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ECON 101 > econ 101 chp 12: monopoly > Flashcards

econ 101 chp 12: monopoly Flashcards

1
Q

define a monopoly

A

a market with a single firm that produces a good/service with no close substitutes and that is protected by a barrier that prevents other firms from entering that market

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2
Q

what are the 2 key reasons for the arising of a monopoly

A
  1. no close substitutes
  2. barriers to entry
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3
Q

how does technological change affect a monopoly

A

technological change can create substitutes and weaken a monopoly

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4
Q

can the arrival of a new product create a monopoly?

A

yes

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5
Q

define a barrier of entry

A

a constraint that protect a firm from potential competitors

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6
Q

what are the types of barriers to entry?

A
  1. natural
  2. ownership
  3. legal
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7
Q

fill in the blanks: a natural barrier to entry creates a

A

natural monopoly

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8
Q

define a natural monopoly

A

a market in which economies of scale enable 1 firm to supply the entire market at the lowest possible cost

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9
Q

define a ownership monopoly

A

a market in which competition and entry are restricted by a concentration of ownership

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10
Q

define a legal monopoly

A

a market in which competition and entry are restricted by the granting of a public franchise, government licence, patent, or copyright

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11
Q

define a public franchise

A

an exclusive right granted to a firm to supply a good or service

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12
Q

define a government licence

A

controls entry into particular occupations, professions, and industries

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13
Q

define a patent

A

an exclusive right granted to the inventor of a product

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14
Q

define a copyright

A

an exclusive right granted to the author or composer

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15
Q

what do patents encourage?

A

the invention of new products and production methods and innovation by encouraging inventors to publicize and license their discoveries

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16
Q

monopoly vs perfect competition

A

monopoly sets its own price

for a competitive firm, price = MR, so price = MC

for a monopoly, price > MR, and price > MC

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17
Q

what are the 2 pricing strategies of monopoly

A
  1. single price
  2. price discrimination
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18
Q

define a single-price monopoly

A

firm that must sell each unit of its output for the same price to all its customers

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19
Q

define price discrimination

A

firm that sells different units of a good or service for different prices

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20
Q

why does a firm price discriminate

A

it charges the highest possible price for each unit sold and make the largest possible profit

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21
Q

why is marginal revenue less than price?

A

the price is lowered to sell 1 more unit, 2 opposing forces affect total revenue - the lower price results in a revenue loss on the original units sold and a revenue gain on the additional quantity sold.

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22
Q

what is marginal revenue?

A

the change in total revenue and relates to the change in the quantity sold

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23
Q

marginal revenue lies ____ the demand curve

A

below

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24
Q

is a single-price monopoly’s marginal revenue related to the elasticity of demand?

A

yes

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25
Q

if demand is elastic, marginal revenue is ___. why?

A

marginal revenue is positive - a fall in price brings an increase in total revenue, the revenue gain from the increase in quantity sold outweighs the revenue loss from the lower price.

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26
Q

if demand is inelastic, marginal revenue is _____. why?

A

marginal revenue is negative - a fall in price brings a decrease in total revenue, the revenue gain from the increase in quantity would is outweighed by the revenue loss from the lower price

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27
Q

if demand is unit elastic, marginal revenue is ______

A

marginal revenue is zero, total revenue does not change, the revenue gain from the increase in the quantity sold offsets the revenue loss from the lower price

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28
Q

in a monopoly, demand is always ____. why?

A

elastic - a profit-maximizing monopoly never produces an output in the inelastic range of the market demand curve

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29
Q

a monopoly set its price + output at the levels that _____

A

maximize economic profit

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30
Q

what’s the relationship between the marginal revenue and marginal cost:

(1) when MR > MC
(2) when MR < MC
(3) when MR = MC

A
  1. profit increases if output increases
  2. profit decreases if output increases
  3. profit is maximized
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31
Q

in a monopoly, why does the firm not sell at the maximum possible price? what price do they sell at instead?

