ECN 453: Pricing and Monopoly
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Questions and Answers

What is the optimal price for the firm in this scenario?

  • 5
  • 6
  • 4 (correct)
  • 3

    • What is the maximum profit the firm can earn?

  • 0.5
  • 2
  • 1 (correct)
  • 1.5

    • At what price does the firm begin to experience diminishing marginal returns?

  • 5 (correct)
  • 4
  • 3
  • 6

    • What is the firm's total revenue when the price is 3?

    <p>6 (C)</p> Signup and view all the answers

    What is the firm's total cost when the price is 2?

    <p>6.5 (A)</p> Signup and view all the answers

    What is the firm's marginal cost when the price is 5?

    <p>1 (A)</p> Signup and view all the answers

    At what price does the firm's profit begin to decrease?

    <p>3 (D)</p> Signup and view all the answers

    What is the firm's marginal revenue when the price is 2?

    <p>-1 (B)</p> Signup and view all the answers

    What is the elasticity of demand for the given demand equation: q = 2 − 15p?

    <p>-3 (C)</p> Signup and view all the answers

    What is the term used to describe the difference in total surplus between a monopoly and a competitive market?

    <p>Deadweight loss (C)</p> Signup and view all the answers

    What is the primary goal of an antitrust policy?

    <p>Protect consumers from unfair competition (A)</p> Signup and view all the answers

    In the context of the Facebook vs FTC case, what did the FTC accuse Facebook of doing?

    <p>Acquiring companies to eliminate competition (B)</p> Signup and view all the answers

    What was the primary objective of the FTC's lawsuit against Facebook?

    <p>To force Facebook to divest itself of Instagram and WhatsApp (B)</p> Signup and view all the answers

    Which of the following is a potential solution to correct the market failure caused by monopolies?

    <p>Breaking up the monopoly into smaller firms (A)</p> Signup and view all the answers

    Why does a monopoly typically set a price ‘too high’ and a quantity ‘too low’ compared to a competitive market?

    <p>To maximize its own profits (C)</p> Signup and view all the answers

    What is the term used to describe the situation where a company has complete control over a particular market?

    <p>Monopoly (A)</p> Signup and view all the answers

    Which of the following is NOT a benefit of competition in a market?

    <p>Reduced efficiency and innovation (D)</p> Signup and view all the answers

    What is the formula for price, derived from the elasticity rule, in terms of marginal cost (MC) and price elasticity of demand (e)?

    <p>p = MC / (1 + e) (B)</p> Signup and view all the answers

    What key relationship does the elasticity rule derive from?

    <p>Marginal Revenue (MR) = Marginal Cost (MC) (A)</p> Signup and view all the answers

    The elasticity rule states that the ratio of (p - MC) to p is equal to what?

    <p>The inverse of the price elasticity of demand (A)</p> Signup and view all the answers

    What is the correct formula for calculating Price Elasticity of Demand (e)?

    <p>e = (dQ/Q) / (dP/P) (B)</p> Signup and view all the answers

    Which of the following is NOT a direct implication of the elasticity rule?

    <p>Firms with higher marginal costs should set lower prices. (A)</p> Signup and view all the answers

    Given an inverse demand curve of p = P(q), how is total revenue (TR) calculated?

    <p>TR = P(q) * q (B)</p> Signup and view all the answers

    What is the formula for calculating the marginal revenue (MR) from the inverse demand curve, p = P(q), using the product rule?

    <p>MR = dP(q)/dq * q + P(q) (B)</p> Signup and view all the answers

    To find the optimal price (p*) and quantity (q*) using the MR = MC approach, what must you first do?

    <p>Solve for the quantity (q) at which MR = MC (A)</p> Signup and view all the answers

    What was the primary reason the court dismissed the FTC's challenge against Facebook's monopoly status?

    <p>The FTC's challenge was filed too late after Facebook's acquisitions. (A)</p> Signup and view all the answers

    Which of these companies was not a result of breaking up Standard Oil?

    <p>Shell (A)</p> Signup and view all the answers

    Why was AT&T broken up into smaller firms in 1984?

    <p>All of the above. (D)</p> Signup and view all the answers

    Which of the following is NOT an example of a natural monopoly?

    <p>A grocery store (D)</p> Signup and view all the answers

    What is the primary goal of marginal cost pricing regulation?

