microeconomics book solution 14

microeconomics book solution 14 -...

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Solution Solution Monopoly 1. Each of the following firms possesses market power. Explain its source. a. Merck, the producer of the patented cholesterol-lowering drug Zetia b. WaterWorks, a provider of piped water c. Chiquita, a supplier of bananas and owner of most banana plantations d. The Walt Disney Company, the creators of Mickey Mouse 1. a. Merck has a patent for Zetia. This is an example of a government-created barrier to entry, which gives Merck market power. There are increasing returns to scale in the provision of piped water. There is a large fixed cost associated with building a network of water pipes to each house- hold; the more water delivered, the lower its average total cost becomes. This gives WaterWorks a cost advantage over other companies. This cost advantage gives WaterWorks market power. c. Chiquita controls most banana plantations. Control over a scarce resource gives Chiquita market power. d. The Walt Disney Company has the copyright over animations featuring Mickey Mouse. This is another example of a government-created barrier to entry that gives the Walt Disney Company market power. 2. Skyscraper City has a subway system, for which a one-way fare is $1.50. There is pres- sure on the mayor to reduce the fare by one-third, to $1.00. The mayor is dismayed, thinking that this will mean Skyscraper City is losing one-third of its revenue from sales of subway tickets. The mayor’s economic adviser reminds her that she is focusing only on the price effect and ignoring the quantity effect. Explain why the mayor’s estimate of a one-third loss of revenue is likely to be an overestimate. Illustrate with a diagram. 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. Price of ticket Quantity of tickets $1.50 1.00 0 D Price effect Quantity effect S-197 14 chapter: S197-S208_Krugman2e_PS_Ch14.qxp 9/16/08 9:22 PM Page S-197
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Solution S-198 CHAPTER 14 MONOPOLY 3. Consider an industry with the demand curve ( D ) and marginal cost curve ( MC ) shown in the accompanying diagram. There is no fixed cost. If the industry is a single-price monopoly, the monopolist’s marginal revenue curve would be MR. Answer the following questions by naming the appropriate points or areas. a. If the industry is perfectly competitive, what will be the total quantity produced? At what price? b. Which area reflects consumer surplus under perfect competition?
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