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Monopoly

Chapter

1CHAPTER OUTLINE

I. Explain how monopoly arises and distinguish between single-price monopoly and price-discriminating monopoly.

A. How Monopoly Arises1. No Close Substitutes2. A Barrier to Entry

a. Natural Barrier to Entryb. Ownership Barrier to Entryc. Legal Barrier to Entry

B. Monopoly Price-Setting Strategies1. Single-Price2. Price Discrimination

2.Explain how a single-price monopoly determines its output and price.

A. Price and Marginal Revenue B. Marginal Revenue and ElasticityC. Output and Price Decision

3.Compare the performance of a single-price monopoly with that of perfect competition.

A. Output and PriceB. Is Monopoly Efficient?C. Is Monopoly Fair?

© 2013 Pearson Education, Inc. Publishing as Addison Wesley

194 Part 3 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE

D.Rent Seeking1. Buy a Monopoly

E. Create a MonopolyF. Rent-Seeking Equilibrium

4.Explain how price discrimination increases profit.A. Price Discrimination and Consumer Surplus

1. Discriminating Among Groups of Buyers2. Discriminating Among Units of a Good

B. Profiting by Price DiscriminatingC. Perfect Price DiscriminationD.Price Discrimination and Efficiency

5.Explain why natural monopoly is regulated and the effects of regulation.

A. Efficient Regulation of a Natural MonopolyB. Second-Best Regulation of a Natural Monopoly

1. Average Cost Pricing2. Government Subsidy3. And the Second-Best Is … 4. Rate of Return Regulation5. Price Cap Regulation

What’s New in this Edition?The material in Chapter 12 is largely unchanged from the fifth edition, though the Eye applications have been updated and slightly rewritten.

Where We AreIn this chapter, we examine another market struc-ture: monopoly. We discuss how monopoly arises and how a monopoly (single-price or price-discrimi-nating) chooses its profit-maximizing output and price. Recognizing that monopoly creates a dead-weight loss, we discuss whether monopoly is effi-cient and fair. The concept of rent seeking is exam-ined and reveals that rent seeking is likely to extract all of the economic profit made by a monopoly. Fi-nally, regulation of natural of monopoly is covered.

Where We’ve BeenThe previous chapter studied perfectly competitive firms’ demand and marginal revenue curves. We combined them with the cost curve analysis in Chap-


Chapter 12 . Monopoly 195

ter 14 to determine perfectly competitive firms’ profit-maximizing output and price decisions.

Where We’re GoingAfter this chapter we examine two more market structures: monopolistic competition and oligopoly in Chapter 13.

IN THE CLASSROOM

Class Time NeededBecause the students are familiar with firm behavior in perfect com-petition, this chapter is somewhat easier to present. Even so, there is a lot of important material, so you should spend approximately three to four class sessions on this material.

An estimate of the time per checkpoint is:

12.1 Monopoly and How It Arises—15 minutes

12.2 Single-Price Monopoly—30 to 50 minutes

12.3 Monopoly and Competition Compared—20 to 30 minutes

12.4 Price Discrimination—30 to 40 minutes

12.5 Monopoly Regulation—30 to 40 minutes

Classroom Activity: After defining a monopoly, you can ask your students to dis-cuss the economic factors which lead to the development of monopolies. To what extent are those conditions products of the free market? In which case, students can debate the role of government with regard to monopoly. If it is the result of natural coalescence in a free market, then is it equitable and/or efficient to inter-vene? Clearly there is no definitively correct answer to these questions, which is perhaps why they are so much fun to debate!

There are many examples of government licensing. Licensing can protect con-sumers from fraud and abuse, but they can also hurt consumers by preventing competition from producing an efficient allocation of resources. Have the stu-dents debate the merits of the following licensing arrangements: 1) Doctors can receive a medical license to practice medicine only by graduating from an AMA approved medical program; 2) Lawyers can practice law only after passing an extensive Bar Exam; 3) Cab drivers in New York City can operate a taxi only if they have purchased a medallion from the city, of which there are a finite num-ber; 4) Beauticians in many states cannot operate a beauty parlor without a state certification that requires training in sanitary practices as well as other courses completely unrelated to their profession (such as civics and history courses).



