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1. Sources of monopoly power

A monopolist, unlike a competitive firm, has some market power. It can raise its price, within limits, without the quantity demanded falling to zero.

The main way it retains its market power is through barriers to entry—that is, other companies cannot enter the market to create competition in that
particular industry.

Complete the following table by indicating which barrier to entry appropriately explains why a monopoly exists in each scenario.

Barriers to Entry
Exclusive
Ownership Government-
of a Key Created Economies
Scenario Resource Monopolies of Scale

The Aluminum Company of America (Alcoa) formerly controlled all U.S. sources of bauxite, a key

component in the production of aluminum. Given that Alcoa did not sell bauxite to any other
companies, Alcoa was a monopolist in the U.S. aluminum industry from the late 19th century

until the 1940s.

In the public water industry, low average total costs are obtained only through large-scale

production. In other words, the initial cost of setting up all the necessary pipes makes it risky
and, most likely, unprofitable for competitors to enter the market.

In an imaginary country, there is only one federally licensed lottery agency in any state; that is,

it is impossible for any private firm to start up a competitive lottery without a government
license to do so.

Points: 1/1

Explanation: Close Explanation

Exclusive ownership of a key resource, namely, bauxite, serves as a barrier to entry in the market for aluminum. The exclusivity of this essential

resource prevented the entry of rival firms.

Companies that provide public utilities, such as public water, are called natural monopolies. Economies of scale (when average total cost

decreases as more goods are produced or supplied) serve as an entry barrier, protecting the monopolist from competition and new entrants.

Patents and licenses are legal barriers created by the government to limit entry to an industry or to protect inventors of goods or processes

from rivals. Patents are particularly important in the case of pharmaceuticals and technological innovations because research and development
are critical but costly steps in developing most patentable inventions and products. Licenses are government-provided permits that allow

economic agents to conduct specified activities and require them to meet specific standards; they may prevent new suppliers (some of which
may not meet the standards) from entering industries and driving down prices and profits.

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2. Profit maximization and loss minimization

BYOB is a monopolist in beer production and distribution in the imaginary economy of Hopsville. Suppose that BYOB cannot price discriminate; that is,

it sells its beer at the same price per can to all customers. The following graph shows the marginal cost (MC), marginal revenue (MR), average total

cost (ATC), and demand (D) for beer in this market.

Place the black point (plus symbol) on the graph to indicate the profit-maximizing price and quantity for BYOB. If BYOB is making a profit, use the
green rectangle (triangle symbols) to shade in the area representing its profit. On the other hand, if BYOB is suffering a loss, use the purple rectangle

(diamond symbols) to shade in the area representing its loss.

4.00

3.50
Monopoly Outcome
3.00
PRICE (Dollars per can)

2.50
Profit
ATC

2.00

1.50 Loss

1.00
MC
0.50

D
MR
0
0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0
QUANTITY (Thousands of cans of beer)

Suppose that BYOB charges $2.50 per can. Your friend Andrew says that since BYOB is a monopoly with market power, it should charge a higher price
of $3.00 per can because this will increase BYOB’s profit.

Complete the following table to determine whether Andrew is correct.

Price Quantity Demanded Total Revenue Total Cost Profit

(Dollars per can) (Cans) (Dollars) (Dollars) (Dollars)

2.50

3.00

Given the earlier information, Andrew correct in his assertion that BYOB should charge $3.00 per can.

Suppose that a technological innovation decreases BYOB’s costs so that it now faces the marginal cost (MC) and average total cost (ATC) given on the

following graph. Specifically, the technological innovation causes a decrease in average fixed costs, thereby lowering the ATC curve and moving the MC

curve.

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Aplia: Student Question 30/11/2021, 11:40 PM

Place the black point (plus symbol) on the following graph to indicate the profit-maximizing price and quantity for BYOB. If BYOB is making a profit,

use the green rectangle (triangle symbols) to shade in the area representing its profit. On the other hand, if BYOB is suffering a loss, use the purple

rectangle (diamond symbols) to shade in the area representing the loss.

4.00

3.50
Monopoly Outcome
3.00
PRICE (Dollars per unit)

2.50
Profit

2.00

ATC
1.50 Loss

1.00

0.50

MC D
MR
0
0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0
QUANTITY (Thousands of cans of beer)

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3. Monopoly outcome versus competition outcome

Consider the daily market for hot dogs in a small city. Suppose that this market is in long-run competitive equilibrium with many hot dog stands in the

city, each one selling the same kind of hot dogs. Therefore, each vendor is a price taker and possesses no market power.

The following graph shows the demand (D) and supply (S = MC) curves in the market for hot dogs.

Place the black point (plus symbol) on the graph to indicate the market price and quantity that will result from competition.

Your Answer Correct Answer

Competitive Market

5.0

4.5

PC Outcome
4.0
PRICE (Dollars per hot dog)

3.5

3.0

2.5

2.0
S=MC
1.5

1.0

0.5
D
0
0 45 90 135 180 225 270 315 360 405 450
QUANTITY (Hot dogs)

Points: 1/1

Explanation: Close Explanation

In a competitive market, the intersection of the demand and supply curves determines the market equilibrium. Therefore, the market

equilibrium price is $1.50 per hot dog, and the market equilibrium quantity is 225 hot dogs in this case. Because the market is competitive, the

equilibrium outcome maximizes total welfare, and resources are allocated efficiently.

Assume that one of the hot dog vendors successfully lobbies the city council to obtain the exclusive right to sell hot dogs within the city limits. This

firm buys up all the rest of the hot dog vendors in the city and operates as a monopoly. Assume that this change doesn't affect demand and that the
new monopoly's marginal cost curve corresponds exactly to the supply curve on the previous graph. Under this assumption, the following graph shows

the demand (D), marginal revenue (MR), and marginal cost (MC) curves for the monopoly firm.

Place the black point (plus symbol) on the following graph to indicate the profit-maximizing price and quantity of a monopolist.

