CUNY Brooklyn College Microeconomics Questions
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Regulations:This assignment is an individual assignment to be submitted in a word file.Students are encouraged to use their own words.Students must follow Saudi Electronic University academic writing standards and APA style guidelines.Support your submission with course material concepts, principles, and theories from the textbook, along with at least two scholarly, peer-reviewed journal articles.A mark of zero is awarded for any submission that includes copying from other resources without proper referencing it.Write at least 4-5 pages in length, excluding the title page and required reference page, which is never a part of the minimum content requirements.It is strongly encouraged that the student submits his/her assignment into the Safe Assignment Originality Check before sending it to your instructor for grading.Plagiarism is NOT be tolerated. All assignments will be auto-checked for plagiarism. If you are found to have more than 15 % similarity with previous work, you will be graded zero in your assignmentQ1. Firms in oligopoly must constantly think in terms of how other firms in the industry will react to whatever they do. Why do they have to do this? Why is it that firms in perfect competition and in monopoly dont have to worry about how other firms will react? (5 Marks)Q2. Governments are frequently tempted to introduce price ceilings in markets. Use an example to explain why this is not such a good idea, at least when markets are competitive. Give some ideas as to what the government could do instead in order to help consumers in these markets. (5 Marks)Q3. If perfectly competitive firms are price takers, and monopolistic, monopolistic competitive, and oligopolistic firms are price searchers, then it follows that three times as many firms in the real world are price searchers than are price takers. Do you agree or disagree? Explain your answer. (5 Marks)Q4. Critically analyze the following statement with views of your own:There is no substitute for an airline pilot: Someone has to fly the plane. Therefore, an increase in the wage of airline pilots will not change the number of pilots used by the airlines.(5 Marks)Note: For all your answers support your views/opinions with at least two to three scholarly references, and a word count of 400-500 words for each answer.Learning Resource: Chapters 7, 8 & 10 of the Text Book OSullivan, A., Sheffrin, S. M., & Perez, S.J. (2014).Survey of Economics: Principles, Applications, and Tools. (6th).Upper Saddle River, NJ: Pearson Education. Print version: ISBN-10: 0-13-294885-0 or ISBN-13: 978-0-13-294885-2.Digital version: ISBN-13:978-0-13-13-9370-7.
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CHAPTER 7
Monopoly and Price
Discrimination
Copyright © 2012 Pearson
Prentice
Hall.
All rights
reserved.
Copyright
© 2012
Pearson
Prentice
Hall. All rights reserved.
7-1
CHAPTER
Monopoly and Price
Discrimination
7
Why does movie popcorn cost so much? That $4.00 bucket of popcorn you
get in the movie theater costs less than $0.10 to produce.
PREPARED BY
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
Brock Williams
CHAPTER 7
Monopoly and Price
Discrimination
APPLYING THE CONCEPTS
1
What is the value of a monopoly?
A Casino Monopoly in Creswell, Oregon?
2
What happens when a patent expires and a monopoly
ends?
Bribing the Makers of Generic Drugs
3
When do firms have an opportunity to charge different
prices to different consumers?
Paying for a Cold Soft Drink on a Hot Day
4
Does voluntary pricing work?
Radiohead Lets Consumers Pick the Price
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-3
CHAPTER 7
Monopoly and Price
Discrimination
Monopoly and Price Discrimination
?monopoly
A market in which a single firm sells a
product that does not have any close
substitutes.
?market power
The ability of a firm to affect the price
of its product.
?barrier to entry
Something that prevents firms from
entering a profitable market.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-4
CHAPTER 7
Monopoly and Price
Discrimination
Monopoly and Price Discrimination
?patent
The exclusive right to sell a new good
for some period of time.
?network externalities
The value of a product to a consumer
increases with the number of other
consumers who use it.
?natural monopoly
A market in which the economies of
scale in production are so large that
only a single large firm can earn a profit.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-5
CHAPTER 7
Monopoly and Price
Discrimination
7.1
THE MONOPOLISTS OUTPUT DECISION
Total Revenue and Marginal Revenue
FIGURE 7.1
The Demand Curve and the Marginal-Revenue Curve
Marginal revenue equals the price for the first unit sold, but is less
than the price for additional units sold. To sell an additional unit, the
firm cuts the price and receives less revenue on the units that could
have been sold at the higher price.