CHAPTER LECTURE

12.1 Monopoly and How It ArisesLecture Launcher: Students love monopoly! Many of your students are taking an

economics course because they think it will help them either get a better job or run a better business. Indeed, it is likely that many of your students are aspiring entrepreneurs. You’ve just had them slog through a heavy chapter on perfect competition, the bottom line of which is that the bottom line is miserable. Nor-mal profit might be the best that many people can achieve but it is not very ex-citing. This chapter teaches the students how to make a serious entrepreneurial income. Innovate, create a monopoly that produces something that people value much more than the cost of producing it, and price discriminate as much as pos-sible.

Lecture Launcher: Explain that the monopoly model is a benchmark model - simi-lar to the case of perfect competition. Although no real-world industry satisfies the full definition of a monopoly market, the behavior of firms in many real world industries can be predicted by using the monopoly model. Mention that this chapter examines the least competitive end of the spectrum of markets, just like Chapter 15 discussed the most competitive end.

A monopoly has two key features: No Close Substitutes: There are no close substitutes for the good or ser-

vice. Barriers to Entry: Legal or natural constraints that protect a firm from po-

tential competition are called barriers to entry. Monopolies are protected by barriers to entry. Natural barriers to entry create a natural monopoly, which is an indus-

try in which one firm can supply the entire market at a lower price than two or more firms can.

When one firm owns all (or most) of a natural resource, it creates an own-ership barrier to entry.

Legal barriers to entry create a legal monopoly, which is a market in which competition and entry are restricted by the granting of a public franchise (an exclusive right is granted to a firm to supply a good or ser-vice—the U.S. Postal Service has a public franchise to deliver first-class mail), a government license (when the government controls entry into particular occupations, professions and industries—a license is required to practice law), a patent (an exclusive right granted to the inventor of a product or service) or a copyright (exclusive right granted to the author or composer of a literary, musical, dramatic, or artistic work).

Monopoly Price-Setting Strategies A single-price monopoly is a firm that must sell each unit of its output for

the same price to all its customers.



Price discrimination is the practice of selling different units of a good or service for different prices. Many firms price discriminate, but not all of them are monopoly firms.



12.2 Single-Price MonopolyPrice and Marginal Revenue

The demand curve facing a mo-nopoly firm is the market de-mand curve. Total revenue (TR) is the price (P ) multiplied by the quantity sold (Q ). Marginal revenue (MR ) is the change in total revenue resulting from a one-unit increase in the quantity sold. The table shows the calcu-lation of TR and MR.

A key feature of a single-price monopoly is that MR < P at each quantity so, as illustrated in the figure below, the MR curve lies below the demand curve. MR < P be-cause a single–price monopoly must lower its price on all units sold to sell an additional unit of output.

Land Mine: Marginal revenue can be a sticking point for many students. Students find it easier to see the difference between the monopoly’s demand and marginal revenue curves if you take two steps. First develop a total revenue schedule using price and quantity data. Then add another column showing marginal rev-enue. Place the marginal revenue values between the quantity values. In the next step, draw the demand and marginal revenue curves. Again, emphasize that marginal revenue is plotted be-tween two quantity levels. By explicitly graphing the data, you also have the framework for showing that the price of the good is always less than marginal revenue of a monopoly.

Marginal Revenue and Elasticity When demand is inelastic, fall in

price decreases total revenue. A monopoly never profitably pro-duces along the inelastic range of its demand curve because it could increase total revenue by raising the price and selling a smaller quantity.

Output and Price Decisions To maximize its profit, a monopoly

produces the level of output where MR = MC. The monopoly then uses its demand curve to set the price at the maximum possible price for which it will be able to


PriceQuantity

de-manded

Total revenue

Marginal revenue

$4 0 $0 $3

$3 2 $6 $1

$2 4 $8$1

$1 6 $6


sell the quantity it produces. In the figure, which uses the demand and MR schedules from the table above, the firm produces 200 units of output and sets a price of $160 per unit.

