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United CH13 1. The States Postal Service has a monopoly on non-urgent First Class Mail and the exclusive right to put mail in private mailboxes. Pfizer Inc. makes LIPITOR, a prescription drug that lowers cholesterol. Cox Communications is the sole provider of cable television service in some parts of San Diego. a. What are the substitutes, if any, for the goods and services described above? Substitutes for the U.S. Postal Service include email, fax, and private delivery services, such as FedEx or UPS. Substitutes for Lipitor are other statin drugs, such as Zocor, non-statin drugs that also lower cholesterol, and exercise. Substitutes for Cox Communications include satellite television services. b. What are the barriers to entry, if any, that protect these three firms from competition? The U.S. Postal Service and Pfizer are protected by legal barriers to entry. The Postal Service has the legal right given to it by the Private Express Statutes to be the only first class non-urgent mail service and Pfizer has a patent on Lipitor. Cox Communications has a natural barrier to entry because it is a natural monopoly. It also has a legal barrier to entry because it has been given the public franchise to be the only cable provider in its area. c. Which of these three firms, if any, is a natural monopoly? Explain your answer and illustrate it by drawing an appropriate figure. Cox Communications is the only natural monopoly. Its average cost curve will look similar to that in Figure 13.1. Cox Communications has a large fixed cost of creating a massive infrastructure and then a small marginal cost when it increases the quantity of its customers. As a result, its economies of scale mean that its long-run average cost curve is downward sloping when it intersects the demand curve. Neither the U.S. Postal Service nor Pfizer has such strong economies of scale so their long-run average cost curves are upward sloping when they intersect their demand curves. d. Which of these three firms, if any, is a legal monopoly? Explain your answer. Both the U.S. Postal Service and Pfizer are legal monopolies. The Postal Service has the legal right given to it by the Private Express Statutes to be the only first class non-urgent mail service and Pfizer has a patent on Lipitor. Cox has a public franchise. e. Which of these three firms are most likely to be able to profit from price discrimination and which are most likely to sell their good or service for a single price? All three of the firms practice price discrimination. The second ounce in a first class letter is less expensive to mail than the first ounce. Lipitors price varies according to the insurance policy a customer has. Cox Communications bundles packages of services that have a lower price than each item taken separately so that additional units of service are less expensive than the initial units. 2. Barbies Revenge: Brawl over Doll is Heading to Trial Four years ago, Mattel Inc. exhorted its executives to help save Barbie from a new doll clique called the Bratz. Market share was dropping at a chilling rate, the presentation said. Barbie needed to be more aggressive, revolutionary, and ruthless. That call to arms has led to a federal courthouse. ... Mattel accuses ... the maker of Bratz, of ... stealing the idea for the pouty-lipped dolls with the big heads. Mattel is trying to seize ownership of the Bratz line, ... The Wall Street Journal, May 23, 2008 a. Before Bratz entered the market, what type of monopoly did Mattel Inc. possess in the market for the pouty-lipped dolls with the big heads? Mattel might have thought it had a legal monopoly to produce pouty-lipped dolls with big heads. b. What is the barrier to entry that Mattel might argue should protect it from competition in the market for Barbie dolls? Mattel might argue that it had a patent or some other legal barrier to entry that prevented others from producing dolls such as Bratz. Mattel actually argued that the inventor of Bratz was working for Mattel when he invented Bratz and because of this fact Mattel had the legal right to be the only producer of Bratz or Bratz-like dolls. c. Explain how the entry of Bratz dolls might be expected to change the demand for Barbie dolls. The entry of Bratz decreased the demand for Barbie dolls. As the story reports, Barbies market share was dropping at a chilling rate . 