The marginal revenue is positive for the first four units, and negative
for larger quantities.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-6
CHAPTER 7
Monopoly and Price
Discrimination
7.1
THE MONOPOLISTS OUTPUT DECISION
(contd)
A Formula for Marginal Revenue
marginal revenue = new price + (slope of demand curve × old
quantity)
The first part of the formula is the good news, the money received for
the extra unit sold.
The second part is the bad news from selling one more unit, the revenue
lost by cutting the price for the original customers.
The revenue change equals the price change required to sell one more
unitthe slope of the demand curve, which is a negative numbertimes
the number of original customers who get a price cut.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-7
CHAPTER 7
Monopoly and Price
Discrimination
7.1
THE MONOPOLISTS OUTPUT DECISION
(contd)
Using the Marginal Principle
A monopolist can use the marginal principle to decide how
much output to produce.
MARGINAL PRINCIPLE
Increase the level of an activity as long as its marginal benefit exceeds its
marginal cost. Choose the level at which the marginal benefit equals the
marginal cost.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-8
CHAPTER 7
Monopoly and Price
Discrimination
7.1
THE MONOPOLISTS OUTPUT DECISION
(contd)
Using the Marginal Principle
FIGURE 7.2
The Monopolist Picks a Quantity and a Price
To maximize profit, the monopolist picks point a,
where marginal revenue equals marginal cost.
The monopolist produces 900 doses per hour at a
price of $15 (point b).
The average cost is $8 (point c), so the profit per
dose is $7 (equal to the $15 price minus the $8
average cost) and the total profit is $6,300 (equal
to $7 per dose times 900 doses).
The profit is shown by the shaded rectangle.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-9
CHAPTER 7
Monopoly and Price
Discrimination
7.1
THE MONOPOLISTS OUTPUT DECISION
(contd)
Using the Marginal Principle
The three-step process explaining how a monopolist picks a
quantity and how to compute the monopoly profit is as
follows:
1 Find the quantity that satisfies the marginal principle, that
is, the quantity at which marginal revenue equals marginal
cost.
2 Using the demand curve, find the price associated with the
monopolists chosen quantity.
3 Compute the monopolists profit. The profit per unit sold
equals the price minus the average cost, and the total
profit equals the profit per unit times the number of units
sold.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-10
CHAPTER 7
Monopoly and Price
Discrimination
7.2
THE SOCIAL COST OF MONOPOLY
Deadweight Loss from Monopoly
FIGURE 7.3
Monopoly versus Perfect Competition: Its Effect on Price and Quantity
(A) The monopolist picks the quantity at which the long-run marginal cost equals marginal revenue200
does per hour, as shown by point a. As shown by point b on the demand curve, the price required to sell this
quantity is $18 per dose.
(B) The long-run supply curve of a perfectly competitive, constant-cost industry intersects the demand curve
at point c. The equilibrium price is $8, and the equilibrium quantity is 400 doses.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-11
CHAPTER 7
Monopoly and Price
Discrimination
7.2
THE SOCIAL COST OF MONOPOLY
(contd)
Deadweight Loss from Monopoly
FIGURE 7.4
The Deadweight Loss from a Monopoly
A switch from perfect competition to monopoly
increases the price from $8 to $18 and
decreases the quantity sold from 400 to 200
doses.
Consumer surplus decreases by an amount
shown by the areas B and D, while profit
increases by the amount shown by rectangle B.
The net loss to society is shown by triangle D,
the deadweight loss from monopoly.
The formula for the area of a rectangle is
area of rectangle = base × height
The formula for the area of a triangle is
area of triangle = 1/2 × base ×
height
?deadweight loss from monopoly
A measure of the inefficiency from monopoly;
equal to the decrease in the market surplus.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-12
CHAPTER 7
Monopoly and Price
Discrimination
7.2
THE SOCIAL COST OF MONOPOLY
(contd)
Rent Seeking: Using Resources to Get Monopoly Power
?rent seeking
The process of using public policy
to gain economic profit.
