CHAPTER15 I\/ONOPOLY 325
o A monopolist often can raise its profits by charg- lower welfare compared to the outcome with a
ing different prices for the same good based on single monopoly price.
a buyer's willingness to pay. This practice of
Policynakers can respond to the inefficiencyof
price discrimination can raise economic welfare
monopoly behavior in four ways. They can use
by getting the good to some consumers who
the antitrust laws to try to make the industry more
otherwise would not buy it. In the extreme case
competitive. They can regulate the prices that the
of perfect price discrimination, the deadweight
monopoly [Link] can tum the monopolist
loss of monopoly is completely eliminated, and
into a government-run enterprise. Or if the market
the entire surplus in the market goes to the
failure is deemed small compared to the inevitable
monopoly producer. More generally, when price
imperfections of policies, ihey can do nothing at all.
discrimination is imperfect, it can either raise or
KEY CONCEPTS
monopoly,p.300 natural monopoly, p, 302 price discrimination, p. 31"4
QUgST|ONSFOR'REVtEW
1, Define natural [Link] does the size of a 5 . Give two examples of price discrimination. In
s.A market have to do with whether an industry is a each case,explain why the monopolist chooses
; not natural monopoly? to follow this businessstrategy.
2. Give an example of a government-created In your diagram from the previous question,
monopoly. Is creating this monopoly necessarily show the level of output that maximizes total
ruly bad public policy? Explain. surplus. Show the deadweight loss from the
Ben 3. Draw the demand, marginal-revenue, average- monopoly. Explain your answer.
ales, total-cost, and marginal-cost curves for a 7, Describe the two problems that arise when
:h to monopolist. Show the profit-maximizing level regulators tell a natural monopoly that it must
of output, the profit-maximizing price, and the set a price equal to marginal cost.
irms amount of profit. 8 . What gives the government the power to regulate
rally 4. Why is a monopolist's marginal revenue less mergersbetween firms? From the standpoint of
lrate than the price of its good? Can marginal the welfare of society,give a good reasonand a
revenue ever be negative? Explain. bad reasonthat two firms might want to merge.
P R O B L EM 5 A N D A P F L I C A T I O N S
:IAXI-
'hich 1. A small town is servedby many competing Price Quantity Demanded
The supermarkets,which have the same constant $1 0 0 0 novels
that marginal cost. 90 100,000
firm, a. Using a diagram of the market for groceries, BO 200,000
ginal show the consumer surplus, producer 70 300,000
surplus, and total surplus. 60 400,000
b. Now supposethat the independent super- 50 500,000
:ut is markets combine into one chain. Using a new 40 600,000
ulner diagram, show the new consumer surplus, 30 700,000
rpoly producer surplus, and total surplus. Relative 70 800,000
suln- 10 900,000
to the competitive market, what is the transfer
'pro- 0 1,000,000
from consumersto producers?What is the
}USES deadweightloss? The author is paid $2 million to write the book,
AXCS. 2. A publisher facesthe following demand schedule and the marginal cost of publishing the book
for the next novel from one of its popular authors: is a constant$10per book.
326 PARTV FIRMBEHAVIOR
ANDTHEORGANIZATION
OFINDUSTRY
a. Compute total revenue, total cost, and profit department determines that the demand for the
at each quantity. What quantity would a CD is as follows:
profit-maximizing publisher choose? What
Price Number
of CDs
price would it charge? 6.
b. Compute marginal revenue. (Recall that $24 10,000
MR : ATR/AQ.) How does marginal 22 20,000
revenue compare to the price? Explain. 20 30,000
c. Graph the marginal-revenue, marginal-cost,
18 40,000
16 50,000
and demand curves. At what quantity do the
14 60,000
marginal-revenue and marginal-cost curves
cross? What does this signify? The company can produce the CD with no fixed
d. In your graplt, shade in the deadweight loss. cost and a variable cost of $5 per CD.
Explain in words what this means. a. Find total revenue for quantity equal to 7.
e. If the author were paid $3 million instead of 10,000,20,000,and so on. What is the
$2 million to write the book, how would this marginal revenuefor each 10,000increasein
affect the publisher's decision regarding what the quantity sold?
price to charge? Explain. b. What quantity of CDs would maximize profit?
f. Suppose the publisher was not profit- What would the price be?What would the
maximizing but was concerned with maxi- profit be?
mizing economic efficiency. What price c. If you were ]ohnny's agent, what recording
would it charge for the book? How much fee would you advise Johnny to demand
profit would it make at this price? from the record company? Why?
