Exercise session 6
1. A monopoly firm can sell 150 units of output for $10 per unit. Alternatively, it can sell 151
units of output for $9.90 per unit. The marginal revenue of the 151st unit of output is
a. -$5.10.
b. -$0.10.
c. $2.45.
d. $5.90.
2. Why might economists prefer private ownership of monopolies over public ownership of
monopolies? Explain.
The private monopolist is governed by the market. Even though the market solution is
sub-optimal, it may be better than outcomes generated by publicly owned monopolies.
Publicly owned monopolies may restrict output to levels below the private market outcome
and thus generate an even lower level of social surplus than a private profit-maximizing
monopolist. Private owners have an incentive to minimize cost as long as they reap benefits
in the form of higher profits. Government bureaucrats have no incentive to reduce costs.
The losers are customers and taxpayers, whose only recourse is the political system.
3. For each question, state clearly whether you find the statement to be true, false, or uncertain.
Then provide a clear explanation.
(a) Hockey is a public good.
Uncertain. It’s not a pure public good. If we’re talking about the attendance of a hockey
the game, then the good is clearly excludable (you need a ticket to get in) and it’s rival to
the extent that once the seats are full, one person’s presence excludes another from
viewing. Hockey on television is less excludable and is entirely non-rival. So arguably it’s
more of a public good. Excludability is the issue here. If it’s shown on free TV (as opposed
to cable), then anyone can watch it. But can people watch it without paying? Depends how
you view advertising. In order to watch a hockey game on TV, you’re basically forced to
watch advertising (you have to engage in costly activities to avoid the ads). This can be
viewed as a form of the admission fee, which implies excludability. So, it’s certainly not a
pure public good, but it’s also not a pure private good. Hence, it’s likely to be
underprovided (as some are now sorely aware). This could be used as justification for
government intervention in the current labor dispute.
(b) The free-rider problem tends to get worse as the number of beneficiaries from a
public good rises.
True. The free-rider problem arises when you believe someone else will provide the good
for you. The more people there are to provide the good for you, the more you can rely on
those other sources of provision. Also, the more people there are, the more the gap is
between one person’s personal valuation of an extra unit of the good, and societies
marginal valuation of the good. Free-riding on things like doing the dishes is much less
likely to be a problem when you have one roommate than when you have ten.
(c) Because drivers of cars have their own life on the line, they will exert the efficient
level of care when driving.
False. We can think of driver carefulness as a good with an associated positive externality.
My being careful benefits me primarily, but also has spillover benefits for others on the
road. I’ll be careful up to the point where the marginal benefit to me equals the marginal
cost to me. But others are benefiting as well from my care, implying that the MSB curve
lies above my private MB curve. Thus, I will be providing too little care, from a social
welfare (efficiency) perspective. Just because my life is on the line doesn’t mean I take
sufficient care to account for the external benefits.
(d) Assuming you and I benefit from a public good, your marginal benefit for the last unit
consumed must equal my marginal benefit from the last unit consumed, for efficiency
to hold.
False. For private goods where everyone consumes at least some of the good, MB for
person A must equal MB for person B in order for efficiency to hold. Otherwise we could
take some of the good away from the person with lower marginal benefit and give it to the
person with higher marginal benefit, while compensating the person with the lower
marginal benefit. This would increase overall social welfare. Hence with private goods,
MB must be equal across all consumers for each good consumed. For public goods, this is
not the case. All consumers consume the same amount of the good. For some, the last unit
of the good may give very little benefit. For others, it may give significant benefit. Suppose
I get MB=1 out of the last unit consumed and you get MB=4. If the two of us make up
society as a whole, then we know that as long as Q is such that MC=5, the good is being
efficiently provided. We don’t need our individual MBs to be equal.
4. A monopoly operated in a market with (inverse) demand 𝑃(𝑄)=20 −
𝑄
5
. The marginal cost is
10.
(a) Find the monopoly’s optimal output and price
the optimal quantity will be defined from the condition MR=MC: 𝑅(𝑄)=𝑄∗𝑃(𝑄)=𝟐𝟎𝑸 −
𝑸 𝟐
𝟓
therefore 𝑀𝑅(𝑄)= 𝟐𝟎 −
𝟐𝑸
𝟓
, hence, from 𝑀𝑅(𝑄)= 𝟐𝟎 −
𝟐𝑸
𝟓
=10, we get that Q*=25, plugging
this value into the (inverse) demand function will give: P*=15.
(b) Compute the deadweight loss (DWL) due to the monopoly.
If 𝑃=𝑀𝐶=10, then 𝑄=100−5P=100−5∗10=50, therefore 𝐷𝑊𝐿=
𝟏
𝟐
(15−10)∗(50−25)=62.5
(drawing the graph would help you calculate the DWL more easily).
7. If a non-discriminating monopolist decides to lower its price to sell one more unit of its
product, then
a. total revenue rises by an amount equal to the price
b. some revenue is lost to the extent that units previously sold at a higher price now sell
for a lower price; however, the additional unit sold brings in new revenue
c. marginal revenue increases when total revenue increases
d. the net effect on total revenue is typically zero since the price must fall
e. the net effect on total revenue is typically negative since the price must fall
8. Suppose that a non-discriminating monopolist lowers its price from $75 to $70 in order to sell
more output. Marginal revenue will
a. equal $75
b. equal $70
c. be between $75 and $70
d. be less than $70
e. be greater than $75
9. What is the total profit (or loss) for the (single-price) monopolist shown in Figure?
a. profit of cbgf
b. loss of fcbg
c. profit of egbd
d. loss of edcf
e. profit of edcf
10. The Figure shows a single-price monopolist. The maximum level of profit that could be
achieved is:
Total Total
revenuePrice Quantity Cost Profit
$100 1 $150 $100 ($50)
$90 2 $180 $180 $0
$80 3 $220 $240 $20
$70 4 $300 $280 ($20)
$60 5 $400 $300 ($100)
$50 6 $550 $300 ($250)
a. -$20
b. $20
c. $300
d. $280
e. $40
11. Suppose that for a monopolist, MR = MC = $10 and P = $15 at the profit-maximizing level of
output. At this level of output, the firm
a. is earning a profit
b. will shut down if AVC > $15
c. is making $5 profit on each unit sold
d. will shut down if ATC > $15
e. is losing $5 per unit produced
12. If a firm earns zero economic profit in the long run, then it
a. must be in a perfectly competitive market
b. must be in a monopolistically competitive market
c. cannot be in a monopolistically competitive market
d. could be in any of the four major market structures
e. is not in an oligopoly
13. If a monopolistically competitive firm engages in a successful advertising campaign resulting in
above positive economic profits then in the long run that firm will
a. continue to earn positive economic profits because successful advertising is one of the
barriers to entry
b. earn zero economic profits because the government will begin to regulate the industry
c. earn negative economic profits because it won’t be able to advertise indefinitely
d. earn zero economic profits because other firms will also begin to advertise
e. continue to earn positive economic profits because most monopolistically competitive
firms can earn economic profits in the long run