The firm makes an economic profit if P> ATC, which is the case for the firm in the figure. The monopoly can make the economic profit even in the long run because the barriers to entry protect the firm from competition. How-ever, a monopoly firm is not guaranteed an economic profit. In the short run and/or long run, it might make zero economic profit, (P = ATC) or in the short run, it might incur an economic loss (P > ATC ).

Lecture Launcher: The figure on the previous page, the classic monopoly diagram, provides a good opportunity to tell your students about the contribution of one of the most brilliant economists of the 20th century, Joan Robinson. This diagram first appeared in her book The Economics of Imperfect Competition, published in 1933 when she was just 30 years old. Women are still not attracted to economics on the scale that they’re attracted to most other disciplines. So the opportunity to talk about an outstanding female economist shouldn’t be lost. Joan Robinson was a formidable debater and reveled in verbal battles, a notable one of which was with Paul Samuelson on one of her visits to MIT. Anxious to make and illus-trate a point, Samuelson asked Robinson for the chalk. Monopolizing the chalk and the blackboard, the unyielding Robinson snapped, “Say it in words young man.” Samuelson meekly obeyed. This story illustrates Joan Robinson’s approach to economics: work out the answers to economic problems using the appropriate techniques of math and logic, but then “say it in words.” Don’t be satisfied with formal argument if you don’t understand it. Your students will benefit from this story if you can work it into your class time.

12.3 Monopoly and Competition ComparedOutput and Price

Perfect Competition: The market demand curve (D) in perfect competition is the same demand curve that the firm faces in monopoly. The market sup-ply curve (S ) in perfect competition is the horizontal sum of the individual firm’s marginal cost curves. This supply curve also is the monopoly’s mar-ginal cost curve, so in the figure above the supply curve is labeled MC. In a competitive market, equilibrium occurs where the quantity demanded equals the quantity supplied, which in the figure above is 250 units of output and a price of $140 per unit.

Monopoly: The monopoly produces where MR = MC and sets its price using its demand curve. In the figure, the monopoly produces 200 units of output and sets a price of $160 per unit.

Compared to a perfectly competitive industry, a single-price monopoly pro-duces less output and sets a higher price.

Is Monopoly Efficient? A perfectly competitive industry produces the efficient quantity of output. Be-

cause a single-price monopoly produces less output, it creates a deadweight loss.

Though the monopoly creates a deadweight loss, the monopoly benefits its owners because it makes an economic profit. A monopoly benefits the owner



because it redistributes some of the consumer surplus away from the con-sumer and to the monopoly producer.

It is important for students to recognize that the source of the inefficiency of a mo-nopoly firm’s output and pricing decision arises from the absence of competition in the market, rather than any change in the behavioral assumptions about the firm owners. The intentions of a monopoly firm are the same as a competitive firm – max-imize profit. So, “Mom and Pop,” the owners of a perfectly competitive firm, are maximizing their profit as surely as the owners of a monopoly.

Is Monopoly Fair? A monopoly redistributes gains from consumers to producers. According to

the fair results standard, this is fair if the consumers are richer than the mo-nopoly. According to the fair rules standard, this is fair if everyone is free to acquire the monopoly.

Rent Seeking The social cost of monopoly might exceed the deadweight loss it creates be-

cause of rent seeking, which is any attempt to capture consumer surplus, producer surplus, or economic profit. Rent seeking can occur when someone uses resources seeking the opportunity to buy a monopoly for a price less than the monopoly’s economic profit. Rent seeking also can occur when someone uses resources lobbying the government to restrict the competition faced by the lobbyist.

The resources used up in rent seeking are a cost to society that adds to the monopoly’s deadweight loss. Because there are no barriers to entry in the ac-tivity of rent seeking, the resources used up can equal the monopoly’s poten-tial economic profit.

A person can become the owner of a monopoly in two ways: Buy a monopoly: A person can buy a firm (or a right) that is protected

by a barrier to entry. Competition to buy a monopoly will drive up the price to the point at which they make zero economic profit.

