Lecture 23: Theory of the firm and Monopoly

Question 1

For perfectly competitive firms, we will see that AR =

Answer 1

AR = MR = P

Question 2

The goal of a competitive firm is to what?

Answer 2

maximise profit

Question 3

At what point is profit maximised in a perfectly competitive firm?

Answer 3

MR = MC

Question 4

If firms in a perfectly competitive market are price takers, how do they determine how much they sell?

Answer 4

They sell at the market price and pick the quantity that will maximise their profit

Question 5

The quantity to maximise profit for a firm in a perfectly competitive market will be where?

Answer 5

where MR = MC

Question 6

How can we calculate economic profit on a perfectly competitive market curve?

Answer 6

π = Q (AR - ATC)

Question 7

On the curve for a perfectly competitive market, where is there zero economic profit?

Answer 7

Where P = MR = AR

Question 8

On the curve for a perfectly competitive market, where are firms making negative economic profit?

Answer 8

When AR < ATC

because the cost of making the product is below the price it is being sold for

Question 9

In the short run supply curve, the MC curve shows how much the supplier will produce and sell at each price. Therefore, the MC curve appears to be the what?

Answer 9

supply curve

Question 10

What is the short run shut-down rule?

Answer 10

a firm will operate only if the average revenue is greater than or equal to the average variable cost

ie P>AVC otherwise the firm will shut down

Question 11

When P < ATC, we have ___________ economic profits

Answer 11

negative

Question 12

When will a firm shut down in a perfectly competitive market?

Answer 12

If P < AVC

Question 13

In the long run, firms will enter or exit the market until profit is driven to ___________ and price equals the minimum ___________ _________ ___________ (___________ scale)

Answer 13

zero
average total cost
efficient

Question 14

The study of the long run depends on how entry of new firms affects the price of inputs. They may

Answer 14

1. be unaffected by entry
2. increase due to entry
3. decrease due to entry

Question 15

What happens in the long run if there is economic profit in the market?

Answer 15

Firms will enter in the long run, enticed by the profit. However this changes the industry and the profit eventually disappears

Question 16

Why is the long-run supply curve up-ward sloping?

Answer 16

because previously some resources used in production may be available only in limited quantities and firms have different costs

Question 17

Define marginal firm

Answer 17

the firm that would exit the market if the price were any lower

Question 18

What happens if the price decreases instead of increased (eg a decrease in demand)?

Answer 18

firms would leave the industry until there was zero economic profit

Question 19

A monopoly firm is a price __________-

Answer 19

maker

Question 20

When is a firm considered a monopoly?

Answer 20

• if it is the sole seller of its product

- its product does not have close substitutes

Question 21

What are the three cases that cause a monopoly?

Answer 21

1. when a firm owns a key resource
2. when a firm has exclusive production rights from the government
3. when a firm has production costs much lower than many smaller producers

Question 22

What is a natural monopoly?

Answer 22

An industry where a single firm can supply a good or service to an entire market at a smaller cost than two or more firms could

Question 23

What can governments do to create monopolies?

Answer 23

• by giving a single firm the exclusive rights to sell a particular good in certain markets
• by giving a single firm patent and copyright laws (to serve the public interest)

Question 24

When does a natural monopoly arise?

Answer 24

When there are economies of scale over the relevant range of output

Question 25

What sort of demand curve does a natural monopoly face?

Answer 25

a downward sloping demand curve

Question 26

What subcategories does a monopoly fit under in the market structure?

Answer 26

When there is only one curve

Question 27

Compare a monopoly and a perfectly competitive market: - number of producers - demand curve - price maker or taker - how much does it sell

Answer 27

- in a monopoly, there is only one producer, a competitive firm there are lots of producers - a monopoly faces a downward-sloping demand curve whereas a competitive firm faces a horizontal demand curve - a monopoly is a price maker and a competitive firm is a price taker - a monopoly reduces the price to increase sales whereas a competitive firm sells as much or as little at the same price

Question 28

Where does the MR curve fall in a monpoly?