A

bc they can only sell 1 unit of output.

the firm produces at the profit-maximizing quantity and sells that quantity for the highest price it can get

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32
Q

can new firms enter the monopoly when there’s positive economic profit

A

no, barriers to entry prevent new firm from entering the market, so a monopoly can make a positive economic profit and might continue to do so.

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33
Q

compared to a perfectly competitive market, a single-price monopoly produce a

A

smaller output and charges a higher price

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34
Q

what happens when a perfectly competitive market becomes a monopoly

A

the demand curve of the perfect competitive market becomes the constraint for the monopoly’s marginal revenue

the market supply curve from the perfectly competitive market becomes the monopoly’s marginal cost curve

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35
Q

are monopolies inefficient? why?

A

yes, they create a deadweight loss

the smaller output and higher price drive a wedge between MSB and MSC cost (deadweight loss)

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36
Q

why does the consumers surplus shrink in monopolies?

A
  1. consumers lose by having to pay more for the good - this loss to consumers is a gain for the monopoly and increases the product surplus
  2. consumers lose by getting less of the good (loss is part of the deadweight loss)
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37
Q

why does the producer surplus shrink in the monopoly

A

the producer produces a smaller output - loss is part of deadweight loss

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38
Q

does a monopoly produce at he lowest possible long-run average cost?

A

no, because they produce a smaller output than perfect competition and faces no competition

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39
Q

how does the monopoly damage the consumer interest?

A
  1. monopoly produces less
  2. increase cost of production
  3. raises the price by more than the increase cost of production
40
Q

does a monopoly bring a redistribution of surpluses?

A

yes - some of the lost consumer surplus goes tot he monopoly

this portion of loss of consumer surplus is not a loss to society - it’s a redistribution from consumers to the monopoly producer

41
Q

how can the social cost of monopoly exceed teh deadweight loss

A

due to rent seeking

42
Q

define economic rent

A

any surplus (producer or consumer)

43
Q

define rent seeking

A

pursuit of wealth by capturing economic rent

44
Q

how do rent seekers pursue their goals?

A
  1. buy a monopoly
  2. create a monopoly
45
Q

what’s the rent seeking of a monopoly

A

to capture consumer surplus

46
Q

how does a rent seeker buy a monopoly

A

a person searches for a monopoly that is for sale at a lower price than the monopoly’s economic profit

47
Q

what’s the social cost of a monopoly?

A

time + effort to seeking out profitable monopoly business to buy

use of scarce resources that could otherwise have been used to produce goods + services

48
Q

why is the amount paid for a monopoly not a social cost?

A

because the payment transfers an existing producer surplus from the buyer to the seller

49
Q

how does a rent seeker create a monopoly

A

mainly a political activity - takes the form of lobbying and trying to influence the political process (campaign contribution in exchange for legislative support or by indirectly seeking to influence political outcomes through publicity in the media or more direct contact with politicians + bureaucrats

this is a costly activity that uses up scarce resources - firms spend billions of dollars lobbying politicians and bureaucrats in the pursuit of licenses + laws that create barriers to entry + establish a monopoly

50
Q

are there barriers to entry into rent seeking?

A

no - it’s like a perfect comopetition

51
Q

what does competition among rent seekers create?

and how does it affect the economic profit

A

competition creates a higher price to the point where the rent seeker makes zero economic profit

52
Q

what type of cost is rent seeking to a monopoly’s cost

A

a fixed cost

53
Q

how does rent seeking affect the cost of the monopoly

A

the average total cost curve includes the fixed cost of rent seeking - the ATC shifts upward until it touches the demand curve

54
Q

what happens to economic profit, consumer surplus, and deadweight loss when the ATC touches the demand curve?

A

economic profit is zero, the profit is lost in rent seeking

consumer surplus is unaffected

deadweight loss from monopoly increases to include the original deadweight loss triangle plus the lost producer surplus

55
Q

are all price differences, price discrimination? why?

A

not all price difference are price discrimination - many reflect difference in production costs

56
Q

if price discrimination profitable? why?

