Krugman_SolMan_CH14 - Krugman_SolMan_CH14 11/11/04 4:24 PM...

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chapter Monopoly 1. a. Merck has a patent for Zetia. This is an example of a government-created barrier to entry, which gives Merck market power. b. There are economies of scale in the provision of local telephone service. There is a large fixed cost associated with building a network of copper cables to each house- hold; the more telephone calls Verizon produces, the lower its average total cost becomes. This gives Verizon a cost advantage over other companies. This cost advantage gives Verizon market power. c. Chiquita controls most banana plantations. Control over a scarce resource gives Chiquita market power. 2. A reduction in fares from $1.50 to $1.00 will reduce the revenue on each ticket that is currently sold by one-third; this is the price effect. But a reduction in price will lead to more tickets being sold at the lower price of $1.00, which creates additional revenue; this is the quantity effect. The accompanying diagram illustrates this. The price effect is the loss of revenue on all the currently sold tickets. The quantity effect is the increase in revenue from increased sales as a result of the lower price. 3. a. In a perfectly competitive industry, each firm maximizes profit by producing the quantity at which price equals marginal cost. That is, all firms together produce a quantity S where the marginal cost curve crosses the demand curve. Price will be equal to marginal cost, E . Consumer surplus is the area under the demand curve and above price. In part a, we saw that the perfectly competitive price is E . Consumer surplus in perfect com- petition is therefore the triangle ARE . c. A single-price monopolist produces the quantity at which marginal cost equals marginal revenue, that is, quantity I . Accordingly, the monopolist charges price B , the highest price it can charge if it wants to sell quantity I . d. The single-price monopolist’s profit per unit is the difference between price and the average total cost. Since there is no fixed cost and the marginal cost is con- stant (each unit costs the same to produce), the marginal cost is the same as the average total cost. That is, profit per unit is the distance BE . Since the monopolist sells I units, its profit is BE times I , or the rectangle BEHF . e. Consumer surplus is the area under the demand curve and above price. In part d, we saw that the monopoly price is B . Consumer surplus in monopoly is therefore the triangle AFB . Price of ticket Quantity of tickets $1.50 1.00 0 D Price effect Quantity effect 119 14 Krugman_SolMan_CH14 11/11/04 4:24 PM Page 119
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f. Deadweight loss is the surplus that would have been available (either to con- sumers or producers) under perfect competition but that is lost when there is a single-price monopolist. It is the triangle FRH .
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This note was uploaded on 04/30/2008 for the course ECON 2106 taught by Professor Minjaesong during the Spring '06 term at Georgia Institute of Technology.

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Krugman_SolMan_CH14 - Krugman_SolMan_CH14 11/11/04 4:24 PM...

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