3. Antitrust Inquiry Launched into Intel The Federal Trade Commission has opened a formal probe into whether Intel, the world's largest chipmaker, has used its dominance to illegally stifle its few competitors. The move follows years of complaints from smaller chip rival Advanced Micro Devices Intel is many times larger, holding 80 percent of the microprocessor market. ... In a sign that suggests the chip market remains competitive, Intel said, prices for microprocessors declined by 42.4 percent between 2000 and 2007... evidence that this industry is fiercely competitive Intel said. The Washington Post, June 7, 2008 a. Is Intel a monopoly in the chip market? Intel is not a monopoly because a competitor, Advanced Micro Devices, has a 20 percent market share. If Intel was a monopoly it would have no competitors. b. Evaluate the argument made by Intel that the significant decline in prices is evidence that this industry is fiercely competitive. Technology has advanced rapidly in the microprocessor market. Technological advances shift the firms marginal cost curve downward. Even if Intel was a monopoly, such a downward shift in the marginal cost curve would lead the firm to increase its profit-maximizing quantity and lower its profit-maximizing price. So the fall in price is not necessarily evidence that the industry is competitive. Price Quantity (dollars per demanded 4. Minnies Mineral Springs, a bottle) single-price monopoly, faces (bottles per hour) the market demand schedule 10 0 8 1 6 2 4 3 Minnies total revenue 2 4 schedule lists the total 0 5 shown in the table. a. Calculate Minnies total revenue schedule. revenue at each quantity sold. For example, Minnies can sell 1 bottle for $8 a bottle, which is $8 of total revenue at the quantity 1 bottle. Minnies entire total revenue schedule is in the table in part b (on the next page). b. Calculate its marginal revenue schedule. Minnies marginal revenue schedule (and her total revenue schedule) is in the table below. The marginal revenue schedule lists the marginal revenue that results from increasing the quantity sold by 1 bottle. For example, Minnies can sell 1 bottle for total revenue of $8. Minnies can sell 2 bottles for $6 each, for total revenue of $12. So by increasing the quantity sold from 1 bottle to 2 bottles, marginal revenue is $4 a bottle ($12 minus $8). This marginal revenue is placed midway between the quantities 1 bottle and 2 bottles. Price Quantity Total revenue Marginal (dollars per demanded (dollars) revenue bottle) (bottles per (dollars per hour) bottle) 10 0 0 8 8 1 8 4 6 2 12 0 4 3 12 4 2 4 8 8 0 5 0 c. Draw a graph of the market demand curve and Minnies marginal revenue curve. Minnies demand curve and marginal revenue curve are in Figure 13.2 The demand curve intersects the vertical axis at a price of $10 and intersects the horizontal axis at a quantity of 5. The marginal revenue curve intersects the vertical axis at a price of $10 and intersects the horizontal axis at a quantity of 2.5. d. Why is Minnies marginal revenue less than the price? Minnies marginal revenue is less than her price because to sell an additional unit of output, Minnie must lower her price on all units sold. So when Minnie sells an additional unit of output, her revenue consists of the price she receives for this extra unit minus what she loses on all previous units she sells now at the new, lower price. e. At what price is Minnies total revenue maximized? Interpolating along the demand curve, Minnies total revenue is maximized at a price of $5. At this price she sells 2.5 bottles an hour for total revenue of $12.50. f. Over what range of prices is the demand for water from Minnies Mineral Springs elastic? The demand for Minnies Mineral Springs water is elastic between $5 per bottle and $10 per bottle. g. Why will Minnie not produce a quantity at which the market demand for water is inelastic? Minnie will not produce a quantity at which the demand for her water is inelastic because producing at such a price does not maximize her profit. If Minnie is producing where her demand is inelastic, she can decrease the quantity she produces and 1) increase her total revenue, and 2) decrease her total cost. Because her total revenue increases and her total cost decreases, Minnies total profit increases. Anytime Minnies production is at a quantity at which demand is inelastic, she can always increase her total profit by decreasing her production. 5. Minnies Mineral Springs faces the demand schedule in problem 4 and has the total cost schedule in the table. Quantity Total cost produced (dollars) (bottles per hour) a. Calculate the marginal cost of 0 1 producing each output listed in 1 3 the table. 2 7 Marginal cost is the increase in 3 13 total cost that results from 4 21 increasing output by 1 unit. For 5 31 output from 1 bottle to 2 bottles, Quantity Marginal total cost increases by $4. The produced cost (bottles per (dollars) example, when Minnies increases marginal cost of increasing output from 1 bottle to 2 bottles is $4. The remaining marginal hour) 0 2 costs are calculated similarly. The second table to the right shows 1 4 the marginal cost schedule. b. Calculate Minnies 2 6 profit-maximizing output and price. 