Create a Monopoly by Rent Seeking: A person can try to influence the political process to get laws that create legal barriers to entry. Rent-seek-ing equilibrium: Competition among rent seekers pushes up the cost of rent seeking until it leaves the monopoly making zero economic profit af-ter paying rent-seeking costs. Rent seeking leaves consumer surplus un-affected but converts producer surplus into deadweight loss.

12.4 Price DiscriminationPrice discrimination is the practice of selling different units of a good or service for different prices. Price discrimination converts consumer surplus into economic profit. To be able to price discriminate, a firm must:

Identify and separate different buyer types. Sell a product that cannot be resold.

Students tend to find price discrimination very interesting, so take advantage of that by getting them to brainstorm examples and discuss those as a class. Outside of movie tickets (matinee pricing, student/senior/child discounts), air travel (14-day window for business/emergency vs. leisure travelers), and haircuts (age, gender?),



here are some more examples to get the ball rolling:

- Happy Hour: For most people, going out to eat dinner and drink during the mid-af-ternoon hours is undesirable. Restaurants and bars offer the lower prices during these times to allow buyers to separate themselves according to willingness to pay. Those with a lower willingness to pay get a deal by going to happy hour, while those with a higher willingness to pay have to pay more to go during “normal” times. This is similar to twilight rates at golf courses, movie matinees, and mid-week rates at hotels and theme parks.

- Coupons: Finding, clipping, and keeping coupons can be a hassle. The only people willing to do it, are the ones who are most price sensitive. Coupons allow those with a lower willingness to pay to end up paying lower prices, while those not willing to go through the coupon hassle have to pay more.

- Financial Aid: College students end up paying different amounts for their educa-tion as a result of financial aid. Many financial aid programs are income based, try-ing to target those with a lower willingness to pay as a result of lower income. In general, those with higher incomes (and higher willingness to pay) pay more for col-lege, while those with lower incomes pay less after financial aid. In addition, schol-arships can be a hassle to apply for. Those willing to go through the process (per-haps as a result of a lower willingness to pay), end up paying a lower price.

- Hardcover Books: Dedicated followers of a particular writer are eager for the re-lease of a new book and are willing to pay more for it. When the more expensive hardcover book sales slow down enough, publishers release a far cheaper paper-back version for those readers who are more price sensitive.

Price Discrimination and Consumer Surplus Price discrimination occurs because of differences in willingness to pay for

the good. A firm can charge the same buyer different prices for different units of a good or a firm can charge different prices to different groups of buyers. Discriminating Among Groups of Buyers: A firm can charge different

customers different prices for the product. Groups with a higher average willingness to pay are charged a higher price and groups with a lower av-erage willingness to pay are charged a lower price. An example is airline travel, where business travelers who have a high average willingness to pay and often make last-minute reservations are charged a higher price than leisure travelers, who have a low average willingness to pay and of-ten make advance reservations.

Discriminating Among Units of a Good: A firm can charge a higher price for the first units purchased and a lower price for later units pur-chased. An example is pizza delivery, where the second pizza is generally cheaper than the first.

Profiting by Price Discriminating By pushing the price closer to what groups of buyers are willing to pay,

price discrimination converts consumer surplus into economic profit.

Perfect Price Discrimination Perfect price discrimination occurs when a firm is able to sell each unit of

output for the highest price that consumers are willing to pay for each



unit. In this case, the price of each unit is the same as the unit’s marginal revenue, so the firm’s (downward sloping) demand curve becomes the same as its marginal revenue curve. Output increases to the point where the marginal revenue (demand) curve intersects the marginal cost and the efficient quantity is produced. The deadweight loss is eliminated. The firm’s economic profit is the largest possible. The firm captures the entire consumer surplus, however, so consumer surplus equals zero.

Price Discrimination and Efficiency With perfect price discrimination, the monopoly produces the identical out-

put of perfect competition - an efficient outcome. In contrast to perfect com-petition, consumer surplus is zero and the total surplus is all producer sur-plus. However, these large producer gains encourage rent seeking, which can use up all of the producer surplus.