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Your Answer Correct Answer

Monopoly

5.0

4.5 180, 1.5

Monopoly Outcome
4.0
PRICE (Dollars per hot dog)

3.5

3.0 Deadweight Loss

2.5
168.75, 1.75
2.0
MC
1.5

1.0

0.5
D
MR
0
0 45 90 135 180 225 270 315 360 405 450
QUANTITY (Hot dogs)

Points: 1/1

Explanation: Close Explanation

The hot dog vendor will produce the level of output at which its marginal revenue is equal to its marginal cost; this occurs at 135 hot dogs. It

will charge a monopolist's price of $2.50, the maximum amount consumers are willing to pay at this output level (as determined by the demand

curve).

Consider the welfare effects when the industry operates under a competitive market versus a monopoly.

On the monopoly graph, use the black points (plus symbol) to shade the area that represents the loss of welfare, or deadweight loss, caused by a

monopoly. That is, show the area that was formerly part of total surplus and now does not accrue to anybody.

Explanation: Close Explanation

The deadweight loss caused by the monopoly market structure is equal to the loss of total surplus that results from hot dogs being sold by a

monopolist rather than in a competitive market. When the market was a competitive market, 225 hot dogs were sold each day. Since only 135

hot dogs per day are sold now, nobody is taking advantage of the possible surplus from the 136th through the 225th hot dog sold. This loss of

surplus is called deadweight loss. Visually, it is represented by the area between the demand curve and the marginal cost curve between the

quantities of 135 hot dogs and 225 hot dogs.

Deadweight loss occurs when a monopoly controls a market because the resulting equilibrium is different from the competitive outcome, which is

efficient.

In the following table, enter the price and quantity that would arise in a competitive market; then enter the profit-maximizing price and quantity that

would be chosen if a monopolist controlled this market.

Price Quantity
Market Structure (Dollars) (Hot dogs)

Competitive 1.50 225

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Aplia: Student Question 30/11/2021, 11:40 PM

Monopoly 2.50 135

Points: 1/1

Given the summary table of the two different market structures, you can infer that, in general, the price is higher under a monopoly ,
and the quantity is higher under a competitive market .

Points: 1/1

Explanation: Close Explanation

When a monopoly takes over a competitive industry, all else being equal, the competitive industry supply curve becomes the monopoly’s
marginal cost curve. For the new monopoly, the marginal revenue curve lies below the market demand curve. The intersection of the marginal

revenue and marginal cost curves causes the monopoly to lower output below the competitive level. With lower output, but the same market

demand curve, price rises. Therefore, the price is higher under monopoly ($2.50 versus $1.50), and the quantity is higher under competition

(225 hot dogs versus 135 hot dogs).

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4. Conditionsfor price discrimination

Price discrimination is the practice of selling the same good at more than one price when the price differences are not justified by cost differences.

Evaluate the following statement: "Price discrimination is not possible when a good is sold in a perfectly competitive market."

False, because perfectly competitive firms do not profit maximize by setting marginal revenue equal to marginal cost

False, because perfectly competitive firms have market power

None of these choices

True, because perfectly competitive firms have no market power

Points: 1/1

Explanation: Close Explanation

A firm operating in a perfectly competitive market cannot price discriminate. In this environment, firms are price takers, because there are
many firms selling the same good at the market price. No firm is willing to charge a lower price to any customer, because it believes it can sell

all it wants at the market price. If any firm tried to charge a higher price to a customer, that customer would buy from another firm. For a firm
to price discriminate, that is, charge different prices to different buyers, it must have some power over price. Thus, it must be a price searcher

rather than a price taker. By contrast, if a firm operates in a perfectly competitive market, it is a price taker and thus cannot sell goods to
different buyers at different prices.

Which of the following kinds of price discrimination occurs when each customer is charged one price for the first set of units purchased and a lower

price for subsequent units purchased?

First-degree price discrimination

Second-degree price discrimination

Third-degree price discrimination

This is not an example of price discrimination

Points: 1/1

Explanation: Close Explanation

Second-degree price discrimination occurs when the seller charges a uniform price per unit for one specific quantity, a lower price for an

additional quantity, and so on. Typical applications of this type of price discrimination include bulk pricing, such as that found at big-box
retailers.

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5. Price-discriminating firm

Yakov owns a plot of land in the desert that isn’t worth much. One day, a giant meteor falls on his property. The event attracts scientists and tourists,

and Yakov decides to sell nontransferable admission tickets to the meteor crater to both types of visitors: scientists (Market A) and tourists (Market

B). The following graphs show demand (D) curves and marginal revenue (MR) curves for the two markets. Yakov’s marginal cost of providing
admission tickets is zero.

Market A Market B

10 10

8 8
PRICE (Dollars per ticket)

PRICE (Dollars per ticket)

6 6

4 4

2 2

D
MR A MR D
0 A 0 B B
0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10
QUANTITY (Admission tickets per day) QUANTITY (Admission tickets per day)

Suppose that at first, Yakov charges the same price of $4 per admission in both markets so that the total number of admissions demanded is
8 .

Points: 1/1

Explanation: Close Explanation

At $4 per admission, 6 tickets are demanded in Market A (the interception of the price line and DA curve). Similarly, 2 tickets are demanded in
Market B (the interception of the price line and DB curve). The total quantity demanded is 6 tickets + 2 tickets = 8 tickets .

Suppose now that Yakov decides to charge a different price in each market. To maximize revenue, Yakov should charge $5.00 per

admission in Market A and $3.00 per admission in Market B. At these prices, he will sell a total quantity of 8 admission

tickets per day.

Points: 1/1

Explanation: Close Explanation

Total revenue is maximized when marginal revenue is equal to zero: MR = 0 . In Market A, MRA = 0 when QA = 5 admissions are sold and

scientists are willing to pay PA = $5 per admission. Similarly, in Market B, MRB = 0 when QB = 3 admissions are sold and tourists are willing

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to pay PB = $3 per admission.