A

it is profitable because it can increase economic profit

57
Q

how do firms price discriminate

A
  1. among groups of buyers
  2. among units of a good
58
Q

how does a firm price discriminate among groups of buyers

A

firms use the value (marginal benefit and willingness to pay) difference people place on a good

such differences can be correlated to age, employment status, etc

59
Q

how does a firm price discriminate amount units of a good

A

firms’ discriminate among units of a good due to diminishing marginal benefit

a firm price discriminates among units of a good by charging a buyer 1 price for a single item and a lower price for a 2nd or 3rd item to capture some of the consumer surplus

60
Q

how does a monopoly convert consumer surplus into producers surplus?

A

by getting buyers to pay a price as close as possible to their maximum willingness to pay

61
Q

why does more producer surplus mean more economic profit

A

economic profit = TR - TC
producer surplus = TR - TVC
economic profit = producer surplus - TFC

producer surplus = TR - area under marginal cost curve

62
Q

fill in the blanks: for a given level of total fixed cost, anything that increases producer surplus also _____ economic profit

A

increases

63
Q

fill in the blank: the more consumer surplus a firm is able to capture, the closer it gets to the extreme case called ___

A

perfect price discrimination

64
Q

define perfect price discrimination

A

occurs if a firm can sell each unit of output for the highest price someone is willing to pay for it

in this case, consumer surplus is eliminated and captured as producers surplus

65
Q

what happens to the marginal revenue and market demand curve in perfect price discrimination? why?

A

the market demand curve becomes the marginal revenue curve

this happens because when the monopoly cuts the price to sell a larger quantity, it sells only the marginal unit at the lower price, all other units continue to be sold for the highest price that each buyer is willing to pay - for the perfect price discriminator, marginal revenue = price and the market demand curve becomes the monopoly’s marginal revenue curve - with marginal revneue = price, the firm can obtain even greater producer surplus by increasing output up to the point at which price (aka MR) = MC

66
Q

how is producer surplus maximized in perfect price discrimination

A

when the lowest price = MC

67
Q

what’s the effect on output in a perfect price discrimination

A

output increases to the point at which price = MC - this output is identical to that of perfect competition

68
Q

what’s the effect of perfect price discrimination on consumers surplus, monopoly’s producer surplus and deadweight loss?

A

perfect price discrimination pushes consumer surplus to zero and increases the monopoly’s producer surplus equal to the total surplus in perfect competition, and no deadweight loss is created

69
Q

is perfect price discrimination efficient?

A

yes bc no deadweight loss is created

70
Q

what’s the relationship between perfect price discrimination and monopoly’s efficiency

A

the more perfectly the monopoly can price discriminate, the closer its output is to the competitive output and the more efficient is the outcome

71
Q

what are the differences in the outcomes of perfect competition and perfect price discrimination

A
  1. difference in total surplus distribution - in perfect competition, total surplus is shared by consumers and producers, in perfect price discrimination the monopoly takes it all
  2. rent seeking is profitable in a monopoly bc it takes the total surplus, it’s not profitable in perfect competition bc with free entry into rent seeking, the long0run equilibrium outcome is that rent seekers use up the entire producer surplus
72
Q

what’s the dilemma in natural monopoly

A

with economies of scale, it producers at the lowest possible cost, but with market power it has an incentive to raise the price above the competitive price and produce too little - to operate in self-interest of the monopolist and not in the social interest

73
Q

define regulation

A

rules administered by a government agency to influence prices, quantities, entry, and other aspects of economic activity inn a firm/industry

74
Q

how does the government implement regulation

A

government establishes agencies to oversee and enforce the rules

75
Q

define deregulation

A

process of removing regulation of prices, quantities, entry and other aspects of economic activity in a firm or industry

76
Q

fill in the blanks: regulation is a _____ solution to the dilemma presented by natural monopoly but not a ____ solution

A

possible, guaranteed

77
Q

what are the 2 theories about how regulation actually works

A
  1. social interest theory
  2. capture theory
78
Q

define the social interest theory

A

political and regulatory process relentlessly seeks out inefficiency and introduces regulation that eliminates deadweight loss and allocates resources efficiently