12.5 Monopoly Regulation Regulation consists of rules administered by a government agency to in-

fluence prices, quantities, entry, and other aspects of economic activity in a firm or industry. Conversely, deregulation is the process of removing regulation of prices, quantities, entry, and other aspects of economic ac-tivity in a firm or industry.

The social interest theory of regulation is that the political and regula-tory process relentlessly seeks out inefficiency and introduces regulation that eliminates deadweight loss and allocates resources efficiently.

The capture theory of regulation is that the political and regulatory process gets captured by the regulated firm and ends up serving its self-interest, with maximum economic profit, underproduction, and dead-weight loss.

A natural monopoly is an industry in which one firm can supply the entire market at a lower price than two or more firms can. The figure below shows a natural monopoly. The definition of a natural monopoly means that the firm’s ATC curve falls throughout the relevant range of produc-tion. As a result, the firm’s MC curve is below its ATC curve when the MC curve crosses the firm’s demand curve.



Efficient Regulation of a Natural Monopoly A marginal cost pricing rule sets

price equal to marginal cost, P = MC. In the figure, the firm sets a price of Pmc and produces Qmc. The rule leads to the efficient

level of production in the in-dustry, so it maximizes the to-tal surplus in the industry. It is in the public interest. But the firm incurs an economic loss because P < ATC.

A government subsidy can be used to make a direct payment to the firm equal to its eco-nomic loss, though the govern-ment must use a tax to raise the revenue to pay the subsidy.

Second-Best Regulation of a Natu-ral Monopoly

An average cost pricing rule sets price equal to average total cost, P = ATC. In the figure, the firm sets a price of Patc and produces Qatc. The rule leads to an inefficient level of production so there is a dead-

weight loss so this type of regulation is second-best. But the firm makes a normal profit because P = ATC.

Implementing pricing rules is difficult because the regulator does not know the firm’s true costs. So regulators often use two practical pricing rules: Rate of return regulation is regulation that sets the price at a level that

allows the regulated firm to make a specified target percent return on its capital. When this policy is used, the managers of the regulated firm have the incentive to inflate its costs for beneficial amenities that do not pro-mote efficiency but instead give the managers more amenities.

A price-cap regulation is a regulation that specifies the highest price that a firm is permitted to set—a price ceiling. Price cap regulation gives managers an incentive to minimize costs because if the firm decreases its costs and makes an economic profit, the firm will be allowed to keep all (or part) of the profit. Typically price cap regulation also requires earn-ings sharing regulation, under which profits that rise above a target level must be shared with the firm’s customers.



USING EYE ON THE U.S. ECONOMY

Airline Price DiscriminationThe Eye provides a good example of how airlines identify many buyer types. Charging different prices alone does not guarantee price dis-crimination. Airlines effectively price discriminate by requiring pas-sengers to show identification. Before security scares, passengers could board a plane without showing identification so airlines could not prevent the resale of tickets. At that time, price discrimination was more difficult. You might see tickets advertised in the newspa-pers. There were businesses devoted to reselling low-priced tickets! For example, at that time, you could buy your grandmother’s ticket for which she paid a reduced senior citizen fare. Today, there are valid security reasons for showing identification, so it is much easier for air-lines to prevent resale of tickets. You can no longer resell tickets and so airlines can more easily and more effectively price discriminate.

USING EYE ON MICROSOFT

Are Microsoft’s Prices Too High?Have students brainstorm ideas about how Microsoft could offer their operating system at a price equal to MC (zero), while still earning enough revenue to cover their fixed costs of development. One possi-bility is for Microsoft to charge more for another product they sell to recoup the lost revenue. However, they would need to make sure that consumers are buying this other product from them – which means they need to be a monopolist (or else consumers would buy from a competitor) or need to find a way to tie the operating system to the other product being offered. Tying their operating system with a free browser (Internet Explorer) is what brought about Microsoft’s well-publicized anti-trust cases in the United States. Perhaps Google could serve as their model – could Microsoft sell advertising space in their Windows 7 operating system to cover their fixed costs? As a user of Windows 7, what might be the disadvantages of this? Are there other options that students could come up with for how Microsoft could of-fer free operating systems? What would be the repercussions of a gov-ernment subsidy to pay Microsoft for their losses in a marginal cost pricing rule? Are any of these proposed changes more desirable than simply having consumers buy the operating system? Obviously, there is no indisputably correct answer students can come up with to that question, but the thought process will help them explore various pric-ing scheme options available to a firm and also government regula-tion.Another exercise is to ask students to identify other examples where a firm provides customers with a “free” good or service – and what al-lows them to provide it for free. For example, cell phone service providers often give subscribers free nights and weekends (and some-