Complete the following table by calculating Yakov’s total revenue from selling in both markets under the nondiscriminatory as well as the
discriminatory price policy.

Price Policy Total Revenue

Nondiscriminatory $32.00

Discriminatory $34.00

Points: 1/1

Explanation: Close Explanation

Total revenue under the nondiscriminatory price policy is the product of the number of admissions sold in both markets and the

nondiscriminatory price of $4: (6 tickets + 2 tickets) × $4 = $32 .

Total revenue under the discriminatory price policy is the sum of the products of the number of admissions sold in Market A and the Market A

price and the number of admissions sold in Market B and the price in Market B: 5 tickets × $5 + 3 tickets × $3 = $34 .

Yakov charges a lower price in the market with a relatively high price elasticity of demand.

Points: 1/1

Explanation: Close Explanation

As you found in the last question, Yakov charges a higher price to the scientists. At any given price, scientists have a lower price elasticity of

demand than tourists—that is, scientists’ demand for viewing the meteor is less elastic than tourists’ demand.

Intuitively, this result makes sense—consumers with more elastic demand are more price sensitive than scientists and therefore reduce their

consumption more when higher prices are charged. So, price-discriminating monopolists will charge a lower price to customers who have a

relatively high price elasticity of demand.

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6. Price discrimination and welfare

Suppose Barefeet is a monopolist that produces and sells Ooh boots, an amazingly trendy brand with no close substitutes. The following graph shows

the market demand and marginal revenue (MR) curves Barefeet faces, as well as its marginal cost (MC), which is constant at $20 per pair of Ooh

boots. For simplicity, assume that fixed costs are equal to zero; this, combined with the fact that Barefeet's marginal cost is constant, means that its
marginal cost curve is also equal to the average total cost (ATC) curve.

First, suppose that Barefeet cannot price discriminate. That is, it must charge each consumer the same price for Ooh boots regardless of the

consumer's willingness and ability to pay.

On the following graph, use the black point (plus symbol) to indicate the profit-maximizing price and quantity. Next, use the purple points (diamond

symbol) to shade the profit, the green points (triangle symbol) to shade the consumer surplus, and the black points (plus symbol) to shade the

deadweight loss in this market without price discrimination. (Note: If you decide that consumer surplus, profit, or deadweight loss equals zero,
indicate this by leaving that element in its original position on the palette.)

Your Answer Correct Answer

1, 80
100

90

Monopoly Outcome
80 42.5, 67.5
PRICE (Dollars per pair of Ooh boots)

70

60 Consumer Surplus

50

40 Profit

30

MC = ATC
20
Deadweight Loss
10

MR Demand
0
0 20 40 60 80 100 120 140 160 180 200
QUANTITY (Pairs of Ooh boots)

Points: 1/1

Explanation: Close Explanation

Barefeet will produce the level of output at which its marginal revenue is equal to its marginal cost; this occurs at a quantity of 80 pairs of Ooh

boots. It will charge a monopolist's price of $60 per pair, the maximum amount consumers are willing to pay at this output level.

Recall that profit is equal to total revenue minus total cost:

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Profit = Total Revenue − Total Cost

= (Price × Quantity) − (Average Total Cost × Quantity)
= (Price − Average Total Cost) × Quantity

Therefore, profit is the rectangular area below the monopolist's price of $60, above the average total cost curve, and to the left of the quantity

of Ooh boots produced. Notice that profit is equal to producer surplus, in this case, given the initial assumption that there are no fixed costs.

Consumer surplus is the difference between a buyer's willingness to pay (what the item is worth to the buyer) and the price the buyer actually
pays. Graphically it is the triangular area below the demand curve, above the monopolist's price of $60, and to the left of the equilibrium

quantity of boots consumed.

When the monopolist cannot price discriminate, it charges a price above its marginal cost, so not all consumers who value the good at more

than its marginal cost are able to buy it. Thus, deadweight loss exists and is represented by the triangular area between the demand curve and

the marginal cost curve to the right of the quantity produced. This represents the welfare loss to society due to the higher price charged and

lower quantity sold.

Now, suppose that Barefeet can practice perfect price discrimination—that is, it knows each consumer's willingness to pay for each pair of Ooh boots

and is able to charge each consumer that amount.

On the following graph, use the black point (plus symbol) to indicate the profit-maximizing quantity sold and the lowest price at which the firm sells its

boots. Next, use the purple points (diamond symbol) to shade the profit, the green points (triangle symbol) to shade the consumer surplus, and the

black points (plus symbol) to shade the deadweight loss in this market with perfect price discrimination. (Note: If you decide that consumer surplus,
profit, or deadweight loss equals zero, indicate this by leaving that element in its original position on the palette.)

Your Answer Correct Answer

100

90

Monopoly Outcome 1, 21
80
PRICE (Dollars per pair of Ooh boots)

70

60 Profit
55, 45
50

40 Consumer Surplus

30

MC = ATC
20
Deadweight Loss
10

Demand
0
0 20 40 60 80 100 120 140 160 180 200
QUANTITY (Pairs of Ooh boots)

Points: 1/1

Explanation: Close Explanation

Barefeet will continue to produce until the price it can charge the marginal consumer is equal to the marginal cost of producing that unit.

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Therefore, Barefeet will charge each consumer his or her willingness to pay, and it will supply 160 pairs of Ooh boots.

Under perfect price discrimination, consumer surplus equals zero because the difference between each consumer's willingness to pay and the

price he or she pays is equal to zero. Profit is equal to the difference between the price Barefeet receives for its boots and its average total cost.

Because it receives the maximum price a consumer is willing to pay for each pair, profit is the triangular area below the demand curve, above

the average total cost curve, and to the left of the quantity of boots produced.

When Barefeet can practice perfect price discrimination, every consumer who values a pair of Ooh boots above the monopolist's marginal cost

receives one; although each still pays a price above marginal cost (except for the last consumer to purchase the good), the quantity of boots
produced is the socially efficient quantity. Therefore, there is no deadweight loss under perfect price discrimination.