3. A company is considering building a bridge 5. The residents of the town Ectenia all love
across a river. The bridge would cost $2 million economics,and the mayor proposes building an
to build and nothing to maintain. The following economicsmuseum, The museum has a fixed
table shows the company's anticipated demand cost of $2,400,000 and no variable [Link] 8.
over the lifetime of the bridge: are 100,000town residents,and eachhas the
samedemand for museum visits: QD : 10 - p,
Numberof Crossings,
Priceper Crossing
where P is ihe price of admission.
in Thousands
a. Craph the museum's average-total-costcurve
580 and its marginal-costcurve. What kind of
7 '100
market would describethe museum?
6 200 b. The mayor proposes financing the museum
5 300
with a lump-sum tax of $24 and then opening
4 400
3 500 the museum free to the public. How many
2 600 times would eachperson visit? Calculate
1 700 the benefit each peison would get from the
0 800 museum/measuredas consumersurplus
minus the new tax.
a. If the company were to build the bridge,
c. The mayor's anti-tax opponent saysthe
what would be its profit-maximizing price?
museum should financeitself by charging
Would that be the efficient level of output?
an admissionfee. What is the lowest price
Why or why not?
the museum can chargewithout incurring
b. If the company is interestedin maximizing
Iosses?(Hint: Find the number of visits and
profit, should it build the bridge? \A/hat
museum profits for prices of $2, fi3, $4,
would be its profit or loss?
and $5.) 9.
c. If the government were to build the bridge,
d. For the break-evenprice you found in part
what price should it charge?
(c), calculateeachresident'sconsumersurplus
d. Should the governmentbuild the bridge?
Comparedwith the mayor's plan, who is
Explain.
better off with this admission fee, and who is
4. Johnny Rockabillyhas just finished recording
worseoff? Explain.
his latestCD. His record company'smarketing
CHAPTER15 MONOPOLY 327
he e. What real-world considerationsabsentin the Adults Children
above problem might argue in favor of an $10 0 0
admission fee? o '100 0
Larry, Curly, and Moe run the only saloon in 8 200 0
town. Larry wants to sell as many drinks as 7 300 0
possible without losing money. Curly wants the 6 300 0
saloon to bring in as much revenue as possible. 5 300 100
Moe wants to make the largest possible profits.
A
300 200
Using a single diagram of the saloon's demand 3 300 200
2 300 200
curve and its cost curves, show the price and
1 300 200
:ed quantity combinations favored by each of the 200
0 300
three [Link].
Consider the relationship between monopoly a. To maximize profit, what price would you
pricing and price elasticity of demand: charge for an adult ticket? For a child's
a. Explain why a monopolist will never produce ticket? How much profit do you make?
a quantity at which the demand curve is b. The city council passesa law prohibiting you
ht? inelastic. (Hint: If demand is inelastic and the from charging different prices to different
firm raisesits price, what happens to total [Link] price do you set for a ticket
revenue and total costs?) now? How much profit do you make?
b. Draw a diagram for a monopolist, precisely c. Who is worse off becauseof the law prohib-
labeling the portion of the demand curve that iting price discrimination? Who is better off?
is inelastic. (Hint The answer is related to the (If you can, quantify the changesin welfare.)
marginal-revenue curve.) d. If the fixed cost of the play were $2,500rather
c. On your diagram, show the quantity and than $2,000,how would your answers to
price that maximizes total revenue. parts (a), (b), and (c) change?
For many years, AT&T was a regulated 10. If the govemmentwanted to encouragea monopoly
monopoly, providing both local and long-distance to produce the socially efficierrtquantifi should
telephone service. it use a per-unit tax or a per-unit subsidy?Explain
a. Explain why long-distance phone service how this tax or subsidy would achievethe socially
was originally a natural monopoly. efficient level of output. Among the various inter-
b. Over the past two decades,many companies estedparties-the monopoly firm, the monopoly's
have launched communication satellites,each consurners,and other taxpayers-who would
iI of which can transmit a limited number of support the policy and who would opposeit?
ing calls. How did the growing role of satellites 1 1 . Many schemesfor price discriminating involve
change the cost structure of long-distance some cost. For example, discount coupons
phone service? take up the time and resourcesof both the
buyer and the seller. This question considers
After a lengthy legal battle with the govemment,
the implications of costly price discrimination.
