Chapter 11/Monopoly
CHAPTER 11
MONOPOLY
TEST YOURSELF
1. Which of the following industries are pure monopolies?
a. The only supplier of heating fuel in an isolated town
b. The only supplier of IBM notebook computers in town
c. The only supplier of digital cameras
Explain your answers.
(a) Pure monopolist. There is no good substitute for heat (bulky sweaters don’t help a
great deal), and one firm controls the source.
2. The following are the demand and total cost schedules for Company Town Water, a local
monopoly:
Output in
Gallons
Price per
Gallon
Total
Cost
50,000 $0.28 $ 6,000
100,000 0.26 15,000
150,000 0.22 22,000
200,000 0.20 32,000
250,000 0.16 46,000
300,000 0.12 64,000
How much output will Company Town Water produce, and what price will it charge? Will
it earn a profit? How much? (Hint: First compute the firm’s MR and MC
schedules.)
From the data given, one can calculate total revenue, marginal revenue, marginal cost and
profit. For convenience, MR and MC per 50,000-gallon unit are shown, although students
may choose to calculate MR and MC per gallon:
Output Price TR MR TC MC Profit
50,000 0.28 14,000 14,000 6,000 6,000 8,000
Chapter 11/Monopoly
3. Show from the table in Test Yourself Question 2 that for the water company, marginal
revenue (per 50,000-gallon unit) is always less than price.
The price per 50,000-gallon unit is found by multiplying by 50,000. As the following table
shows, for each level of output, marginal revenue is less than price.
Output Price MR
50,000 14,000 14,000
100,000 13,000 12,000
4. A monopoly sells Frisbees to two customer groups. Group A has a downward-sloping
straight-line demand curve, whereas the demand curve for Group B is infinitely elastic.
Draw the graph determining the profit-maximizing discriminatory prices and sales to the
two groups. What will be the price of Frisbees to Group B? Why? How is the price to
Group A determined?
Group B has an infinitely elastic demand curve; hence P = MR. Since the firm maximizes
profits, it sets output at, for example, QB, where MC = MR. To maximize overall profits,
FIGURE 1
Chapter 11/Monopoly
DISCUSSION QUESTIONS
1. Suppose that a monopoly industry produces less output than a similar competitive
industry. Discuss why this may be considered socially undesirable. Is this because it
is always socially beneficial to produce more of some product?
There are many ways of discussing this question. For example:
(a) It is obvious that consumers are hurt if they get less output and at the same time have
to pay a higher price.
2. If competitive firms earn zero economic profits, explain why anyone would invest
money in them. (Hint: What is the role of the opportunity cost of capital in economic
profit?)
If a firm earns zero economic profits, money invested in it earns just as high a return as it
3. Suppose that a tax of $28 is levied on each item sold by a monopolist, and as a
result, it decides to raise its price by exactly $28. Why might this decision be against
its own best interests?
Any price increase by the monopolist will result in a reduction in sales, because of the
negatively sloping demand curve. When a tax of $28 per item is levied, if the monopolist
4. Use Figure 2 to show that Adam Smith was wrong when he claimed that a monopoly
would always charge “the highest price which can be got.”
5. General Motors declared bankruptcy in 2009 but exited bankruptcy just 40 days
later, after streamlining its operations and selling the U.S. government a majority
stake in the company. If GM had gone out of business altogether, why might that not
have reduced the competition facing rival automaker Ford? (Hint: At what price
would the assets of the bankrupt companies be offered for sale?)
Chapter 11/Monopoly
If General Motors went out of business, its assets would be offered for sale at relatively
6. What does your answer to the previous question tell you about the ease or difficulty
of entry into the automobile industry?
7. A firm cannot break even by charging uniform (nondiscriminatory) prices, but with
price discrimination it can earn a small profit. Explain why in this case consumers
must be better off if the firm is permitted to charge discriminatory prices.
The gains from exchange are mutual. Firms generate income for themselves, and
consumers benefit as well, gaining more in utility than they give up in payment for the
8. It can be proved that, other things being equal, under price discrimination the price
charged to some customer group will be higher the less elastic the demand curve of
that group is. Why is that result plausible?