Solutions for Topic 9: Monopolies

Question 9.1

If the monopolist's demand curve is downward sloping, then the marginal revenue curve is

        A)           horizontal

        B)            vertical

        C)            downward sloping with the same slope

        D)           downward sloping with steeper slope

        E)            downward sloping with more gentle slope

The correct answer is (D).

When demand curve is a downward sloping straight line, the marginal revenue is also a downward sloping straight line, and it is twice the slope of the demand curve.

Question 9.2

For perfectly competitive firm price _____ marginal revenue, and for monopolist price ____ marginal revenue.

        A)           equals; equals

        B)            equals; is greater than

        C)            equals; is less than

        D)           is greater than; equals

        E)            is less than; equals

The correct answer is (B).

For perfect competition, price is fixed for every unit.  The firm will always earn an additional revenue equal to the price when selling one more unit.

For monopoly, price drops for all units when selling one more unit of output.  The firm earns an additional revenue less than the price when selling one more unit

Perfect Competition                                                               Monopoly

Q     P             TR           MR                                         Q             P             TR           MR

1      5              5              5                                              1              5              5              5

2      5              10           5                                              2              4              8              3

3      5              15           5                                              3              3              9              1

Question 9.3

Perfect competition is efficient and monopoly is not because in perfect competition __________ while in monopoly __________.

        A)           P=MC; P>MC

        B)            P=MC; P<MC

        C)            P<MR; P=MR

        D)           P=MR; P=MC

        E)            P=MR; P<MR

The correct answer is (A).

For perfect competition, the optimal output is P = MC, which means allocative efficiency.

For monopoly, the optimal output is MR = MC.  Since P > MR, at the optimal output P > MC, implies allocative inefficiency.

Question 9.4

(a) Explain why a firm that practices price discrimination tend to earn a higher profit than one that charge a single price.

(b) If the demand for residential phone line is elastic while the demand for commercial phone line is inelastic, what should the telecommunication firm do to its pricing in order to maximize profit?

(a) Different consumers have different willingness to pay.  If the firm charge a single price to all customers, some consumers may actually be willing to pay more and hence they enjoy consumer surplus.  With price discrimination, the firm can charge a higher price to those who are willing to pay more, hence profit can be increased.

(b) The firm should charge a higher price for commercial phone and a lower price for residential phone in order to maximize profit.

Question 9.5

(1) Can a monopoly incur losses?

(2) Is the monopoly always inefficient compared to perfect competition?

(1) A monopoly need not always earn economic profit.  Economic profit occurs when P > ATC but some monopolists may encounter price control such that they operate at a loss.  They need the government subsidy to remain operational.

(2) A natural monopoly can be more efficient than perfect competition when there are economies of scale to exploit.  Also a monopolist that practice perfect price discrimination is as efficient as perfect competition.