Monopoly
Define a monopoly and why do they arise.
- when a firm is the only seller of a product with no close substitutes
- arise because of barriers to entry
what is oligopoly?
- market is shared by a few producers or sellers
Define a public good and give one example.
a public good is something that is
- not rival - people cannot be prevented from using it
- not excludable - a person's use of it does not reduce another's use
example: national defense
what does being a price taker mean?
- firms are unable to independently change market price of a particular type of goods
draw a positive externality diagram (of production)
graph
- Qe and Qo
- Pe and Po
- eq and optimum
- MSC, MSB, MPC, MPB, S, D
Why is marginal revenue (MR) less than price (P) for a monopolist, but equal to price for a competitive firm?
monopoly
- faces a downward sloping demand curve -> for every extra unit sold, it must lower the price
- price effect -> MR < P
competition
- demand curve is perfectly elastic (price taker, cannot change price) -> MR = P
what is a cartel?
- an agreement where competing firms collude and produce
Classify each of the following goods as private goods, public goods, common resources, or natural monopolies. Briefly justify each answer.
a) Fish in the open ocean
c) An uncongested, non-toll road
a) common resource (rival but not excludable)
b) public good
A perfectly competitive firm faces a market price of $8. Its short-run cost structure is as follows:
Total Fixed Cost (TFC) = $30
Average Variable Cost (AVC) = $6 at the profit-maximizing output level.
Should this firm shut down in the short run?
No
- shut down if P < AVC. Here, P ($8) > AVC ($6)
- the firm covers its variable costs and should continue operating, even though it may have losses if P < ATC.
how might a centrally planned economy be inefficient?
- gov doesnt know the exact behavior of every firm
Explain how a monopolist determines its profit-maximizing quantity and price.
Profit maximizing quantity is when MC = MR, price is the quantity on its demand curve
* because MC = MR and P > MR, P > MC
what is collusion?
an agreement between firms to reduce competition and maximize joint profits -> makes them behave collectively like a monopolistic market
Explain the free-rider problem and why it leads to market failure in the production of public goods.
- when individuals receive the benefit of the good without paying for it
- public goods are not excludable so people have the incentives to become a free-rider
- because of this private goods cannot earn enough revenue even if the social benefits exceed the cost
- leads to under-production -> market failure
Explain the process by which a market returns to long-run equilibrium. What happens to the firms in the market?
- profit attracts firms to enter -> zero economic profit
increasing opp. costs as the economy shifts from producing one good to another
Explain why monopoly causes deadweight loss and identify the source of the inefficiency.
- produces less than the socially efficient output where P = MC
- because MR < P at the maximizing quantity, firms charge a higher price so P > MC -> some consumers' WTP exceeds the cost of production but goods are not produced
- results in DWL
what is monopolistic competition
a market where producers sell differentiated products but serve in the same end market
eg. burgers
Using the concept of externalities, explain why common resources tend to be overused.
- Common resources are rival but not excludable, so individuals can use them without paying
- Each user considers only their private benefit, while ignoring the negative externality imposed on others.
(tragedy of the commons)
Explain why the long-run equilibrium in a perfectly competitive market is considered allocatively efficient. Use the condition P = MC in your answer.
- Allocative efficiency occurs when the price of a good equals the marginal cost of producing it (P = MC)
- In competitive long-run equilibrium, P = MC = min ATC -> the value consumers place on the last unit (P) equals the cost of the resources used to produce that unit (MC)
why might externalities lead to market failure?
- overproduction/underproduction
- market fails to allocate its resources efficiently
Evaluate the claim: “Price discrimination is unfair and inefficient and should be banned.” Use economic reasoning to support your answer.
- may seem unfair because consumers pay different prices for the same good
- increases total surplus by allowing consumers with lower WTP to enter the market -> output expands to efficient levels and DWL is reduced
- banning price discrimination reduces overall efficiency and welfare
what is one difference between monopolistic competition and monopoly?
- monopoly faces high barriers to entry but it is easier for monopolistic competition firms to enter the market
Choose ONE policy the government could use to address overuse of a common resource. Explain how it improves efficiency and one potential drawback.
- imposing a corrective tax - internalizes the externalities
- drawback: hard for the government to determine the specific tax levels
How does the concept of sunk cost influence a firm's short-run decision to shut down? Why are fixed costs irrelevant to this decision?
sunk costs are irrelevant to a firm's SR decisions
- fixed costs have to be paid regardless of the shutdown decision
why do price control exist if they create a DWL?
- eg. more affordable housings, supports the production of agricultural products, etc. -> might benefit the society but the costs might exceed the benefits