3 8 Minnies profit-maximizing output is 1.5 bottles and her 4 10 profit-maximizing price is $7a bottle. 5 To maximize profit Minnies needs to produce the quantity at which marginal revenue equals marginal cost. The marginal cost of increasing the quantity from 1 bottle to 2 bottles is $4 a bottle ($7 minus $3). That is, the marginal cost at 1.5 bottles of water is $4 a bottle. The marginal revenue of increasing the quantity sold from 1 bottle to 2 bottles is $4 ($12 minus $8). So the marginal revenue from 1.5 bottles is $4 a bottle. The profit-maximizing output is 1.5 bottles. The profit-maximizing price is the highest price that Minnies can sell the profit-maximizing output of 1.5 bottles. Minnies can sell 1 bottle for $8 and 2 bottles for $6, so it can sell 1.5 bottles for $7 a bottle. c. Calculate the economic profit. Economic profit equals total revenue minus total cost. Total revenue equals price ($7 a bottle) multiplied by quantity (1.5 bottles), which is $10.50. Total cost of producing 1 bottle is $3 and the total cost of producing 2 bottles is $7, so the total cost of producing 1.5 bottles is $5. Minnies economic profit equals $10.50 minus $5, which is $5.50. 6. La Bella Pizza can produce a pizza for a marginal cost of $2. Its standard price is $15 a pizza. It offers a second pizza for $5. It also distributes coupons that give a $5 rebate on a standard- price pizza. a. How can La Bella Pizza make a larger economic profit with this range of prices than it could if it sold every pizza for $15? La Bella Pizza is price discriminating, which increases its profit. It is price discriminating along two dimensions. First, it is charging consumers a second price for the second pizza they buy. This sort of price discrimination essentially is moving downward along a consumers demand curve and increasing the quantity the consumer purchases. Second, it is giving away coupons that lower the price on a standard-priced pizza. La Bella must have consumers with different willingness to pay and the coupon enables La Bella to increase its sales to the coupon users who have a lower willingness to pay for the pizza. On both counts, La Bella is increasing its sales and, because its marginal revenue from these additional sales exceeds its marginal cost of $2, the additional sales increase La Belles profit. b. Draw a graph that illustrates your answer to a. Figure 13.3 illustrates La Bella Pizzas situation. With no price discrimination La Bella produces 300 pizzas and sells them at a price of $10 a pizza. With the price discrimination, some consumers buy pizzas at a price of $15, others buy pizzas at a price of $10 (the $15 regular price minus the $5 coupon), and still others buy pizzas at a price of $5. The economic profit when La Bella sells at one price is equal to area A. When La Bella price discriminates, it makes additional economic profit: area B from the pizzas sold at $15 and area C from the pizzas sold at $5. c. Can you think of a way of increasing La Bella Pizzas economic profit even more? La Bella could further price discriminate. For instance, it might sell a third pizza for $4, which, given the marginal cost of $2, would still increase economic profit. d. Is La Bella Pizza more efficient than it would be if it charged just one price? A firm that can price discriminate increases its production relative to what it would produce if it could not price discriminate. So the quantity of pizza La Bella produces is closer to the efficient quantity with the price discrimination that it would be if La Bella did not price discriminate. 7. The Saturday-Night Stay Requirement Is on Its Final Approach The Saturday-night staythat pesky and expensive requirement that airlines instituted to ensure that the business traveler pays outrageous airfares if he or she wants to go home to the family for the weekendhas gone the way of the dodo bird. Many low-fare carriers, such as Southwest, JetBlue and AirTran, never had the Saturday-night rule. Some of the so-called legacy airlines, including America West and Alaska, have eliminated the restriction. United and American did away with it in response to competition but only on some routes. Still others, including Continental, Delta, US Airways and Northwest, mostly continue to enforce the rule, especially in the markets they dominate. Experts and industry spokesmen agree that low-fare carriers are the primary reason legacy airlines are adopting more consumer-friendly fare structures, which include the elimination of the Saturday-night stay, the introduction of one-way and walk-up fares and the general restructuring of its