Monopoly and Public Policy
Given the social costs of monopoly, the government uses a number of
policies to intervene in markets dominated by a single firm or likely to
become a monopoly.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-13
CHAPTER 7
Monopoly and Price
Discrimination
APPLICATION
1
A CASINO MONOPOLY IN CRESWELL, OREGON?
APPLYING THE CONCEPTS #1: What is the value of a
monopoly?
A developer interested in building a casino in Creswell,
Oregon, placed a curious announcement in the local
newspaper. If the voters approved the casino, the developer
promised to give the citizens a total of $2 million a year.
This is an example of rent seeking.
The developer was seeking the profit from a monopoly in the casino
market.
He was willing to pay up to $2 million to get it.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-14
CHAPTER 7
Monopoly and Price
Discrimination
7.3
PATENTS AND MONOPOLY POWER
Incentives for Innovation
Lets use the arthritis drug to show why a patent encourages innovation. Suppose a
firm called Flexjoint hasnt yet developed the drug but believes the potential benefits
and costs of doing so are as follows:
The economic cost of research and development will be $14 million, including all
the opportunity costs of the project.
The estimated annual economic profit from a monopoly will be $2 million (in
todays dollars).
Flexjoints competitors will need three years to develop and produce their own
versions of the drug, so if Flexjoint isnt protected by a patent, its monopoly will
last only three years.
Based on these numbers, Flexjoint wont develop the drug unless the firm receives a
patent that lasts at least 7 years. Thats the length of time the firm needs to recover
the research and development costs of $14 million ($2 million per year times 7 years).
If there is no patent and the firm loses its monopoly in 3 years, it will earn a profit of
$6 million, which is less than the cost of research and development. In comparison,
with a 20-year patent the firm will earn $40 million, which is more than enough to
recover its $14 million cost.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-15
CHAPTER 7
Monopoly and Price
Discrimination
7.3
PATENTS AND MONOPOLY POWER
(contd)
Trade-Offs from Patents
It is sensible for a government to grant a patent for a product that
would otherwise not be developed, but it is not sensible for other
products.
Unfortunately, no one knows in advance whether a particular
product would be developed without a patent, so the government
cant be selective in granting patents.
In some cases, patents lead to new products, while in other cases
they merely prolong monopoly power.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-16
CHAPTER 7
Monopoly and Price
Discrimination
APPLICATION
2
BRIBING THE MAKERS OF GENERIC DRUGS
APPLYING THE CONCEPTS #2: What happens
when a patent expires and a monopoly ends?
When the patent for a brand-name drug expires, other firms introduce
generic versions of the drug. The generics are virtually identical to the
original branded drug, but they sell at a much lower price. The producers
of branded drugs have an incentive to delay the introduction of generic
drugs and sometimes use illegal means to do so.
In recent years, the Federal Trade Commission (FTC) has investigated allegations
that the makers of branded drugs made deals with generic suppliers to keep
generics off the market.
Alleged practices included cash payments and exclusive licenses for new versions
of the branded drug.
In 2003, the FTC ruled that two drug makers had entered into an illegal agreement
when Schering-Plough paid Upsher-Smith Laboratories $60 million to delay the
introduction of a low-price alternative to its prescription drug K- Dur 20, which is
used to treat people with low potassium.
Another tactic is to claim that generics are not as good as the branded drug.
Because generic versions are virtually identical to the branded drugs, such claims
are not based on science.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-17
CHAPTER 7
Monopoly and Price
Discrimination
7.4
PRICE DISCRIMINATION
?price discrimination
The practice of selling a good at
different prices to different consumers.
Although price discrimination is widespread, it is not always
possible. A firm has an opportunity for price discrimination if
three conditions are met:
1 Market power.
2 Different consumer groups.
3 Resale is not possible.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-18
CHAPTER 7
Monopoly and Price
Discrimination
7.4
PRICE DISCRIMINATION (contd)
Senior Discounts in Restaurants
FIGURE 7.5
The Marginal Principle and Price Discrimination
To engage in price discrimination, the firm divides potential customers into two groups and applies
the marginal principle twiceonce for each group.
