Econ302-hw5-spring11-solutions - Econ302 Homework...

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Econ302 Homework Assignment 5 Solution 1. What factors determine the amount of monopoly power an individual firm is likely to have? Explain each one briefly. Three factors determine the firm’s elasticity of demand: (1) the elasticity of market demand, (2) the number of firms in the market, and (3) interaction among the firms in the market. The elasticity of market demand depends on the uniqueness of the product, i.e., how easy it is for consumers to substitute away from the product. As the number of firms in the market increases, the demand elasticity facing each firm increases because customers may shift to the firm’s competitors. The number of firms in the market is determined by how easy it is to enter the industry (the height of barriers to entry). Finally, the ability to raise the price above marginal cost depends on how other firms react to the firm’s price changes. If other firms match price changes, customers will have little incentive to switch to another supplier. 2. Why is there a social cost to monopoly power? If the gains to producers from monopoly power could be redistributed to consumers, would the social cost of monopoly power be eliminated? Explain briefly. When the firm exploits its monopoly power by charging a price above marginal cost, consumers buy less at the higher price. Consumers enjoy less surplus, the difference between the price they are willing to pay and the market price on each unit consumed. Some of the lost consumer surplus is not captured by the seller and is a deadweight loss to society. Therefore, if the gains to producers were redistributed to consumers, society would still suffer the deadweight loss. 3. The following table shows the demand curve facing a monopolist who produces at a constant marginal cost of $10. Price Quantity 18 0 16 4 14 8 12 12 10 16 8 20 6 24 4 28 2 32 0 36 a. Derive the equation of the firm’s marginal revenue curve. To find the marginal revenue curve, we first derive the inverse demand curve. The intercept of the inverse demand curve on the price axis is 18. The slope of the inverse demand curve is the change in price divided by the change in
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quantity. For example, a decrease in price from 18 to 16 yields an increase in quantity from 0 to 4. Therefore, the slope is 1 2 and the demand curve is P 18 0.5 Q .
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This note was uploaded on 05/25/2011 for the course ECON 302 taught by Professor Toossi during the Spring '08 term at University of Illinois at Urbana–Champaign.

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Econ302-hw5-spring11-solutions - Econ302 Homework...

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