had this urge to play Monopoly the whole time (Chapter 9 Q & A)

06/01/2013 § Leave a comment

#2. 25 marks.

a) Explain, using an appropriate diagram, how the monopolist determines the profit-maximizing level of output and price.

The monopolist will produce at the point where the marginal costs (MC) equal marginal revenue (MR). This is the highest point of production for the firm and here the monopolist can experience normal and abnormal profits as well as losses, but producing at this point will maximize profits or minimize losses. When MC equals MR, then all costs are being covered. Anything above the price of marginal cost is profit. The difference then between the firms’ ATC (average total costs) and AR (average revenue) is abnormal profit, which is what all firms aim to achieve. This particular point is a high in cost and low in quantity, which suggests that the monopolist is underproducing. It does this to maximize profits.

b) Discuss the view that competitive markets are always more efficient than monopolies.

One of the disadvantages of a monopoly is that it will usually produce at higher prices and lower quantities, therefore it is maximizing profit and not allocation. The firm does not produce enough of the good to achieve productive efficiency. Also, monopolists may undergo problems with incentive and innovation, which can convince the firm to spend unwisely and inefficiently. Competitive markets are more efficient than monopolies because they all sell at only one price, the market price. This means that they will always strive to improve their goods and produce efficiently. Generally, monopolists are less efficient than competitive firms but the natural monopolies, whose goods includes water, electricity, sewage, and power, i.e. necessities, are quite efficient. A good example of this would be the electricity power system in Kansai. It is the only company that controls our electricity because the barriers of entry are too high for any other firm to try and enter the market (they would have to set up pays for all the rooms in all the apartments in all the little towns). Public monopolies that are already in the market are then forced to be efficient, also because they deal with a lot of regulation and government oversight, but are given subsidies to provide the public with more services at lower prices.

#5. 25 marks.

a) Explain how a third-degree price discriminator will determine price and output.

The monopolist will have to take into account their different consumer groups for third-degree price discrimination, and the different elasticities that come with these groups. Let’s take two different markets. Let’s say market A is the more elastic market where the consumers are more sensitive to a price change, and market B is the more inelastic market where the consumers are less sensitive to a price change. The firm will produce where its marginal costs equal the marginal revenue of market A and market B and from there, will take the profits from both markets (add profit A and profit B for full results!) to maximize profits from both consumer groups.

b) Price discrimination of any kind only brings harm to consumers. Discuss.

Monopolists price discriminate so that they can maximize the profits from their consumers and take more from them (us). Consumers will generally pay higher prices because monopolists tend to produce where MC = MR, not where MR = 0 (hits the x-axis and MR is still positive), and that point is further to the left, which means that the quantity produced is less, and the price is higher, which hurts consumers. Also, since the firm receives more revenue from different consumers, the consumer surplus is reduced or completely eliminated, depending on the type of discrimination and how successfully they appeal to the different markets. On the other hand, society benefits from a certain amount of price discrimination. Firms can appeal to and provide services and goods for all kinds of income groups and age groups who may or may not be able to afford the good. Similarly to how government subsidies to a natural monopoly are for the greater good of society, some price discrimination (like, charging higher-income families more than lower-income families at the dentist) can be beneficial for society.

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