Consider the welfare effects when the industry operates under a monopoly and cannot price discriminate versus when it can price discriminate.

Complete the following table by indicating under which market conditions each of the statements is true. (Note: If the statement isn't true for either
single-price monopolies or perfect price discrimination, leave the entire row unchecked.) Check all that apply.

Statement Single-price Monopoly Perfect Price Discrimination

Total surplus is not maximized.

There is no deadweight loss associated with the profit-maximizing output.

Barefeet produces a quantity less than the efficient quantity of Ooh boots.

Points: 1/1

Explanation: Close Explanation

Under single-price monopoly (that is, when the monopolist cannot price discriminate), the monopoly charges a price above its marginal cost, so

not all consumers who value the good at more than its marginal cost are able to buy it. Thus, deadweight loss exists and is represented by the
triangular area between the demand curve and the marginal cost curve to the right of the quantity produced. Moreover, total surplus is not

maximized because the quantity of goods produced is less than the socially efficient quantity.

When Barefeet can practice perfect price discrimination, every consumer who values a pair of Ooh boots above the monopolist's marginal cost

receives one; although each still pays a price above marginal cost (except for the last consumer to purchase the good), the quantity of Ooh

boots produced is the socially efficient quantity. Therefore, there is no deadweight loss under perfect price discrimination, and total surplus is

maximized.

You can see this by comparing the sum of consumer surplus and producer surplus (which equals profit in this case). Despite a consumer surplus

of zero in the case of perfect price discrimination, total surplus is maximized; this is not true under a single-price monopoly due to the

deadweight loss.

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7. Regulating a natural monopoly

Consider the local cable company, a natural monopoly. The following graph shows the monthly demand curve for cable services and the company’s

marginal revenue (MR), marginal cost (MC), and average total cost (ATC) curves.

100

90

80
PRICE (Dollars per subscription)

70

60

50

40

30
ATC
20 MC

10

MR D
0
0 2 4 6 8 10 12 14 16 18 20
QUANTITY (Thousands of subscriptions)

Suppose that the government has decided not to regulate this industry, and the firm is free to maximize profits, without constraints.

Complete the first row of the following table.

Short Run
Quantity Price
Pricing Mechanism (Subscriptions) (Dollars per subscription) Profit Long-Run Decision

Profit Maximization 6,000 50 Positive Stay in business

Marginal-Cost Pricing 12,000 20 Negative Exit the industry

Average-Cost Pricing 10,400 28 Zero Stay or exit

Points: 1/1

Explanation: Close Explanation

A natural monopolist chooses its quantity of production by setting marginal revenue equal to marginal cost, which in this case occurs at a

quantity of 6,000 subscriptions. The natural monopolist will then charge the maximum price that it can charge ($50), which is the price on the

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demand curve that corresponds to a quantity of 6,000 subscriptions.

Profit is equal to total revenue minus total cost:

Profit = Total Revenue − Total Cost

= (Price × Quantity) − (Average Total Cost × Quantity)
= ($50 per subscription × 6,000 subscriptions) − ($34 per subscrition × 6,000 subscriptions)
= $96,000

Because price is above average total cost, profit is positive in this case. Therefore, in the long run, the firm will continue to stay in business.

Suppose that the government forces the monopolist to set the price equal to marginal cost.

Complete the second row of the previous table.

Explanation: Close Explanation

Under a marginal-cost pricing rule, price equals marginal cost, and the monopolist will supply the quantity at which the MC curve intersects the

demand curve. This is the quantity that would be provided if the market were competitive. This point occurs at a price of $20 and an output of

12,000 subscriptions.

Profit is equal to total revenue minus total cost:

Profit = Total Revenue − Total Cost

= (Price × Quantity) − (Average Total Cost × Quantity)
= (Price − Average Total Cost) × Quantity

Under this pricing scheme, price is equal to marginal cost, but marginal cost is always below average total cost for a natural monopoly.

Therefore, the cable company operates at a loss in this case, and it will exit the industry in the long run in order to avoid future losses. (Note:

The firm would incur losses even if it reduced output, as long as it is required to price its product at $20 per subscription.)

Suppose that the government forces the monopolist to set the price equal to average total cost.

Complete the third row of the previous table.

Explanation: Close Explanation

Regulators want the cable company to continue to produce in the long run, which requires that the company earn at least a normal accounting

profit (zero economic profit). This outcome occurs at the price where the demand curve intersects the ATC curve. For the cable company, this
occurs at a price of $28 and a quantity of 10,400 subscriptions. At the point where price equals average cost, total revenue exactly equals total

cost, and the monopolist’s economic profit is zero.

True or False: Over time, the cable company has a very strong incentive to lower costs when subject to average-cost pricing regulations.

True

False

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Points: 1/1

Explanation: Close Explanation

Under average-cost pricing, the government will require that the firm charge the price at which long-run average cost intersects the demand
curve. If the firm lowers its costs, it will not realize any economic profit because the government will require the firm to lower its price

accordingly. If the firm’s costs increase, the firm will not suffer economic losses because the government will allow the price to rise accordingly.

As a result, the firm faces no incentive to lower costs and no penalty for allowing costs to rise. The firm’s costs will likely creep upward over

time.

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8. Monopolyversus perfect competition

Consider the daily market for hot dogs in a small city. Suppose that this market is in long-run competitive equilibrium, with many hot dog stands in

the city, each one selling the same kind of hot dogs. Therefore, each vendor is a price taker and possesses no market power.

The following graph shows the demand (D), and supply curves (S = MC ) in the market for hot dogs.

Place the black point (plus symbol) on the graph to indicate the market price and quantity that will result from perfect competition.

Your Answer Correct Answer

Perfect Competition

5.0

4.5

PC Outcome
4.0
PRICE (Dollars per hot dog)

3.5

3.0

2.5
S=MC
2.0

1.5

1.0

0.5
D
0
0 40 80 120 160 200 240 280 320 360 400
QUANTITY (Hot dogs)

Points: 1/1

Explanation: Close Explanation

Under perfect competition, the intersection of the demand and supply curves determines the market equilibrium. Therefore, the market

equilibrium price is $2.00 per hot dog, and the market equilibrium quantity is 200 hot dogs in this case.