Using the marginal principle, the profit-maximizing prices are $3 for seniors (point b) and $6 for
nonseniors (point d ).
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-19
CHAPTER 7
Monopoly and Price
Discrimination
7.4
PRICE DISCRIMINATION (contd)
Price Discrimination and the Elasticity of Demand
We can use the concept of price elasticity of demand to
explain why price discrimination increases the restaurants
profit.
From the chapter on elasticity, we know that when demand is
elastic (Ed > 1), there is a negative relationship between price
and total revenue: When the price decreases, total revenue
(price times quantity sold) increases because the percentage
increase in the quantity demanded exceeds the percentage
decrease in price.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-20
CHAPTER 7
Monopoly and Price
Discrimination
7.4
PRICE DISCRIMINATION (contd)
Examples: Movie Admission versus Popcorn, and Hardback
versus Paperback Books
Why do senior citizens pay less than everyone else for admission to a movie, but the
same as everyone else for popcorn? As weve seen, a senior discount is not an act of
generosity by a firm, but an act of profit maximization. Senior citizens are typically
willing to pay less than other citizens for movies, so a theater divides its consumers
into two groupsseniors and othersand offers a discount to seniors. This price
discrimination in favor of senior citizens increases the theaters profit.
Why are hardback books so much more expensive than paperback books? Most
books are published in two formshardback and paperback. Although the cost of
producing a hardback book is only about 20 percent higher than producing a
paperback, the hardback price is typically three times the paperback price. Booksellers
use hardbacks and paperbacks to distinguish between two types of consumers: those
who are willing to pay a lot and those who are willing to pay a little.
The pricing of hardback and paperback books is another example of price
discrimination, under which consumers with less elastic demand pay a higher price.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-21
CHAPTER 7
Monopoly and Price
Discrimination
APPLICATION
3
PAYING FOR A COLD SOFT DRINK ON A HOT DAY
APPLYING THE CONCEPTS #3: When do firms have
an opportunity to charge different prices to different
consumers?
On a hot day, are you willing to pay more than you normally would for an icecold can of Coke?
Coca-Cola Company developed a high-tech vending machine,
complete with heat sensors and microchips, that charges a higher
price when the weather is hot. According to then-CEO Douglas Ivester,
the desire for a cold drink increases when the weather is hot, so it is
fair that it should be more expensive. The machine will simply make
the process more automatic.
The announcement of the new vending machine led to howls of protest
from consumers.
In response, Coca-Cola Company said it would not actually use the
new machine.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
7-22
CHAPTER 7
Monopoly and Price
Discrimination
APPLICATION
4
RADIOHEAD LETS CONSUMERS PICK THE PRICE
APPLYING THE CONCEPTS #4: Does voluntary
pricing work?
In late 2007, Radiohead released its album In Rainbows for downloading directly from its
Web site. The band adopted an unusual pricing strategy: Let each consumer decide how
much to pay. This looks like price discrimination with a twist.
The twist is that consumers decide how much to pay, and wed expect some
freeloaders.
It turned out that roughly 60 percent of U.S. consumers simply downloaded the album
for free, and the other 40 percent voluntarily paid an average of $8.05.
Worldwide, about 38 percent paid something, and the average price was $6.00.
What are the trade-offs in Radioheads pricing strategy?
The typical music artist gets roughly 15 percent of the revenue from the sale of a CD,
or $2.25 for a $15.00 album.
Using the U.S. numbers listed earlier, the average payment from a Radiohead
downloader (including the people who paid and the freeloaders) was $3.22.
In this case, Radioheads strategy would increase its total revenue, because it would
get an average of $3.22 per customer rather than $2.25 from a music company.
Across the world market, the average payment from a downloader was only $2.28, or
just above the revenue from a conventional CD.
7-23
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
CHAPTER 7
Monopoly and Price
Discrimination
KEY TERMS
barrier to entry
deadweight loss from monopoly
market power
monopoly
natural monopoly
network externalities
patent
price discrimination
rent seeking
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
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