times free mobile-to-mobile calls). The MC of providing this service is very low, but what are the fixed costs? How do cell service providers make up the lost revenue from free calling times and cover their fixed costs? Why do cell phone users get offered free phones if they sign a contract with a service provider? The MC of providing a phone is cer-tainly not zero, so how do cell phone service providers not incur losses from giving away (or heavily reducing the price of) cell phones? Or why do most cable or satellite television service providers offer free installation, free receivers, and free satellite dishes?

USING EYE ON YOUR LIFE

Monopoly in Your Everyday LifeThe story provides a good example of how monopoly can help individ-uals. Here is another example in which the answer is also not so clear cut. It implicitly introduces the idea of “network externalities” by pointing out to the students how complicated their lives might be if there were many different operating systems, each with a wide range of applications. You can challenge your students to think of other in-stances where there might be “network externalities.” One example they might come up with is cellular phones. Think how much more difficult it would be if each brand of cellular phone used its own, pro-prietary technology. Of course, note that most monopolies have noth-ing to do with network externalities, but those that do can pose a problem for society. In particular, are we better off with a monopoly Microsoft or might we be better off with, say, 2 or 3 competitive oper-ating systems?


Price(dollars

per carat)

Quantity(carats

per day)

Total cost(dollars per day)

2,200 0 800

2,000 1 1,600

1,800 2 2,600

1,600 3 3,800

1,400 4 5,200

1,200 5 6,800


ADDITIONAL EXERCISES FOR ASSIGNMENT

Questions Checkpoint 12.1 Monopoly and How It Arises1. Which of the following situations is a monopoly? 1a. The supermarket that stocks the best-quality products 1b. The supermarket that charges the highest prices 1c. The firm that has the largest share of the market sales 1d. The truck stop in the Midwest, miles from anywhere 1e. A firm that produces a good that has a perfectly inelastic demand 1f. The only airline that flies from St. Louis to Kansas City

2. Which of the cases in Exercise 1 are natural monopolies and which are legal monopolies? Which can price discriminate, which cannot, and why?

Checkpoint 12.2 Single-Price Monopoly3. Dolly’s Diamond is a single-price monop-

oly. The first two columns of the table show the demand schedule for Dolly’s Diamond, and the middle and third col-umn show the firm's total cost schedule.

3a. Calculate Dolly’s total revenue schedule and marginal revenue schedule.

3b. Sketch Dolly’s demand curve and mar-ginal revenue curve.

3c. Calculate Dolly’s profit-maximizing out-put, price, and economic profit.

3d. If the government places a fixed tax on Dolly’s Diamond of $1,000 a day, what are Dolly’s new profit-maximizing out-put, price, and economic profit?

3e. If instead of imposing a fixed tax on Dolly’s, the government taxes diamonds at $600 a carat, what are Dolly’s new profit-maximizing output, price, and economic profit?



Checkpoint 12.3 Monopoly and Competition Compared4. Figure 12.1 shows an industry. If the

market is perfectly competitive, what is the equilibrium quantity that will be pro-duced and the equilibrium price? If the market is a single-price monopoly, darken in the area of the deadweight loss.

Checkpoint 12.4 Price Discrimination5. What is price discrimination? Give some real-world examples of

price discrimination.

6. Which of the following situations is price discrimination? 6a. The local drug store offers senior citizens a discount on all pur-

chases made on Tuesdays. 6b. Domino’s offers “Buy 1 pizza for $15 and get a second one for

only $1.” 6c. Farmers in Southern California pay a lower price for water than

do the residents of Los Angeles. 6d. The U.S. Postal Service charges a lower price to mail a postcard

than to mail a letter.