fares. Los Angeles Times, August 15, 2004 a. Explain why the opportunity for price discrimination exists for air travel. Even though there are many airlines overall, on some flights an airline might be the only company or one of a few on that route, thereby giving it significant pricing power. Then, because vacation travelers and business travelers have differing marginal benefits from travel (and therefore different willingness to pay) the airline is able to price discriminate between these groups. b. How does an airline profit from price discrimination? Airlines profit from price discrimination because they can charge business travelers, who have a lower elasticity and a higher willingness to pay, a high price that exceeds the price charged vacation travelers, who have a larger elasticity and a lower willingness to pay. By adjusting the prices they charge the different classes of customers so that the prices are closer to the customers willingness to pay, the airline can increase its economic profit by transferring consumer surplus from consumers to itself. c. Describe the change in price discrimination in the market for air travel when discount airlines entered the market. The expansion of low cost carriers into routes previously served by only one (or a very few) other carrier has increased competition and lowered the price. More importantly the increase in competition means that the airlines have less ability to determine their own price and increasingly must act as perfect competitors that take the market price as given. The less the airline can affect the price it charges, the less it can price discriminate. d. Explain the effect of the change in price discrimination when discount airlines entered the market on the price and the quantity of air travel. The entry of discount airlines lowered the average price of tickets and, by increasing the supply, increased the total market quantity. 8. The figure shows a situation similar to that facing Calypso U.S. Pipeline, a firm that operates a natural gas distribution system in the United States. Calypso is a natural monopoly that cannot price discriminate. What quantity will Calypso produce and what is the price of natural gas if Calypso is a. An unregulated profit-maximizing firm? Calypso will produce 2 million cubic feet a day and sell it for 6 cents a cubic foot. The marginal revenue curve will run from 10 cents on the y-axis to 2.5 cubic feet on the x-axis. The profit-maximizing output is 2 million cubic feet at which marginal revenue equals marginal cost. The price charged is the highest that people will pay for 2 million cubic feet a day, which is 6 cents a cubic foot. b. Regulated to make zero economic profit? If Calypso is regulated to make zero economic profit, it produces the output at which price equals average total costat the intersection of the demand curve and the LRAC curve. Calypso will produce 3 million cubic feet a day and charge 4 cents a cubic foot. c. Regulated to be efficient? If the firm is regulated to be efficient, it will produce the quantity at which price (marginal social benefit) equals marginal social costat the intersection of the demand curve and the marginal cost curve. Calypso will produce 4 cubic feet a day and charge 2 cents a cubic foot. 9 In problem 8, what is the producer surplus, consumer surplus, and deadweight loss if Calypso is a. An unregulated profit-maximizing firm? If Calypso is unregulated, it produces 2 million cubic feet a day and sells it for 6 cents a cubic foot. The consumer surplus is $40,000, the producer surplus is $80,000, and the deadweight loss is $40,000. The consumer surplus is the triangular area under the demand curve and above the price. The price is 6 cents, so consumer surplus equals (10 cents minus 6 cents) multiplied by 2 million cubic feet/2, which is $40,000. The producer surplus is the rectangular area under the price and above the MC curve. The price is 6 cents, so producer surplus equals (6 cents minus 2 cents) multiplied by 2 million cubic feet a day, which is $80,000. The efficient output is 4 cubic feet, at which marginal cost equals price (marginal benefit). The deadweight loss is the triangular area between the demand (or marginal benefit) curve and the marginal cost curve between the equilibrium quantity and the efficient quantity. So the deadweight loss equals (4 million cubic feet minus 2 million cubic feet) multiplied by (6 cents minus 2 cents)/2, which is $40,000 a day. b. Regulated to make zero economic profit? If Calypso is regulated to make zero economic profit, it produces 3 million cubic feet a day and sets a price of 4 cents a cubic foot. The consumer surplus is $90,000, the producer surplus is $60,000, and the deadweight loss $10,000. is The