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University of Southern California - ECON 351 Lecture 17: Monopoly  1)A monopolist is producing at a point at which marginal cost exceeds marginal revenue

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University of Southern California - ECON 351

Lecture 17: Monopoly

 1)A monopolist is producing at a point at which marginal cost exceeds marginal revenue.  How should it adjust its output to increase profit?

2. We write the percentage markup of prices over marginal cost as (P - MC)/P.  For a profit-maximizing monopolist, how does this markup depend on the elasticity of demand?  Why can this markup be viewed as a measure of monopoly power?
3. Why is there no market supply curve under conditions of monopoly?

4. What are some of the different types of barriers to entry that give rise to monopoly power?  Give an example of each.

 

 

5.  Suppose that an industry is characterized as follows:  

1. If there is only one firm in the industry, find the monopoly price, quantity, and level of profit.

 

 

2. Find the price, quantity, and level of profit if the industry is competitive. 
3. Graphically illustrate the demand curve, marginal revenue curve, marginal cost curve, and average cost curve.  Identify the difference between the profit level of the monopoly and the profit level of the competitive industry in two different ways.  Verify that the two are numerically equivalent.

 

8.  A firm has two factories for which costs are given by:

1. The firm faces the following demand curve:

where Q is total output, i.e. Q = Q₁ + Q₂.

b.         Calculate the values of Q₁, Q₂, Q, and P that maximize profit.

c. Suppose labor costs increase in Factory 1 but not in Factory 2.  How should the firm adjust the following(i.e., raise, lower, or leave unchanged): Output in Factory 1?  Output in Factory 2?  Total output?  Price?

 

9.  A drug company has a monopoly on a new patented medicine.  The product can be made in either of two plants.  The costs of production for the two plants are MC₁ = 20 + 2Q₁, and MC₂ = 10 + 5Q₂.  The firm’s estimate of the demand for the product is P = 20 - 3(Q₁ + Q₂).  How much should the firm plan to produce in each plant?  At what price should it plan to sell the product?

10.  A monopolist faces the demand curve P = 11 - Q, where P is measured in dollars per unit and Q in thousands of units.  The monopolist has a constant average cost of $6 per unit.

1. Draw the average and marginal revenue curves and the average and marginal cost curves.  What are the monopolist’s profit-maximizing price and quantity?  What is the resulting profit?  Calculate the firm’s degree of monopoly power using the Lerner index (p-mc)/p.
2. A government regulatory agency sets a price ceiling of $7 per unit.  What quantity will be produced, and what will the firm’s profit be?  What happens to the degree of monopoly power?
3. What price ceiling yields the largest level of output?  What is that level of output?  What is the firm’s degree of monopoly power at this price?

 

11.  Dayna’s Doorstops, Inc. (DD), is a monopolist in the doorstop industry.  Its cost is C = 100 - 5Q + Q², and demand is P = 55 - 2Q.

1. What price should DD set to maximize profit?  What output does the firm produce?  How much profit and consumer surplus does DD generate?
2. What would output be if DD acted like a perfect competitor and set MC = P?  What profit and consumer surplus would then be generated?
3. What is the deadweight loss from monopoly power in part (a)?
4. Suppose the government, concerned about the high price of doorstops, sets a maximum price at $27.  How does this affect price, quantity, consumer surplus, and DD’s profit?  What is the resulting deadweight loss?

 

 

 

5. Now suppose the government sets the maximum price at $23.  How does this affect price, quantity, consumer surplus, DD’s profit, and deadweight loss?
6. Finally, consider a maximum price of $12.  What will this do to quantity, consumer surplus, profit, and deadweight loss?

12.  There are 10 households in Lake Wobegon, Minnesota, each with a demand for electricity of Q = 50 - P.  Lake Wobegon Electric’s (LWE) cost of producing electricity is  TC = 500 + Q.

a. If the regulators of LWE want to make sure that there is no deadweight loss in this market, what price will they force LWE to charge?  What will output be in that case?  Calculate consumer surplus and LWE’s profit with that price.

b. If regulators want to ensure that LWE doesn’t lose money, what is the lowest price they can impose?  Calculate output, consumer surplus, and profit.  Is there any deadweight loss?

c. Kristina knows that deadweight loss is something that this small town can do without. She suggests that each household be required to pay a fixed amount just to receive any electricity at all, and then a per-unit charge for electricity.  Then LWE can break even while charging the price you calculated in part (a).  What fixed amount would each household have to pay for Kristina’s plan to work?  Why can you be sure that no household will choose instead to refuse the payment and go without electricity?

 

 

 

13. The Umbrella Corporation is thinking of developing a new drug (called “ResEv”) designed to fight new strands of pneumonia.  The Corporate Development department is analyzing whether to go ahead with the project or not. In order to develop a business plan, they first analyze the scenario in which the drug development stage succeeds, it is approved by the FDA and can be fully protected by a patent.

In this scenario, , the marketing department estimates that demand in the USA per year for “ResEv” will be given by 

Q_D =100-P.

Where price is in dollars. The Operations department estimates that the costs of production in this scenario (on a yearly basis) are given by

C(q)=10+4q+q²

 

1. What will be the price and quantity sold (per year) by the Umbrella

Corporation of “ResEv”

 

 

2. At the optimal price set by the Umbrella Corporation, what is the (price) elasticity of demand? Is demand elastic or inelastic?

 

 

 

3. Draw the average cost of production and marginal cost of production for

“ResEv”. At the optimal output level, is the Umbrella Corporation exhibiting economies of scale, diseconomies of scale, or neither?

 

4. What are the profits of the Umbrella Corporation (on a yearly basis)? What is the value of consumer surplus (on a yearly basis)?

 

 

 

5. The Umbrella Corporation is thinking of exporting “ResEv” to Africa, where demand for the product is 

Q_D =40-(1/2)P.

Suppose that the transports cost to Africa are zero and that consumers cannot arbitrage between markets (i.e. consumers in Africa cannot buy from the US and viceversa, and consumers in Africa cannot buy in Africa and sell themselves in the US). What will be the optimal price in Africa and the US for “ResEv”? Has the price in the US changed as a result of the Umbrella

Corporation selling in both markets and, if so, why?

 

 

f. The Umbrella Corporation estimates that consumers in Africa and the US will be able to arbitrage perfectly between markets (i.e. consumers in Africa will be able to buy from the US market and consumers in the US will be able to buy from the African market). What will be the market price in the US and Africa now?