Assume that one of the hot dog vendors successfully lobbies the city council to obtain the exclusive right to sell hot dogs within the city limits. This

firm buys up all the rest of the hot dog vendors in the city and operates as a monopoly. Assume that this change doesn't affect demand and that the

new monopoly's marginal cost curve corresponds exactly to the supply curve on the previous graph. Under this assumption, the following graph shows
the demand (D), marginal revenue (MR), and marginal cost (MC) curves for the monopoly firm.

Place the black point (plus symbol) on the following graph to indicate the profit-maximizing price and quantity of a monopolist.

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Your Answer Correct Answer

Monopoly

5.0

4.5

Monopoly Outcome
4.0
PRICE (Dollars per hot dog)

3.5

3.0

2.5
MC
2.0

1.5

1.0

0.5
D
MR
0
0 40 80 120 160 200 240 280 320 360 400
QUANTITY (Hot dogs)

Points: 1/1

Explanation: Close Explanation

The hot dog vendor will produce the level of output at which its marginal revenue is equal to its marginal cost, which occurs at 120 hot dogs per

day. It will charge a monopolist's price of $3.00, the maximum amount consumers are willing to pay at this output level (as determined by the

demand curve).

In the following table, enter the price and quantity that would arise in a perfectly competitive market; then enter the profit-maximizing price and
quantity that would be chosen if a monopolist controlled this market.

Price Quantity
Market Structure (Dollars) (Hot dogs)

Perfect Competition 2 200

Monopoly 3 120

Points: 1/1

Given the summary table of the two different market structures, you can infer that, in general, the price is lower under a

perfectly competitive market , and the quantity is lower under a monopoly .

Points: 1/1

Explanation: Close Explanation

When a monopoly takes over a perfectly competitive industry, all else being equal, the perfectly competitive industry supply curve becomes the

monopoly’s marginal cost curve. For the new monopoly, the marginal revenue curve lies below the market demand curve. The intersection of the
marginal revenue and marginal cost curves causes the monopoly to lower output below the perfectly competitive level. With lower output, but

the same market demand curve, price rises. Therefore, the price is higher under monopoly ($3.00 versus $2.00), and the quantity is higher

under perfect competition (200 hot dogs versus 120 hot dogs).

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9. Examples of price discrimination

Complete the following table by indicating whether or not each scenario is an example of price discrimination.

Hint: To determine whether a scenario is an example of price discrimination, think about whether the market can be segmented into two groups that

pay different prices for the same good.

Price
Discrimination
Scenario Yes No

Hotels charge a higher price for rooms with a nicer view, such as a skyline view or a coastal view. Assume that all consumers
receive a higher utility when staying in a room with a nicer view.

Every year, Lesspay ShoeSource promotes its giant BOGO sale—buy one pair of shoes and get one half off—through
commercials and other means of advertising. Note that the price of one pair of shoes is the regular retail price, so a customer
must buy two pairs of shoes to receive the discount.

Points: 1/1

Explanation: Close Explanation

Price discrimination is the practice of selling the same good at different prices to different types of customers.

Because Lesspay is offering a different price menu for different quantities of shoes, this is an example of price discrimination through bulk
pricing. Lesspay is trying to extract consumer surplus by exploiting the differences among consumers' diminishing marginal utilities of

consumption. To see why this is true, consider the following example. Assume that Sheila's demand for shoes is downward sloping. Sheila is
willing to pay $56 for her first pair of shoes and $34 for a second pair. If the store wants Sheila to purchase two pairs of shoes, it can set its
price at $34 and Sheila will purchase two pairs, paying $68 and enjoying $22 of consumer surplus. An alternative would be for the store to run a

BOGO half-off sale with the price of a pair of shoes set at $56. With this sale, Sheila still purchases two pairs of shoes. She purchases the first
pair because she is willing to pay $56 for the first pair and buys the second pair because she is willing to pay $34 for it, but it costs her only

$28. But Sheila's purchase of two pairs of shoes now costs her $84 instead of $68, and her consumer surplus falls from $22 to $6.

The existence of various prices is not considered price discrimination if the good being sold is not identical. For example, a hotel room with a

nice view is technically a different good from a hotel room with a standard view. Therefore, the difference in price is simply a result of the

difference in the quality of the good, not of price discrimination.

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10. The Sherman and Clayton Acts

The Clayton Act of 1914 classifies several business practices as illegal, including price discrimination and tying contracts, if they "substantially lessen

competition or tend to create a monopoly."

The Clayton Act of 1914 is an example of which of the following?

Price regulations

Antitrust laws

Points: 1/1

Explanation: Close Explanation

Government laws and policies that are used to prevent or eliminate monopolies are known as "antitrust laws."

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11 . Individual Problems 9-4

Relative to managers in more monopolistic industries, managers in more competitive industries are more likely to spend their time on

reducing costs rather than on pricing strategies.

Points: 1/1

Explanation: Close Explanation

Products produced in competitive industries have many close substitutes. Furthermore, firms in competitive industries have many rivals and face

minimal barriers to entry and exit. In such industries, because demand is highly elastic, increases in price are not profitable. Instead, the
primary way to increase profits in competitive industries is to reduce costs. Compared with managers in monopolistic industries, managers in

competitive industries spend time more usefully on reducing costs.

On the other hand, monopolies have no rivals, because such firms produce products or services with no close substitutes, and barriers to entry
in these industries prevent other firms from entering in the short run and competing on price. As such, firms in monopolistic industries can
increase price up to a certain point while also increasing profits. Therefore, relative to managers in competitive industries, managers in

monopolistic industries are more likely to spend time formulating pricing strategies.