consumer surplus is the triangular area under the demand curve and above the price. The price is 4 cents, so consumer surplus equals (10 cents minus 4 cents) multiplied by 3 million cubic feet/2, which is $90,000. The producer surplus is the rectangular area under the price and above the MC curve. The price is 4 cents, so producer surplus equals (4 cents minus 2 cents) multiplied by 3 million cubic feet, which is $60,000. The efficient output is 4 million cubic feet, at which marginal cost equals price (marginal benefit). The deadweight loss is the triangular area between the demand (or marginal social benefit) curve and the marginal cost curve between the equilibrium quantity and the efficient quantity. So the deadweight loss equals (4 million cubic feet minus 3 million cubic feet) multiplied by (4 cents minus 2 cents)/2, which is $10,000 a day. c. Regulated to be efficient? If Calypso is regulated to be efficient, it produces 4 million cubic feet a day and sells it for 2 cents a cubic foot. The consumer surplus is $160,000, the producer surplus is $0, and the deadweight loss is $0. The consumer surplus is the triangular area under the demand curve and above the price. The price is 2 cents, so consumer surplus equals (10 cents minus 2 cents) multiplied by 4 million cubic feet/2, which is $160,000. There is no producer surplus because the price equals the marginal cost. And there is no deadweight loss because the quantity produced is the efficient quantity. 10. The following list gives some information about seven firms. Coca-Cola cuts its price below that of Pepsi-Cola in an attempt to increase its market share. A single firm, protected by a barrier to entry, produces a personal service that has no close substitutes. A barrier to entry exists, but the good has some close substitutes. A firm offers discounts to students and seniors. A firm can sell any quantity it chooses at the going price. The government issues Nike an exclusive license to produce golf balls. A firm experiences economies of scale even when it produces the quantity that meets the entire market demand. a. In which of the seven cases might monopoly arise? The second, sixth, and seventh cases suggest that a monopoly might be a possibility. b. Which of the seven cases are natural monopolies and which are legal monopolies? It is not possible to determine if the second case is a legal barrier or natural barrier to entry because we do not know the type of barrier. The sixth case describes a legal barrier to entry because Nike has been given an exclusive license by the government. The seventh case is a natural monopoly because it describes the firm as having economies of scale over the entire market demand. c. Which can price discriminate, which cannot, and why? Coca-Cola in the first case cannot price discriminate because there are not separate classes of customers with different willingness to pay. The fifth case, the firm that can sell any quantity it wants at the going price, is a perfect competitor and cannot price discriminate. The fourth case, the firm offering discounts to students, and seniors, is price discriminating. The other situations describe firms that might be able to price discriminate if there are different classes of customers and if the firm can determine into which class a customer falls. 11. Hot Air Balloon Rides, a single-price monopoly, has the demand schedule shown in columns 1 and 2 Price Quantity Total (dollars demanded cost per (rides per (dollars ride) month) per of the table and the total cost schedule shown in columns 2 and 3 of the table. month) 220 0 80 200 1 160 180 2 260 a. Construct Hot Airs 160 3 380 total revenue and 140 4 520 marginal revenue 120 5 680 schedules. The table showing Hot Airs total revenue schedule and marginal revenue schedule is below. Total revenue equals price multiplied by quantity. Marginal revenue equals the change in total revenue divided by the change in quantity. For example, between 1 ride and 2 rides the total revenue increases by $160 and the quantity increases by 1 ride, so the marginal revenue equals $160/1, which is $160. This marginal revenue is placed midway between the 1 ride and 2 rides rows. Price Quantity Total Marginal (dollars demanded revenue revenue per (rides per (dollars (dollars ride) month) per per ride) month) 220 0 0 200 200 1 200 160 180 2 360 120 160 3 480 80 140 4 560 40 120 5 600 b. Draw a graph of the demand curve and Hot Airs marginal revenue curve. Figure 13.5 illustrates Hot Airs demand curve and marginal revenue curve. c. Find Hot Airs profit-maximizing output and price and calculate the firms economic profit. HotAirs marginal cost equals marginal revenue at 2 1/2 rides a month, where both equal $120. From the demand curve, the