John R. Swinton, Ph.D. Center for Economic Education Georgia College & State University
Question Take from 2013 AP Free Response Section: The graph below illustrates the demand, marginal revenue (MR), marginal cost (MC), and average total cost (ATC) curves for a profit-maximizing monopolist.
Assumptions (before getting to the question): ◦ Price setter ◦ Barriers to entry ◦ Large Number of Buyers (I will discuss Monopsony if time permits) ◦ Unique Product ◦ Complete Information ◦ Profit-maximizing Behavior
Barriers to entry ◦ Patent/ Copy write ◦ Government Contract ◦ Economies of Scale ◦ Access to Unique Resource ◦ Illegal Activity
(a) Assume that the profit-maximizing monopolist is unregulated. Using the labeling in the graph, identify each of the following. i. The monopolist’s quantity of output ii. The monopolist’s price iii. The profit earned by the monopolist iv. The deadweight loss
Individual Firm Decision: ◦ Rule #1: Set Output such that MC=MR MR not the same as Market Price (because the demand curve is downward sloping) ◦ There is no guarantee that a monopoly will be profitable
Determine Marginal Revenue (given in graph by line MR): Price Quantity Demand
Determine Marginal Revenue (given in graph by line MR): Price Quantity Demand
Answer part (a): Setting MR = MC we see that the profit maximizing level of output is Q 1
Answer part (a): The price that will clear the market (Qs=Qd) is P 3
Answer part (a): Profit will be area P 1 P 3 ac
Answer part (a): The deadweight loss will be area caf.
(b) Now assume that the monopolist can perfectly price discriminate. Using the labeling of the graph, identify each of the following. i. The quantity produced = Q 3
(b) Now assume that the monopolist can perfectly price discriminate. Using the labeling of the graph, identify each of the following. ii. The total revenue received by the monopolist
(c) Instead, assume the monopolist charges a single price and is regulated to produce the socially efficient quantity. Using the labeling of the graph, identify each of the following. ◦ i. The social efficient quantity ◦ ii. The consumer surplus at the socially efficient quantity
(c) Instead, assume the monopolist charges a single price and is regulated to produce the socially efficient quantity. Using the labeling of the graph, identify each of the following. ◦ i. The socially efficient quantity.
(c) Instead, assume the monopolist charges a single price and is regulated to produce the socially efficient quantity. Using the labeling of the graph, identify each of the following. ii. The consumer surplus at the socially efficient quantity = P 1 P 4 f.
(d) Is the monopolist facing the regulation in part (c) earning a positive economic profit, earning zero economic profit, or incurring a loss? Explain.
(e) Is point f in the elastic, inelastic, or unit elastic portion of the demand curve? Explain. elastic inelastic Unit elastic
Key diagrammatic difference: Price Quantity Supply Marginal Cost Derived Demand (MRP) Q1 P1