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12 . Individual Problems 9-5

Describe the difference in economic profit between a competitive firm and a monopolist in both the short and long run. Which should take longer to

reach the long-run equilibrium?

In the short run, both monopolists and competitive firms can earn positive economic profits. In the long run,

neither monopolists nor competitive firms can earn a positive economic profit.

Points: 1/1

Explanation: Close Explanation

Monopolists have no rivals, because they produce a product or service with no close substitutes and enjoy high barriers to entry, which prevent
potential competitors from entering the industry. For example, pharmaceutical companies with patents on new drugs are likely to enjoy
monopoly power, since a patent ensures that there will be no close substitutes or competitors for a period of time. These barriers to entry and

lack of substitute products allow monopolies to earn positive profits in the short run. In the long run, however, even the barriers that protect
monopolists in the short run eventually fall; for example, patents expire, and other firms become able to develop close substitutes or invent new

products that can compete with the products produced by monopolies. Thus, in the long run, even monopoly economic profit is driven to zero.

By contrast, competitive firms face constant competition from rival firms producing substitute products as well as new firms that are free to
enter the industry (due to low barriers to entry). These factors drive any positive economic profits, which may exist in the short run, to zero for

all firms in a competitive industry in the long run.

True or False: The adjustment to long-run equilibrium occurs more quickly for monopolists than for competitive industries.

True

False

Points: 1/1

Explanation: Close Explanation

While long-run adjustments drive economic profit to zero in the long run for both competitive industries and monopolies, this adjustment will
likely occur more rapidly in competitive industries than in monopolies. This is due in large part to the freedom of entry and exit that is present in

a competitive market, causing any positive or negative economic profit to adjust quickly to zero. If there are positive economic profits, firms can

quickly enter the industry and drive economic profits to zero. If negative economic profit is present, firms will exit the industry rapidly until

economic profit for the remaining firms rises to zero. In the case of monopolies, barriers to entry, such as patents or ownership of natural
resources, are more likely to last longer and greatly slow the long-run adjustment to zero economic profit.

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13 . Individual Problems 10-4

Consider the U.S. passenger airline industry through the lens of the Five Forces model. The industry, composed of many similar airlines, requires high

fixed costs and is experiencing relatively low growth.

Based on this information, rivalry among existing firms will tend to be high . All else equal, this implies that the airline industry is

less attractive to enter.

Points: 1/1

Explanation: Close Explanation

According to Michael Porter, a Harvard Business School professor, the most attractive industries to enter are characterized by:

• Low threat of entry (or high barriers to entry)

• Low buyer power

• Low supplier power

• Low threat from substitutes

• Low levels of rivalry between existing firms

If a large number of similarly situated firms compete in an industry with high fixed costs and slow industry growth, rivalry is likely to be high.

Rivalry also tends to be higher when products are not well differentiated and buyers find it easy to switch between products, which is also the

case with air travel. This high level of rivalry erodes profits and makes the industry less attractive to potential entrants.

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14 . Conditions for monopolistic competition

Consider the monopolistically competitive market structure, which has some features of a competitive market and some features of a monopoly.

Complete the following table by indicating if each attribute characterizes a competitive market, a monopolistically competitive market, both, or

neither. Check all that apply.

Attributes Competitive Market Monopolistically Competitive Market

Price taker

Identical products

Few sellers

Free entry

Points: 1/1

Explanation: Close Explanation

A monopolistically competitive market is characterized by the following attributes:

• Many sellers

• Product differentiation

• Free entry

Under monopolistic competition, many firms compete for the same group of customers. Additionally, each firm produces a product that is at

least slightly different from that of other firms, while free entry into the market allows firms to enter (or exit) the market without restriction.

Monopolistically competitive firms—like monopoly firms but unlike competitive ones—are not price takers; thus, they face a downward-sloping
demand curve. However, profit for monopolistically competitive firms—as for perfectly competitive firms but not monopoly firms—is driven to

zero in the long run as the demand for each firm's product adjusts with the entry and exit of other firms until price equals average total cost.

Like oligopoly, monopolistic competition lies “between” the extreme market structures of perfect competition and monopoly. However

monopolistic competition is characterized by many sellers, whereas oligopoly is characterized by a relatively small number of large firms,

making rigorous competition less likely and increasing the importance of strategic interactions between firms.

Therefore, monopolistic competition differs from perfect competition in that differentiated products are sold and firms are not price takers.

However, monopolistic competition resembles perfect competition in that there is free entry, many sellers, and zero profit in the long run.

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15 . How short-run profits or losses induce entry or exit

Suppose that the market for bottles of scotch is a monopolistically competitive market.

For various monthly production quantities, the following graph shows a typical firm's marginal cost curve (MC), average total cost curve (ATC),

demand curve (Demand), and marginal revenue curve (MR) in the short run.

Short Run

500

450
PRICE AND COSTS (Dollars per bottle)

400

350

300
ATC

250

200

150 Demand

100 MC

50

MR
0
0 50 100 150 200 250 300 350 400 450 500
QUANTITY (Bottles per month)

According to the graph, a typical firm in this market is suffering an economic loss . Therefore, in the long run, firms will
exit the market.

Points: 1/1

Explanation: Close Explanation

According to the graph, the typical firm is incurring an economic loss. A monopolistically competitive firm's profit-maximizing output corresponds
to an output where marginal revenue equals marginal cost. At this level of output, the average total cost curve is above the demand curve, so

the price is less than the average total cost. Total cost exceeds total revenue, so the firm is suffering an economic loss. Therefore, some firms

will begin to exit the market in the long run, and firms that remain in the industry will see an outward shift in their individual demand curves.

Firms will continue to exit until the average total cost curve for the remaining firms is tangent to the demand curve, and each firm earns zero
profit.

Now the following graph shows a typical firm's marginal cost curve (MC), average total cost curve (ATC), demand curve (Demand), and marginal

revenue curve (MR) in the long run.