price is $170 a ride. Total economic profit equals total revenue minus total cost. The total cost of 2 1/2 rides a month is $320. HotAirs total revenue equals the number of rides multiplied by the price per ride, which is (2 1/2 rides per month) ($170) = $425. So the total economic profit is total revenue minus total cost, which is $425 $320 = $105. d. If the government imposes a tax on Hot Airs profit, how does its output and price change? As a result of the tax, HotAirs fixed cost changes, but its marginal cost does not. The profit-maximizing level of output is still 2 1/2 rides a month and the price still equals $170. The tax decreases HotAirs economic profit but does not change its output or price. e. If instead of taxing Hot Airs profit, the government imposes a sales tax on balloon rides of $30 a ride, what are the new profit-maximizing quantity, price, and economic profit? A $30 a ride tax increases Hot Airs marginal cost by $30 at every level of output. With the increase in the marginal costs, Hot Air now sells 2 rides a month because this is the level at which the new marginal cost equals the marginal revenue (both equal $140). From the demand curve, Hot Air sets a price of $180 a ride. Total economic profit equals total revenue minus total cost. The total revenue is 2 rides $180 which is $360. The total cost is $260 plus the tax of $60, which is $320. So the new economic profit is $360 $320 = $40. 12. Figure 13.6 illustrates the situation facing the publisher of the only newspaper containing local news in an isolated community. a. On the graph, mark the profit-maximizing quantity and price. Profit is maximized when the firm produces the output at which marginal cost equals marginal revenue. The marginal revenue curve runs from 100 on the y-axis to 500 on the x-axis. The marginal revenue curve cuts the marginal cost curve at the quantity 267 newspapers a day. The highest price for which the publisher can sell 267 newspapers a day is read from the demand curve. So the profit-maximizing quantity is 267 newspapers a day and price is 73 cents a paper. b. On the graph show the publishers total revenue per day The daily total revenue is $194.91 (267 papers at 73 cents each). This amount is equal to the rectangular area C in Figure 13.7 (on the next page). c. At the price charged, is the demand for this newspaper elastic or inelastic? Why? Demand is elastic. Along a straight-line demand curve, demand is elastic at all prices above the midpoint of the demand curve. The price at the midpoint is 50 cents. So at 73 cents a paper, demand is elastic. d. What are consumer surplus and deadweight loss? Mark each on your graph. Figure 13.7 shows the consumer surplus, area A, and the deadweight loss, area B. The consumer surplus is $36.05 a day and the deadweight loss is $8.65 a day. The consumer surplus is the area marked A in Figure 13.7 and the deadweight loss is the darker area marked B in the figure. Consumer surplus is the area under the demand curve and above the price. The price is 73 cents, so consumer surplus equals (100 cents minus 73 cents) multiplied by 267/2 papers a day, which is $36.05 a day. Deadweight loss arises because the publisher does not produce the efficient quantity. Output is restricted to 267 newspapers rather than 400, and the price is increased to 73 cents rather than 60 cents. The deadweight loss equals (73 cents minus 46.6 cents) multiplied by 133/2, $17.56. e. Explain why this market might encourage rent seeking. This market would encourage rent seeking because the producer is making an economic profit. Other entrepreneurs would like to make this economic profit and will rent seek in an attempt to do so. f. If this market were perfectly competitive, what would be the quantity, price, consumer surplus, and producer surplus? Mark each on your graph. The quantity would be 400 newspapers a day and the price would be 60 cents a newspaper. The consumer surplus is the triangular area under the demand curve and above the price, marked as area A in Figure 13.8. The price is 60 cents, so consumer surplus equals (100 cents minus 60 cents) multiplied by 400/2 papers a day, which is $80 a day. The producer surplus is the triangular area under the price and above the supply curve, marked as area B in Figure 13.8. The price is 60 cents, so producer surplus equals (60 cents minus 20 cents) multiplied by 400/2 papers a day, or $80 a day. 13. Telecoms Look to Grow by Acquisition A multibillion-dollar telecommunications merger announced Thursday shows how global cellular powerhouses are scouting for growth in emerging economies while consolidating in their own, crowded backyards. France Tlcom offered Thursday to buy TeliaSonera, a Swedish-Finnish telecommunications operator