Pure Monopoly

Question 1

Why is it called pure monopoly?

Answer 1

Because it’s a man-made monopoly

Question 2

What are the assumptions of a monopoly?

Answer 2

1. Single seller with large number of buyers
2. Perfect information for buyers in market
3. No close substitutes for product
   1, 2, and 3: price setter (can decide how much to produce to control the price), downward sloping demand with no supply curve
4. Barriers to enter and exit (extremely high set up costs)
   4: in long run, firm can continue to sustain positive or zero profit made in the short run (firm can never make negative profit in the short run)

Question 3

Why does monopoly have no supply curve?

Answer 3

Because the monopolist determines how much to produce from profit maximisation condition then decides the price later on by substituting x (output level) into demand equation (read from x0 to P0),
unlike firms who have the supply curve to determine output based on price level (read from P0 to x0)

Question 4

What’s the supply rule of a profit-maximising monopolist?

Answer 4

Output at MC = MR
Relation of price and MR depends on demand curve

Question 5

Why is a monopolist’s marginal revenue (MR) twice as steep than the demand curve?

Answer 5

Because the slope of the MR is twice as steep as demand curve when comparing MR and inverse demand equation

Question 6

How do we show that a monopolist is initially making 0 profit, negative profit and positive profit?

Answer 6

1. 0 profit: P0 = AC(x0) -> tangency between AC and Demand
2. Negative Profit: P0 < AC(x0) -> minimum AC on MC above P0
3. Positive Profit: P0 > AC(x0) -> minimum AC on MC below intersection of MC & Demand and above MC = MR

Question 7

//Marginal revenue when price falls, varying on price elasticity of demand

Answer 7

1. When price falls and price is elastic: the total revenue goes up, hence marginal revenue > 0
   (monopolists maximise profit where MC = MR, and MC > 0, implying that MR > 0)
2. When price falls and price is unit elastic: total revenue is constant, hence marginal revenue = 0
3. When price falls and price is inelastic: total revenue falls, hence marginal revenue < 0

Question 8

//What happens to markup of price when the demand is more price elastic?

Answer 8

The price markup becomes smaller

Question 9

//How much is a perfect competition firm’s markup?

Answer 9

P = 1 MC
Can’t be 0 bc if markup is 0, P = (0)(MC) = 0, but PC firms always set the price to MR = MC where price is fixed and > 0

Question 10

Price discrimination

Answer 10

Only applicable to monopolists bc price setter, sole firm in market and no close substitutes for its product -> monopolist has absolute power over price

Question 11

How do monopolists successfully price discriminate?

Answer 11

No arbitrage opportunities (no reselling of products to others)

Question 12

What are the degrees of price discrimination?

Answer 12

1. First degree price discrimination (perfect price discrimination) -> only degree that has allocative efficiency due to P = MC (like PC market)
2. Second degree price discrimination (quantity discount)
3. Third degree price discrimination

Question 13

First degree price discrimination example

Answer 13

Doctor’s consultation, registering with IC which has address. Type of property determines price charged (e.g. HDB: normal rate but private property: higher rate) despite going through the same treatment
No arbitrage opportunity bc patients wouldn’t want to disclose personal health information to other patients

Question 14

Second degree price discrimination example

Answer 14

1. Bakery: 1 donut is $1, but 3 donuts is $2.80, each donut now costs < $1
2. Lazada: 1 shirt is full price, but 2 or more shirts gives you 20% discount -> people buy more apparels which they don’t need
   Focus: consumer behaviour where people buy more when price is low

Question 15

Third degree price discrimination example

Answer 15

1. Airlines: business class (price inelastic, there for work and may buy ticket for better features or to show social status) and economy class (price elastic, usually buy for vacation)
2. Movie tickets: weekdays (price elastic, alternatives of other entertainment) and weekends (fri-sun) (price inealstic as viewers are usually working class who only have time on weekends)
3. Taxi: peak hours (price inelastic, just want to reach work/school and not considering price) and non-peak hours (price elatic, alternative of public transport)

Question 16

What is the condition to maximise profit with price discrimination?

Answer 16

MC = MRx = MRy
Price is either higher or lower than price with no price discrimination, depending on product
Quantity will be inversely related to price (either lower or higher respectively)

Question 17

Is there allocative efficiency in the monopoly model?

Answer 17

No, allocative inefficient because (1) output of monopoly < output of perfect competition (efficient output level where D = S) and (2) deadweight loss in monopoly model -> implies: welfare is not maximised

Question 18

In what scenario will a monopolist accept government’s MC pricing proposal?

Answer 18

When the min AC on MC is below P = MC such that P1 > AC0(x1) and monopolist still makes SR profit, which will sustain in the LR -> eliminates deadweight loss once accepted

Question 19

What are the types of monopoly?

Answer 19

1. Non-natural monopoly (pure monopoly):
   (1) gets patent for product to prevent duplication/imitation such that there are no product substitutes and (2) makes cost to enter industry or set up cost very high such that entrant (firm waiting to enter industry) is discouraged from entering as it’s no longer profitable
2. Regulated monopoly: controlled/regulated by authorities/government
   example: electric & water services industry in SG, SP Power used to be monopoly, government protected (subsidies) and gave direction (rebates), then people felt it was unfair that SP Power is the sole seller, so government allowed competition (e.g. Surabaya Power, Sam Corp. Power, etc.), but SP Power remains as the industry leader
3. Natural monopoly: (1) innocent barriers of entry, comes naturally with the industry, (2) enjoys economies of scale (referring to AC), LR: AC & MC of monopoly decreases as output continues to rise over time
   example: South Africa - natural monopoly of diamonds by exploding mountains using dynamite
   Cost of extraction = cost of dynamite
   (x0) = $1000
   If number of diamonds extracted: 100
   AC of diamond = $1000/100 = $10
   If number of diamonds extracted: 1000
   AC of diamond = $1000/1000 = $1 -> as output increases, AC falls (economies of scale)