Chapter 9 Solutions

6. (Revenue Schedules) Explain why the marginal revenue curve for a monopolist lies below its demand curve, rather than coinciding with the demand curve, as is the case for a perfectly competitive firm. Is it ever possible for a monopolist’s marginal revenue curve to coincide with its demand curve?

The perfectly competitive firm faces a perfectly elastic demand curve, indicating that it can sell additional units of its output without lowering its price. Thus, each additional unit has a marginal revenue equal to the prevailing market price. However, the monopolist faces a downward-sloping demand curve, indicating that it can sell additional units of its output only by lowering the price on all units. If the monopolist lowers its price, it gains revenues by selling more units but loses revenues on units that were previously selling at the higher price. Marginal revenue is the difference between the revenue gain from selling one more unit (which is the price of the unit) and the revenue loss from lowering the price on the other units. Thus, beginning with the second unit sold, marginal revenue is below the price, and the marginal revenue curve is below the demand curve. A monopolist’s marginal revenue curve can coincide with its demand curve if the firm is practicing perfect price discrimination—selling each unit for a different price.

7. (Revenue Curves) Why would a monopoly firm never knowingly produce on the inelastic portion of its demand curve?

In this portion of the demand curve demand is inelastic with respect to price. When demand is inelastic, a decrease in price actually reduces total revenue in spite of the increased unit sales. Thus, marginal revenue is negative. In addition, total cost is higher since output is increased, so profit must fall. Therefore, a firm will never produce where marginal revenue is negative.

8. (Profit Maximization) Review the following graph showing the short-run situation of a monopolist. What output level will the firm choose in the short run? Why?

Chapter 9 Solutions

The firm will shut down in the short run. Average total cost exceeds average revenue at all output levels, indicating that the monopolist cannot earn a normal profit in the short run. In addition, average variable cost also exceeds average revenue. Thus, if the firm operates in the short run, it will suffer a loss equal to its fixed cost plus the uncovered portion of its variable cost. It minimizes its loss by shutting down so that the loss equals only fixed cost.

9. (Allocative and Distributive Effects) Why is society worse off under monopoly than under perfect competition, even if both market structures face the same constant long-run average cost?

Because the monopolist’s demand curve slopes downward, it produces at a point where price exceeds marginal cost. Thus, there are additional units of output for which the marginal value to consumers exceeds the marginal cost to produce them, but the monopolist maximizes profit by producing the smaller output. Consumer surplus is lower than in perfect competition. Part of this reduction is redistributed to the monopolist as profit, but part is a deadweight loss to society.

10. (Welfare Cost of Monopoly) Explain why the welfare loss of a monopoly may be smaller or larger than the loss shown in Exhibit 8 in this chapter.

The loss may be smaller because a monopolist may have economies of scale that are not available to a perfectly competitive firm and, thus, can charge a lower price. A monopolist may charge a lower price to discourage entry of new firms or in response to political pressure. The loss may be larger because resources may be diverted from more productive uses to secure the monopolist’s position (rent seeking). Lack of competition may eliminate pressure for the monopolist to maximize efficiency or to be innovative.

11. (CaseStudy: The Mail Monopoly) Can the U.S. Postal Service be considered a monopoly in first-class mail? Why or why not? What has happened to the price elasticity of demand for first-class mail in recent years?

Chapter 9 Solutions

A monopoly is a single firm producing a unique product that has no close substitutes. The development of new technologies and services has led to several close substitutes for first-class mail—fax machines, e-mail services, and overnight mail services by firms such as UPS and Federal Express. Many customers now use these methods in place of the U.S. Postal Service’s first-class mail, seriously eroding the Postal Service’s control of the market—reducing its monopoly power. The availability of substitutes has greatly increased the elasticity of demand for first-class postage.

12. (Conditions for Price Discrimination) What conditions must be met in order for a monopolist to price discriminate successfully?

Several conditions must be met for successful price discrimination. First, the firm must be a price maker—that is, it must have some control over its price. Second, it must be able to separate consumers into two or more groups with different elasticities of demand. Finally, the firm must be able to prevent the group facing the lower price from reselling the product to the group facing the higher price.

13. (Price Discrimination) Explain how it may be profitable for South Korean manufacturers to sell new autos at a lower price in the United States than in South Korea, even with transportation costs included.

This is a simple price discrimination problem. One need only assume that the demand elasticity in the United States is greater than in Korea. This assumption is reasonable if the U.S. market has more substitutes. Also, the long distance would prevent U.S. buyers from reselling in Korea. Price discrimination calls for a higher price in Korea, where the price elasticity of demand is lower. (By the way, it appears that autos are indeed sold at a higher price in Korea than in the United States.)

14. (Perfect Price Discrimination) Why is the perfectly discriminating monopolist’s marginal revenue curve identical to the demand curve it faces?

The perfectly discriminating monopolist can charge a different price for each unit as output expands. By increasing output by one unit, the perfectly discriminating monopolist loses no revenue from previous output since the prices attached to previous units do not change. The gain in revenue is therefore just the price charged on the marginal unit.

Answers to Problems and Exercises15. (Short-Run Profit Maximization) Answer the following questions on the basis of the

monopolist’s situation illustrated in the following graph.

Chapter 9 Solutions

a. At what output level and price will the monopolist operate?b. In equilibrium, what will be the firm’s total cost and total revenue?c. What will be the firm’s profit or loss in equilibrium?

a. It will produce 100 units of output and sell them at a price of $10 eachb. Total cost of $750; total revenue of $1,000c. Economic profit of $250