Within hours, TeliaSonera rejected the offer as too low, but analysts said higher bidseither from France Tlcom or others could persuade [TeliaSonera] to accept a deal. Meanwhile, in the United States, Verizon Wireless, agreed to buy Alltel for $28.1 billion, a deal that would make the company the biggest mobile phone operator in the country. A combination of France Tlcom and TeliaSonera would create the worlds fourth-largest mobile operator smaller only than China Mobile, Vodafone and Telefnica of Spain. International Herald Tribune, June 5, 2008 a. Explain the rent seeking behavior of global telecommunications companies. France Tlcom and Verizon Wirless are rent seeking because they are attempting to buy a significant competitor to establish a monopoly. b. Explain how mergers may affect the efficiency of the telecommunications market. The mergers would decrease the amount of competition in the telecommunications market. To the extent that they lead to monopoly power in that market they create a deadweight loss and reduce the efficiency of the markets. 14. Zoloft Faces Patent Expiration ... Pfizers antidepressant Zoloft, with $3.3 billion in 2005 sales, loses patent protection on June 30. When a brand name drug loses its patent, both the price of the drug and the dollar value of its sales each tend to drop about 80 percent over the next year, as competition opens to a host of generic drugmakers. ... Some of those lost revenue will go to generic drugmakers. But the real winners are the patients and the insurers, who pay much lower prices. The Food and Drug Administration insists that generics work identically to brand-names. CNN, June 15, 2006 a. Assume that Zoloft is the only antidepressant on the market and that price discrimination is not an option. Draw a graph to illustrate the market price and quantity of Zoloft sold. Figure 13.9 shows the market for Zoloft. Pfizer produces the quantity at which marginal revenue equals marginal cost. In the figure Pfizer produces 30 million doses a day. The price of $7 a dose comes from the demand curve. b. On your graph, identify consumer surplus, producer surplus and deadweight loss. In Figure 13.9 the consumer surplus is equal to area A, the area under the demand curve and above the price. The producer surplus is equal to area B, the area under the price and above the supply curve. The deadweight loss is equal to area C. c. How might you justify protecting Pfizer from competition with a legal barrier to entry? Pfizer must spend hundreds of millions of dollars to develop a drug. Once the drug is developed, the marginal cost to anyone of producing it is low. If the market was competitive Pfizer would not be able to recoup the hundreds of millions of dollars it spent in development because competition would keep the price low. Without the lure of monopoly profit from the patent, Pfizer would not have developed Zoloft, and the patients who do take Zoloft would not have reaped the benefits from this medication. d. Explain how the market for an antidepressant drug changes when a patent expires. When the patent expires other firms can enter the market and produce the drug. The market becomes competitive. The price falls and the quantity increases. e. Draw a graph to illustrate how the expiration of the Zoloft patent will change the price and quantity in the market for antidepressants. Figure 13.10 shows the equilibrium price and equilibrium quantity once the patent expires. The market is competitive so the equilibrium price and equilibrium quantity are determined at the intersection of the demand and supply curves. In Figure 13.10 the equilibrium price is $5 a dose and the equilibrium quantity is 50 million doses. f. Explain how consumer surplus, producer surplus, and deadweight loss change with the expiration of the Zoloft patent. Consumer surplus increases because the price is lower and because consumers respond by increasing the quantity they purchase. In Figure 13.10 the consumer surplus has increased so that it is equal to area A, the area under the demand curve and above the price. The producer surplus decreases because the price is lower. In the figure the producer surplus has decreased to become area B, the area under the price and above the supply curve. Because the market is efficient, there is no deadweight loss. 15. iSurrender ... Getting your hands on a new iPhone ... [means] signing ... a two-year AT&T contract. Some markets, because of the sheer costs of being a player, tend toward either a single firm or a small number of firms. ... Everyone hoped and thought the wireless market would be different. ... A telephone monopoly has been the norm for most of American telecommunication history, except for what may turn out to have been