the next question. X If a consumer consumes at point A, his marginal rate of substitution is than the price ratio. Hence the consumer can get a higher utility by the consumption of Good B and by the consumption of good A. a. Larger; decreasing; increasing b. Larger; increasing; decreasing c. Smaller; decreasing; increasing d. Smaller; increasing; decreasing 3

4 7) Production and Cost Suppose the marginal cost curve is increasing. If at a quantity q* the marginal cost curve is above the average total cost curve, we can conclude that: a. q* is larger than the quantity at which the average total cost curve achieves its minimum. b. q* is smaller than the quantity at which the average total cost curve achieves its minimum. c. At q* the average total cost curve has a negative slope. d. At q* the marginal cost curve has a negative slope. 8) Production and Cost Suppose that when a firm triples all of its inputs, it doubles the amount of output it produces. Then this firm a. Is experiencing increasing returns to scale. b. Is experiencing decreasing returns to scale. c. Is experiencing constant returns to scale. d. Is experiencing diminishing marginal returns. 9) Perfectly Competitive Market Pizza and beer are complementary goods for consumers in a local market. The beer industry, which has constant marginal cost, is perfectly competitive and is now in long run equilibrium. If the market price of pizza permanently decreases, which of the following statements is correct about the beer market in the short run? a. The market price of beer falls and each firm produces less beer. b. The market price of beer does not change, but the quantity increases because new firms enter the beer industry. c. The market price of beer does not change, but the quantity decreases because some firms exit the industry. d. The market price of beer rises and each firm produces more beer. 10) Monopoly P A P 1 B C C 1 D E F! MC = ATC O Q 1 Q 2 MR From the information in the above figure we can say that: a. Monopoly revenues are given by the area BCQ 1O. b. The deadweight loss in this market is given by the area CEF. c. The total profit for this monopolist is given by the area BCED. d. All of the above. Q 4

5 Solutions: Question 1 a. Double the slope of the demand curve to get the MR: MR=42-2Q. Graph should show a line twice as steep as the original demand curve, but with the same intercept. b. Set MR = MC to get 42 2Q = Q Q=14. c. Plug the Q from part b. into the demand curve: P = = $28. d. Socially optimal price where MC = P 42 Q = Q Q = 21, P = = $21. e. TR = P x Q = 28 x 14 = 392 f. P MC P* CS PS DWL MR D 0 Q Q* Question 2 Question 3 False. Monopolist can make profit or loss. False. Firms in perfectly competitive market can make profit or loss. Question 4 a. Since ATC = TC/Q = 400/Q + 4, this exhibits economies of scale. ATC decreases in Q over the range of Q s for which there is demand. b. FC = $400. Yes, there are high barriers to entry. c. Social optimum where P = MC 4 = 120 4Q Q = 29, P = $4 d. MR = 120 8Q 120 8Q = 4 Q = 14.5 P = 120 4(14.5) = $62 e. The monopolist will produce at the social optimum quantity of 29 units. TC = (29) = $516, TR = (4)(29) = $116, Profit = -$400 Government subsidy will be required to keep this firm in business. f. Since P = ATC. The firm will earn zero profit. Practice Midterm 2 Questions 1) a. 2) d. 3) c. 4) b. 5) c. 6) c. 7) a. 8) b. 9) d. 10) d. 5