AT&T agreed to compete with other companies
To keep things simple, let's assumethat our
in the long-distance market. It also agreed to
monopolist's production costsare simply pro-
spin off its local phone service into the "Baby
portional to output so that average total cost
Bells," which remain highly regulated.
and marginal cost are constant and equal to
c. \A/hy might it be efficient to have competition each other.
in long-distance phone service and regulated a. Draw the cost, demand, and marginal-
monopolies in local phone service? revenue curves for the monopolist. Show the
You live in a town with 300 adults and 200 price the monopolist would charge without
children, and you are thinking about putting price discrimination.
lus. on a play to entertain your neighbors and make b. In your diagram, mark the area equal to the
some money. A play has a fixed cost of $2,000, monopolist's profit and call it X. Mark the
)is but selling an extra ticket has zero marginal area equal to consumer surplus and call it Y.
cost. Here are the demand schedulesfor your Mark the area equal to the deadweight loss
two types of customer: and call it Z.
328 PARTV FIRMBEHAVIOR
AND THEORGANIZATION
OF INDUSTRY
c. Now suppose that the monopolist can c. In our analysis of international trade in
perfectly price discriminate. What is the Chapter 9, a country becomesan exporter
monopolist's profit? (Give your answer in when the price without trade is below the
terms of X,Y, andZ.) world price and an importer when the price
d. \Alhatis the changein the monopolist's profit without trade is above the world price. Does
from price discrimination? \A/hatis the change that conclusion hold in your answers to parts
in total surplus from price discrimination? (a) and (b)? Explain.
Which changeis larger? Explain. (Give your d. Supposethat the world price was not $6 but,
answerin terms of X,Y, andZ.) instead, happened to be exactly the same
e. Now suppose that there is some cost of as the domestic price without trade as
price discrimination. To model this cost, let's determined in part (a). Would allowing trade
assurnethat the monopolist has to pay a fixed have changed anything in the Wiknamian
cost C to price discriminate. How would a economy?Explain. How does the result here
monopolist make the decision whether to pay compare with the analysis in Chapter 9?
this fixed cost?(Give your answer in terms of 13. Basedon market research,a film production
X,Y,Z, and C.) company in Ectenia obtains the following
f. How would a benevolent social planner, who information about the demand and production
caresabout total surplus, decide whether the costsof its new DVD:
monopolist should price discriminate? (Give
Demand:P:1,000-108
your answer in terms of X,Y, Z, and C.)
Total Revenue:TR : 1,000Q- 10Q,
g. Compare you-remswersto parts (e) and (0. How Marginal Revenue:MR : 1,000- 20Q
does the monopolist's incentive to price dis- Marginal Cost:MC : 100 + 10Q
criminate differ from the social planner's? Is it
possiblethat the monopolist will price discrimi- where Q indicates the number of copies sold
nate even though it is not socially desirable? and P is the price in Ectenian dollars.
12. Only one firm produces and sells soccerballs in a. Find the price and quantity that maximizes
the country of Wiknam, and as the story begins, the company's profit.
international trade in soccerballs is prohibited. b. Find the price and quantity that would
The following equations describe the monopolist's maximize social welfare.
demand, marginal revenue/ total cost, and c. Calculatethe deadweight loss from monopoly.
marginal cost: d. Suppose,in addition to the costsabove, the
director of the film has to be paid. The
Demand:P:10-Q
Marginal Revenue:MR : 10- 2Q company is considering four options:
Total Cost:TC : 3 + Q + 0.5Q, i. A flat fee of 2.000Ectenian dollars
MarginalCost:MC:1+8 ii. 50 percent of the profits
iii. 150 Ectenian dollars per unit sold
where Q is quantify and P is the price measured iv. 50 percent of the revenue
in Wiknamian dollars. For each option, calculate the profit-
a. How many soccerballs does the monopolist maximizing price and quantity. Which, if any,
produce? At what price are they sold? What of thesecompensationschemeswould alter
is the monopolist's profit? the deadweight loss from monopoly? Explain.
b. One day, the King of Wiknam decreesthat
henceforth there will be free trade---either For further information on topics in this chapter,
imports or exports- of soccerballs at the additional problems, applications, examples, online
world price of $6. The firm is now a price quizzes,and more, please visit our website at www
taker in a competitive market. IAtrhathappens .[Link]/ international.
to domestic production of soccerballs? To
domestic consumption? Does Wiknam export
or import soccerballs?