a brief experimental period from 1984 through 2012 or so [I]t may be that telephone monopolies in America are a national tradition. Slate, June 10, 2008 a. How does AT&T being the exclusive provider of wireless service for the iPhone influence the wireless telecommunication market? AT&T being the exclusive provider of service for the iPhone limits the amount of competition within the wireless market. With this deal, the price of an iPhone is higher than would otherwise be the case and the quantity of iPhone service is lower than would otherwise be the case. b. Explain why the wireless market may tend toward either a single firm or a small number of firms. Why might this justify allowing a regulated monopoly to exist in this market? If the wireless industry is a natural monopoly, there is a natural tendency for the market to have only one firm. The firm that survives obtains a cost advantage over its competitors by increasing the quantity it produces and then the firm uses that cost advantage to drive its competitors out of business. If this industry is a natural monopoly, then granting the firm the public franchise to be a monopoly in exchange for regulating its price and quantity is a reasonable public policy to avoid the deadweight loss that would arise from an unregulated monopoly. 16. F.C.C. Planning Rules to Open Cable Market The Federal Communications Commission is preparing to impose significant new regulations to open the cable television market to independent programmers and rival video services The agency is also preparing to adopt a rule this month that would make it easier for independent programmers, which are often small operations, to lease access to cable channels [and] set a cap on the size of the nations largest cable companies so that no company could control more than 30 percent of the market. ... The New York Times, November 10, 2007 a. What barriers to entry exist in the cable television market? The major barrier to entry is that the cable industry is a natural monopoly. Firms entering the market will have higher average total costs if the amount they produce and sell is less than that of the existing firm. b. Are high cable prices evidence of monopoly power? High prices are not necessarily evidence of monopoly. Prices can be high in competitive markets if the costs are high. For instance, the luxury car market is competitive but these cars are quite expensive. c. Draw a graph to illustrate the effects of the F.C.C.s new regulations on the price, quantity, consumer surplus, producer surplus, and deadweight loss. Presuming that the cable market was an unregulated monopoly before the FCCs actions and that the market becomes competitive after the actions, Figure 13.11 shows what would happen. With the cable television market a monopoly, 200 channels are provided and the price is $3 a channel. The consumer surplus is equal to area A, the producer surplus is equal to area B + area E, and the deadweight loss is equal to area C + area F. Once the market is competitive, 250 channels are provided and the price is $2.50 a channel. Consumer surplus increases to area A + area B + area C. Producer surplus decreases to area E + area F. There is no deadweight loss because the market is allocatively efficient. 17. Study Reading Between the Lines on pp. 316 317 and then answer the following questions: a. What does the news article mean when it says that Microsofts main challenge comes from the marketplace rather than government? The article means that if Microsoft fails to respond to its competitors, Microsofts profit might be severely diminished because consumers no longer need Windows and Microsofts other applications. b. How does Microsoft try to raise barriers to the entry of competitors? Microsoft tries to raise barriers to entry by creating products that compete with the products of its competitors and then embedding the products as part of its Windows operating system. In this fashion customers no longer need the competing products because they already have a Microsoft version as part of Windows. c. Compare and contrast the anti-monopoly regulation in Europe with that in the United States. Monopoly regulation in Europe is frequently used to protect competitors rather than competition. For instance, the discussion for the Reading Between the Lines article points out how the European decision helped preserve Real Networks. In the United States antitrust law is often devoted to preserving competition rather than individual competitors. U.S. antitrust law generally tends to protect and enhance allocative efficiency while European antitrust law often tends to protect and enhance producer surplus. ... View Full Document

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