Answers Checkpoint 12.1 Monopoly and How It Arises1a. The supermarket that stocks only the best-quality products is not

a monopoly. The statement does not say that no other markets stock these products. If indeed it is the only supermarket in the area that stocks these high-quality products, it still is not a mo-nopoly because there are no barriers to entry to prevent other su-permarkets from also stocking the best-quality products.

1b. A supermarket that charges the highest prices is not a monopoly.1c. The firm with the largest market share is not necessarily a mo-

nopoly.1d. A truck stop miles from anywhere is a monopoly.1e. A firm producing a good with perfectly inelastic demand could be

a monopoly. Inelastic demand implies that there are no close sub-


Price(dollars

per carat)

Quan-tity

(carats per day)

Totalrevenue(dollars per day)

Marginalrevenue(dollars

per carat)

2,200 0 0

2,000 1 2,0002,000

1,800 2 3,6001,600

1,600 3 4,8001,200

1,400 4 5,600 800

1,200 5 6,000 400


stitutes for the good (like insulin), but does not imply that other firms are prevented from entering the market. Unless there is a barrier to entry, the firm is not a monopoly. But, more generally, simply because the demand for a product is inelastic does not mean that the producer is a monopoly.

1f. An airline with the only service on a route has monopoly power on that route.

2. Because the truck stop is in the middle of nowhere, the market demand for automobile and truck services is relatively small, so the truck stop is a natural monopoly. If two truck stops supplied the market, costs would be higher. (The truck stop could have a legal monopoly if it has purchased all surrounding land or if it lobbied the government to allow it to have the only building per-mit for the area.) The airline might be a legal monopoly if it has been awarded sole landing rights at one of the airports. The air-line can price discriminate because the service cannot be resold.

Checkpoint 12.2 Single-Price Monopoly3a. The table showing Dolly’s to-

tal revenue and marginal rev-enue schedules is to the right.



3b. Figure 12.2 illustrates Dolly’s demand and marginal cost curves.

3c. Dolly’s marginal cost equals marginal revenue at 2 1/2 carats a day, where both equal $1,200. From the demand curve, the price is $1,700. Total cost of 2 1/2 carats a day is $3,200. Dolly’s to-tal revenue equals (2 1/2 carats) ($1,700) = $4,250. Her total economic profit is $4,250 $3,200 = $1,050.

3d. As a result of the tax, Dolly’s fixed cost changes, but her marginal cost does not. Her profit-maximizing level of out-put is still 2 1/2 carats and her price still equals $1,700. The tax eliminates all but $50 of Dolly’s economic profit.

3e. A $600 a carat tax increases Dolly’s marginal cost by $600 at every level of output. With the increase in her mar-ginal costs, Dolly now sells 1 1/2 carats a day because at this quantity marginal cost equals marginal rev-enue, which is $1,600. From the demand curve, Dolly’s sets a price of $1,900 a carat. Her total profit equals her total revenue minus her total cost. Her total revenue is (1 1/2 carats) ($1,900) = $2,850. Her total cost is $2,100 plus the tax of $600, which is $2,700. Dolly’s economic profit is $2,850 $2,700 = $150.

Checkpoint 12.3 Monopoly and Competition Compared4. If the market is perfectly competitive, 2

units are produced and the price is $30. The darkened triangle in Figure 12.3 shows the deadweight loss if the market is a single-price monopoly.

Checkpoint 12.4 Price Discrimination5. Price discrimination is a firm offering

the same good for sale at different



prices. Examples are a shoe store offering one pair of shoes for $50 and a second pair for half price. A restaurant that offers early bird specials for dinners before 6 pm or a movie theater that of-fers lower matinee ticket prices are engaging in price discrimina-tion.

6a. The drug store is price discriminating.6b. Domino’s is price discriminating.6c. The residents might not face price discrimination. There could be

higher costs to transport the water to Los Angeles. If the differ-ent prices are based on volume use or if the different prices are based on different types of users, then there is price discrimina-tion.

6d. If the price difference is based on different costs of mailing a let-ter versus a postcard, then there is no price discrimination.
