10: Market Power and Monopoly

Question 1

why does a monopolist never choose to produce where demand is price inelastic?

Answer 1

increasing price is a tradeoff
- less quantity demanded but higher price per sale

when demand is inelastic, gain from higher price outweighs the loss from less quantity demanded so increasing price increases revenue

producing less is costly too so profit is higher as a result of raising the price

Question 2

marginal revenue and one price

Answer 2

selling more units means lowering the price for all units - moving down the demand curve

MR is less than the price of the next unit since it includes the revenue-lowering effect of reducing price from where it would have been to sell a smaller quantity

Question 3

PED and MR

Answer 3

MR < 0 when PED < 1
- downward drag on prices effect on revenue outweighs extra sales on revenue

MR = 0 when PED = 1

MR > 0 when PED > 1

Question 4

two-part tariff

Answer 4

lump sum payment:
- shaded area over and above the per-unit price
- whole of what would be consumer surplus is charged as lump sum

per-unit price:
- p=MC
- pricing at MC leads the consumer to purchase as much as their willingness and ability to pay exceeds the MC of providing those units
- makes the surplus value from the per-unit price deal as large as possible so producer can charge up to that amount for lump sum payment

Question 5

assumptions of the monopoly model

Answer 5

single large price-setting firm

barriers to entry and exit

Question 6

first-degree price discrimination

Answer 6

monopolist sells to each individual consumer at their maximum willingness to pay
- MR = D

knows everything about the consumer

Question 7

second-degree price discrimination

Answer 7

different bundles of units sold to consumers at different prices (market by quality and quantity)

Question 8

third-degree price discrimination

Answer 8

monopolists sells units to different consumers at different price points

based on identity - e.g. student discounts

Question 9

second vs. third-degree price discrimination

Answer 9

firm charges different prices depending on characteristics of the purchase for second-degree

firm charges different prices depending on different groups, based on their varying degrees of elasticity for third-degree

Question 10

two-part tariff theory

Answer 10

if there is one type of consumer and all consumers have the same demand curve, then you capture all the consumer surplus by setting price equal to marginal cost and setting the fixed fee equal to the consumer surplus for an individual consumer

Question 11

socially efficient price vs monopolist’s price

Answer 11

p = MC

MR = MC