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Long Run

500

450
PRICE AND COSTS (Dollars per bottle)

400

350

300
ATC

250

200
Demand
150

100 MC

50

MR
0
0 50 100 150 200 250 300 350 400 450 500
QUANTITY (Bottles per month)

Consider the long-run equilibrium in a monopolistically competitive market. The typical firm will produce 275 bottles of scotch per month, which is

less than the minimum-cost level of output.

Points: 1/1

Explanation: Close Explanation

In the long-run equilibrium, the typical firm in a monopolistically competitive market produces at a quantity such that it makes zero profit. This

occurs at 275 bottles of scotch. At this quantity, total revenue exactly equals total cost (275 bottles × $300 per bottle = $82,500 ). Note that this
level of output is on the downward-sloping portion of the U-shaped average total cost curve, which means that it is less than the minimum-cost

level of output. The minimum-cost level of output corresponds to the lowest point on the average total cost curve. In general, firms in a

monopolistically competitive market produce less than the output at which average total cost is at its minimum. This is known as excess

capacity.

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16 . Entry or exit in the long run

Kitsch Bikes is a company that manufactures bikes in a monopolistically competitive market. Assume that Kitsch is operating in the short run.

The following graph shows Kitsch's annual demand curve (Demand), marginal revenue curve (MR ), marginal cost curve (MC ), and average total cost

curve (ATC ).

Place the grey point (star symbol) on the graph to indicate the profit-maximizing price and quantity for the company. Then determine if the company
is experiencing a profit or a loss. If they are experiencing a profit, use the green rectangle (triangle symbols) to shade the area representing the

company's profit. However, if they are suffering from a loss, use the purple rectangle (diamond symbols) to shade the area representing the
company’s loss.

Note: Select and drag the rectangles from the palette to the graph. To resize, select one of the points on the rectangle and move to the desired
position.

Your Answer Correct Answer

100

90

Mon Comp Outcome

80

70
PRICE (Dollars per bike)

60 Profit
ATC
50

40 Loss

30 Demand

20 MC

10

MR
0
0 10 20 30 40 50 60 70 80 90 100
QUANTITY (Thousands of bikes)

Points: 1/1

Explanation: Close Explanation

A firm in a monopolistically competitive market will produce up to the point where its marginal revenue equals marginal cost, MR = MC . This
occurs at a quantity of 50,000 bikes per year. At the same time, because Kitsch operates in a monopolistically competitive market, it faces a

downward-sloping demand curve, which means that at that quantity Kitsch will charge a price of $60 per bike. Therefore, the grey point (star
symbol) at (50, $60) indicates the profit-maximizing price and quantity for the company. Average total cost at this quantity is $55 per bike.

Thus Kitsch's profit is defined by the area of the green-shaded rectangle (triangle symbols), which is between $60 and $55 per bike, and zero

and 50,000 bikes. You could calculate the area as follows:

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Profit = Total Revenue − Total Cost

= (Price × Quantity) − (Average Total Cost × Quantity)
= ($60 per bike × 50,000 bikes) − ($55 per bike × 50,000 bikes)
= $3,000,000 − $2,750,000
= $250,000

Therefore, in the short run, Kitsch Bikes receives a profit of $250,000 per year.

Now consider the long run, in which bike manufacturers are free to enter and exit the market.

Show the possible effect of this free entry and exit by shifting the demand curve for a typical individual producer of bikes on the following graph.

Note: Select and drag the curve to the desired position. The curve will snap into position, so if you try to move a curve and it snaps back to its
original position, just drag it a little farther.

Your Answer Correct Answer

Demand
PRICE (Dollars per bike)

D
1

D
2

QUANTITY (Bikes)

Points: 1/1

Explanation: Close Explanation

Entry by additional producers into a monopolistically competitive market will lead to a leftward shift of the demand curve facing a typical

producer. That is, given that a typical bike manufacturer is making a profit in the short run, some firms will have an incentive to enter the
market in the long run. Because the number of products customers can choose from increases, the demand faced by each firm already in the

market decreases as additional varieties create competition. Thus, at any given price, quantity demanded for each firm falls.

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17 . Is monopolistic competition efficient?

Suppose that a firm produces polo shirts in a monopolistically competitive market. The following graph shows its demand curve, marginal revenue

(MR) curve, marginal cost (MC) curve, and average total cost (ATC) curve.

Place a black point (plus symbol) on the graph to indicate the long-run monopolistically competitive equilibrium price and quantity for this firm. Next,

place a grey point (star symbol) to indicate the minimum average total cost the firm faces and the quantity associated with that cost.

Your Answer Correct Answer

100

90

Mon Comp Outcome

80

70
PRICE (Dollars per shirt)

60 Min Unit Cost

50

ATC
40

30

20
MC
10

MR Demand
0
0 10 20 30 40 50 60 70 80 90 100
QUANTITY (Thousands of shirts)

Points: 0.5 / 1

Explanation: Close Explanation

A firm in a monopolistically competitive market chooses its quantity of production by setting marginal revenue equal to marginal cost, which

occurs at 30,000 shirts in this case. The firm will then charge the maximum price that it can charge ($55 per shirt), which is the price on the

demand curve that corresponds to a quantity of 30,000 shirts.

The minimum average total cost occurs where the average total cost curve and the marginal cost curve intersect. This occurs at a price of $40

per shirt and a quantity of 60,000 shirts. The quantity where the average total cost is minimized is also known as the efficient scale.

Because this market is a monopolistically competitive market, you can tell that it is in long-run equilibrium by the fact that P = ATC at the

optimal quantity for each firm. Furthermore, the quantity the firm produces in long-run equilibrium is greater than the efficient scale.

Points: 0.5 / 1

Explanation: Close Explanation

Under monopolistic competition, P = ATC in the long run for monopolistically competitive firms because firms earn zero profit. However, a

monopolistically competitive firm sets P > MC , which means that P = ATC > MC in the long run. Since ATC is minimized when ATC = MC ,

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the firm's average total cost in long-run equilibrium is greater than the minimum average total cost, and the quantity the firm produces in long-

run equilibrium is less than the efficient scale.