79
Q

define capture theory

A

regulation serves the self-interest of the producer who captures the regulator and maximizes economic profit. Regulation that benefits the producer but creates a deadweight loss gets adopted because of the producer’s gain is large and visible while each individual consumer’s loss is small and invisible - no individual consumer has an incentive to oppose the regulation, but the producers has a big incentive to lobby for it

80
Q

how can a natural monopoly be regulated to produce the efficient quantity of the good

A

marginal cost pricing rule - as the quantity demanded at this price is the efficient quantity

81
Q

define marginal cost pricing rule

A

regulating a natural monopoly to set its price equal to marginal cost

82
Q

what’s the problem with the marginal cost pricing rule?

A

the natural monopoly firm will incur an economic loss and will not stay in the business for long

83
Q

how can the firm in a natural monopoly cover its costs and obey marginal cost pricing rule?

A
  1. price discrimination
  2. 2-part price (2-part tariff)
84
Q

what’s an example of a 2-part price

A

wireless providers offer plans at a fixed monthly price that five access to the cellphone network with unlimited calls

the price of a call (0) = MC of a call

the cable TV operator can charge a 1-time connection fee that covers its fixed cost and then charge a monthly fee equal to its marginal cost

85
Q

what are the 2 possible ways of enabling a regulated monopoly to avoid an economic loss - when a natural monopoly cannot always be regulated to achieve an efficient outcome and which is better?

A
  1. average cost pricing
  2. government subsidy

answer depends on the relative magnitudes of the 2 deadweight losses - average cost pricing generates a deadweight loss in the market served by the natural monopoly, a subsidy generates deadweight losses in the markets for the items that are taxed to pay for the subsidy

the smaller deadweight loss is the second-best solution to regulating a natural monopoly

generally, average cost pricing is preferred to a subsidy

86
Q

define the average cost pricing rule

A

sets price equal to average total cost - firm produces the quantity at which the ATC cure cuts the demand curve - results in the firm making zero economic profit

but for a natural monopoly, ATC exceeds MC, the quantity produced is less than the efficient quantity and a deadweight loss arises

average cost price regulation creates a deadweight loss, but it is less than with unregulated profit-maximization

87
Q

define a government subsidy + effects on the monopoly quantity + pricing

A

government subsidy = direct payment to the firm, which is equal to its economic loss

88
Q

what challenge does the average cost pricing present to a regulator

A

it’s not possible to be sure what a firm’s costs are

89
Q

what practical rules are available for regulators use

A
  1. rate of return regulation
  2. price cap regulation
90
Q

define rate of return regulation

A

a firm must justify its price by showing that its return on capital doesn’t exceed a specified target rate

91
Q

what are some characteristics to know about the rate of return regulation

A

this type of regulation can end up serving the self-interest of the firm rather than the social interest - the firm’s managers have an incentive to inflate costs by spending on items + to use more than the efficient amount of capital

the rate of return on capital is regulated but not the total return on capital, so as the amount of capital used increases the total return on capital increases

92
Q

define a price cap regulation

A

a price ceiling - a rule that specifies the highest price the firm is permitted to set

93
Q

what are the characteristics of the price cap regulation

A

this type of regulation gives a firm an incentive to operate efficiently and keeps costs under control

lowers the price and increases output in a monopoly (sharp contrast to the effect of a price ceiling in a competitive market)

94
Q

why does a price cap regulation lower price and increase output in a monopoly?

A

in a monopoly, the unregulated equilibrium output is less than the competitive equilibrium output an the price cap regulation replicates the conditions of a competitive market

95
Q

define an earnings sharing regulation

A

a regulation that requires firms to make refunds to customers when profits rise above a target level

96
Q

price cap regulations are often combined with _____, why?

A

combined with a earnings sharing regulation to achieve a more efficient than the rate of return regulation

this is because the price cap regulation may set the cap too high (price cap delivers average cost pricing)

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