Answer 28

The MR is twice as steep as the AR and so it falls underneath it.

Question 29

In a monopoly, if a price fall sells one more unit, the revenue received from previously sold units also

Answer 29

decreases

Question 30

A monopoly increasing its sales has two effects of TR. What are these?

Answer 30

- the output effect: more output is sold, so TR is higher | - the price effect: price falls so total revenue is lower

Question 31

A monopoly maximises profit by producing the quantity at which

Answer 31

marginal revenue equals marginal cost

Question 32

How is price determined in a monopoly?

Answer 32

the quantity to produce the profit is given where MC = MR and the corresponding price on the demand curve is the price charged to maximise profit

Question 33

How is profit calculated on a monopoly curve?

Answer 33

(P - ATC) x q

Question 34

The monopolist will receive economic profits as long as price is greater than what?

Answer 34

average total cost

Question 35

When would a monopolist be making a loss?

Answer 35

when their average total costs rise so that they are higher than the price

Question 36

In a monopoly, where is the efficient quantity?

Answer 36

where the demand crosses the marginal cost curve

Question 37

What does demand represent on a monopoly curve?

Answer 37

the value to buyers

Question 38

In a monopoly, what happens at the quantities that are to the left of the efficient quantity equilibrium?

Answer 38

The cost to the monopolist is less than the value to buyers which is a good thing for the monopolist

Question 39

In a monopoly, what happens at the quantities that are to the right of the efficient quantity equilibrium?

Answer 39

the cost to the monopolist is greater than the value to the buyers

Question 40

The market allocates goods to people who ________ it the ________ and to producers who __________ it the ____________

Answer 40

value most produce cheapest

Question 41

In contrast to a competitive firm, a monopoly charges a price above the

Answer 41

marginal cost

Question 42

From the standpoint of consumers, this high price makes monopoly

Answer 42

undesirable

Question 43

From the standpoint of the owners of the firm, the high price makes the monopoly very

Answer 43

desirable

Question 44

Is there a deadweight loss in a competitive market? Why?

Answer 44

no because in a competitive market, total surplus is maximised

Question 45

Is there a DWL in a monopoly? Why?

Answer 45

yes | at q, P>MC so there is economic inefficiency

Question 46

How can this deadweight loss be eliminated in a monopoly?

Answer 46

by charging more than one price (price discrimination)

Question 47

Define price descrtimination

Answer 47

charging different prices on differences in consumer willingness to pay, not on differences in costs

Question 48

How would producers price discriminate?

Answer 48

- charge those who value higher the higher prices | - charge those who have a smaller MV a lower price

Question 49

What are three conditions for price discrimination?

Answer 49

1. the supplier must have some market power (it must be a price maker not a price taker) 2. the firm must be able to distinguish consumers according to their willingness to pay 3. there must be no arbitrage possibilities (a customer can't buy at a low price and sell at a higher price)

Question 50

Why does price discrimination eliminate DWL?

Answer 50

because if every consumer is paying their willingness to pay, total CS = 0 so everything is PS

Question 51

What are the three types of price discrimination?

Answer 51

- first degree - second degree - third degree

Question 52

Where does price discrimination not go past?

Answer 52

MC

Question 53

What is first degree price discrimination?

Answer 53

- the monopolist must charge the most anyone is willing to pay for each unit of output (ie. charge everyone their willingness to pay) - this is perfect price discrimination

Question 54

What is second degree price discrimination?

Answer 54

- within consumer price discrimination some people buy multiple units of a god per time period and their MV falls as Q increases - price discriminating strategy: charge a high price for the first unit, reduce price on additional purchases (eg. buy one get half price)

Question 55

What is third degree price discriminaton?

Answer 55

Where consumers are broken into groups based on their responsiveness to price eg. a price unresponsive group and a price responsive group eg. student discounts in a movie theatre There are several groups with different demand curves (and different revenue curves)