True or False: This indicates that there is excess capacity in the market for shirts.

True

False

Points: 1/1

Explanation: Close Explanation

Excess capacity occurs when firms produce quantities that are less than the efficient scale. The efficient scale refers to the quantity at which
firms minimize average total cost, which occurs at 60,000 shirts in this case. Both monopolistically competitive firms and competitive firms

produce up to the point where P = ATC . However, because the demand curve facing a monopolistically competitive firm is downward sloping,
P = ATC > MC at the profit-maximizing quantity, the quantity produced must be less than the efficient scale, and there is excess capacity in
this case.

Excess Capacity
PRICE (Dollars per shirt)

ATC

MC

MR Demand
Q Efficient Scale

QUANTITY (Thousands of shirts)

Monopolistic competition may also be socially inefficient because there are too many or too few firms in the market. The presence of the
business-stealing externality implies that there is too little entry of new firms in the market.

Points: 0/1

Explanation: Close Explanation

Sometimes the number of firms in a monopolistically competitive market is not “ideal” because there is too much or too little entry. When a new
firm is deciding whether to enter the market with a new product, it considers only the profit it would make. However, its entry has two effects

that are external to the firm:

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Product-variety externality Entry of a new firm conveys a positive externality on consumers because they get some consumer surplus

from the introduction of a new product.

Business-stealing externality Entry of a new firm imposes a negative externality on existing firms because this causes other firms to
lose customers and profit.

Therefore, if there is too little entry in a monopolistically competitive market, this means the product variety externality is present.

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18 . The market for EpiPens

Consider the pharmaceutical company Mylan that produces epinephrine injection devices called EpiPens. In the presence of other firms producing

substitutes for this good, the price of EpiPens is $150.

Now suppose that competitors to Mylan no longer produce epinephrine injection devices, so Mylan now has pricing power in this market. As the

economist on staff at Mylan, you are charged with the task of figuring out what your company’s new pricing strategy should be.

The following graph shows the marginal cost (MC), which is assumed to be constant, and the average total cost (ATC) of Mylan. The graph also shows
the demand curve (D) for EpiPens and the marginal revenue curve (MR) once the firm has market power.

On the graph, use the grey point (star symbol) to indicate the quantity of EpiPens demanded if Mylan continues to charge $150. Dashed drop lines will

automatically extend to both axes.

Your Answer Correct Answer

1000

900

800 Q at $150
D
PRICE (Dollars per EpiPen)

700

600 Profit Max

500

400 ATC at Profit Max

300

200
ATC Profit
100 MC
MR D
0
0 1 2 3 4 5 6 7 8 9 10
QUANTITY (Thousands of EpiPens)

Points: 1/1

If Mylan continues to charge $150 per EpiPen, Mylan will earn negative economic profit.

Points: 1/1

Explanation: Close Explanation

According to the demand curve for EpiPens, consumers will demand 7,250 EpiPens if Mylan continues to charge $150 per device.

Economic profit is total revenue minus total cost:

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Aplia: Student Question 30/11/2021, 11:45 PM

Economic Profit = Total Revenue − Total Cost

= (Price × Quantity) − (Average Total Cost × Quantity)
= (Price − Average Total Cost) × Quantity

At this quantity, the average total cost is greater than the price of an EpiPen, so economic profit is negative.

True or False: Given the demand curve for EpiPens, you should tell Mylan’s CEO that total revenue will increase if she raises the price of EpiPens
because the demand curve in this region is relatively inelastic.

True

False

Points: 0/1

Explanation: Close Explanation

The price elasticity of demand measures the responsiveness of consumers to changes in price. For example, if consumers change their

purchasing behavior very little in response to a drastic change in price, demand is said to be inelastic; if consumers change their purchasing

behavior a lot in response to a small change in price, demand is said to be elastic.

Mathematically, the price elasticity of demand is the percentage change in quantity divided by the percentage change in price. This means that

when the price elasticity of demand is less than 1 (in absolute value), demand is relatively inelastic. If the CEO raises the price of EpiPens by
50% (from $150 to $225), quantity demanded falls by less than 50% (from 7,250 devices to 6,875). Therefore, demand is relatively inelastic in

this region:

Percentage Change in Quantity < Percentage Change in Price

Percentage Change in Quantity
< 1
Percentage Change in Price
Price Elasticity of Demand < 1

Total revenue is equal to price times quantity. Because price and quantity move in opposite directions when you move along a demand curve,

a price change will cause total revenue to move in the direction of whichever variable is overpowering. When demand is inelastic, the

percentage change in price is larger than the percentage change in quantity. This means that total revenue will move in the same direction as
the price change; when price increases, so does total revenue; when price decreases, total revenue decreases as well. Therefore, this statement

is true.

On the previous graph, use the black point (plus symbol) to indicate the profit-maximizing price and quantity. Dashed drop lines will automatically

extend to both axes.

Explanation: Close Explanation

The profit-maximizing quantity occurs at the intersection of the marginal revenue and marginal cost curves, or 3,750 EpiPens in this case. Mylan

will charge a price ($850) on the demand curve that corresponds to the point at which the quantity demanded equals 3,750 EpiPens, because

this is the maximum amount consumers are willing and able to pay for this quantity of devices.

On the previous graph, use the purple point (diamond symbol) to indicate the average total cost at the profit-maximizing quantity. Then use the green

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Aplia: Student Question 30/11/2021, 11:45 PM

rectangle (triangle symbols) to shade the area indicating the firm’s economic profit.

Explanation: Close Explanation

Economic profit is total revenue minus total cost:

Economic Profit = Total Revenue − Total Cost

= (Price × Quantity) − (Average Total Cost × Quantity)
= (Price − Average Total Cost) × Quantity

Graphically, the rectangular area with a width equal to the profit-maximizing quantity (3,750 EpiPens) and a height equal to the difference

between the profit-maximizing price and average total cost at that quantity ($850 − $250 = $600 ) represents economic profit.

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