3. Why is there no market supply curve under conditions of
monopoly?
The monopolist’s output decision depends not only on
marginal cost, but also on the demand curve.
Shifts in demand do not trace out a series of prices and quantities that
we can identify as the supply curve for the firm. Instead, shifts in demand lead to changes in
price, output, or both. Thus, there is
no one-to-one correspondence between the price and the seller’s quantity;
therefore, a monopolized market lacks a supply curve.
4. Why might a
firm have monopoly power even if it is not the only producer in the market?
The degree of monopoly power or market power enjoyed by a
firm depends on the elasticity of the demand curve that it faces. As the elasticity of demand increases, i.e.,
as the demand curve becomes flatter, the inverse of the elasticity approaches
zero and the monopoly power of the firm decreases. Thus, if the firm’s demand curve has any
elasticity less than infinity, the firm has some monopoly power.
5. What are some
of the sources of monopoly power? Give
an example of each.
The firm’s exploitation of its monopoly power depends on
how easy it is for other firms to enter the industry. There are several barriers to entry,
including exclusive rights (e.g., patents, copyrights, and licenses) and economies of scale. These two barriers to entry are the most
common. Exclusive rights are legally
granted property rights to produce or distribute a good or service. Positive economies of scale lead to “natural
monopolies” because the largest producer can charge a lower price, driving
competition from the market. For example, in the production of aluminum, there
is evidence to suggest that there are scale economies in the conversion of
bauxite to alumina. (See U.S. v. Aluminum Company of America, 148
F.2d 416 [1945], discussed in Exercise 8, below.)
6. What factors
determine the amount of monopoly power an individual firm is likely to
have? Explain each one briefly.
Three factors determine the firm’s elasticity of
demand: (1) the elasticity of market
demand, (2) the number of firms in the market, and (3) interaction among the
firms in the market. The elasticity of
market demand depends on the uniqueness of the product, i.e., how easy it is
for consumers to substitute away from the product. As the number of firms in the market
increases, the demand elasticity facing each firm increases because customers
may shift to the firm’s competitors. The
number of firms in the market is determined by how easy it is to enter the
industry (the height of barriers to entry).
Finally, the ability to raise the price above marginal cost depends on
how other firms react to the firm’s price changes. If other firms match price changes, customers
will have little incentive to switch to another supplier.
7. Why is there a
social cost to monopoly power? If the
gains to producers from monopoly power could be redistributed to consumers,
would the social cost of monopoly power be eliminated? Explain briefly.
When the firm exploits its monopoly power to raise the
price above marginal cost, consumers buy less at the higher price. Consumers enjoy less surplus, the difference
between the price they are willing to pay and the market price on each unit
consumed. Some of the lost consumer
surplus is not captured by the seller and is a deadweight loss to society. Therefore, if the gains to producers were
redistributed to consumers, society would still suffer the deadweight loss.
8. Why will a
monopolist’s output increase if the government forces it to lower its
price? If the government wants to set a
price ceiling that maximizes the monopolist’s output, what price should it set?
By restricting price below the monopolist’s
profit-maximizing price, the government can change the shape of the firm’s
marginal revenue, MR, curve. When a price ceiling is imposed, MR is equal to the price ceiling for all
quantities lower than the quantity demanded at the price ceiling. If the
government wants to maximize output, it should set a price equal to marginal
cost. Prices below this level induce the
firm to decrease production, assuming the marginal cost curve is upward
sloping. The regulator’s problem is to
determine the shape of the monopolist’s marginal cost curve. This task is difficult given the monopolist’s
incentive to hide or distort this information.
9. What would the social gain be if this monopolist were
forced to produce and price at the competitive equilibrium? Who would gain and lose as a result?
The social gain
arises from the elimination of deadweight loss.
Deadweight loss in this case is equal to the triangle above the constant
marginal cost curve, below the demand curve, and between the quantities 5.67 and
11.3, or numerically
(18.5-10)(11.3-5.67)(.5)=$24.10.
Consumers gain this deadweight loss plus the monopolist’s
profit of $48.17. The monopolist’s
profits are reduced to zero, and the consumer surplus increases by $72.27.