    <p>To prevent the monopolist from raising prices above the marginal cost of production. (B)</p> Signup and view all the answers

    Why is forcing a monopolist to set p = MC a potential problem?

    <p>It may result in the monopolist shutting down operations. (D)</p> Signup and view all the answers

    What is one proposed solution to the problem of negative profits under marginal cost pricing?

    <p>Provide a government subsidy to the monopolist to cover their fixed costs. (C)</p> Signup and view all the answers

    What is the main difference between marginal cost pricing and average cost pricing?

    <p>Marginal cost pricing sets p = MC, while average cost pricing sets p = AC. (C)</p> Signup and view all the answers

    What is the primary purpose of average cost pricing as a regulatory strategy?

    <p>To ensure that the monopolist operates at a price equal to its average total cost, thus covering fixed costs. (D)</p> Signup and view all the answers

    In the context of average cost pricing, how does the price compare to the monopolist's price in a purely unregulated scenario?

    <p>The average cost pricing price is lower than the unregulated monopolist's price. (B)</p> Signup and view all the answers

    What is the significance of the term 'rate of return regulation' in the context of average cost pricing?

    <p>It refers to the government setting a specific return on investment for the regulated firm. (B)</p> Signup and view all the answers

    What is the primary benefit of average cost pricing, as opposed to marginal cost pricing, for a regulated monopolist?

    <p>Average cost pricing avoids the need for government subsidies, ensuring the monopolist can cover its fixed costs. (C)</p> Signup and view all the answers

    Which of the following is NOT a potential solution to market failure in a monopoly market?

    <p>Price discrimination (C)</p> Signup and view all the answers

    Which of the following correctly describes the relationship between the monopolist’s price (pm) and the average cost pricing price (pac) in the provided graph?

    <p>pac &lt; pm (A)</p> Signup and view all the answers

    How does average cost pricing relate to a competitive market outcome in terms of quantity produced and price?

    <p>Average cost pricing results in a quantity closer to the competitive market outcome, but a higher price. (C)</p> Signup and view all the answers

    What is the key difference between marginal cost pricing and average cost pricing in terms of the price set for the monopolist?

    <p>Marginal cost pricing results in a lower price than average cost pricing, achieving greater efficiency but potentially requiring government subsidies. (B)</p> Signup and view all the answers

    Flashcards

    Elasticity Rule

    Relationship between price, margin, and elasticity: (p - MC) / p = -1/e.

    Inverse Elasticity

    The reciprocal of elasticity; represents how demand changes with price.

    Marginal Cost (MC)

    The cost of producing one additional unit of a good or service.

    Marginal Revenue (MR)

    The additional revenue gained from selling one more unit.

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    Total Revenue (TR)

    Total sales revenue; equals price multiplied by quantity sold.

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    Demand Curve Equation

    Equation representing the relationship between price and quantity demanded.

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    Applying Product Rule

    Technique in calculus used to find the derivative of products in MR calculation.

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    Setting MR = MC

    A key condition for profit maximization in economics.

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    Elasticity of Demand

    A measure of how much quantity demanded changes with price changes.

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    Elasticity Calculation

    e = (dq/dp) * (p/q) where dq is change in quantity.

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    Negative Elasticity

    Indicates that quantity demanded decreases as price increases.

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    Optimal Pricing

    Using MC and demand elasticity to set the best price for a product.

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    Welfare Costs of Monopoly

    Losses in economic efficiency due to a monopolist's pricing above competition levels.

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    Producer Surplus

    The difference between what producers are willing to accept and what they actually receive.

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    Competitive Price/Quantity

    Price and quantity where MC equals demand, indicating a balanced market.

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    Elasticity Rule Use

    A guideline for pricing using known MC and calculated demand elasticity.

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    Consumer Surplus

    The difference between what consumers are willing to pay and what they actually pay.

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    Monopoly Pricing

    A pricing strategy where a single seller sets high prices and low quantities to maximize profit.

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    Dead-weight Loss

    The loss of economic efficiency when the equilibrium outcome is not achieved.

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    Market Failure

    A situation in which the allocation of goods and services is not efficient, often due to monopolies.

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    Antitrust Policy

    Regulations that prevent monopolies and promote competition in the market.

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    Facebook FTC Case

    The 2020 lawsuit where the FTC accused Facebook of monopolistic practices following acquisitions.

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    Divestiture

    The action of selling off subsidiary business interests or investments.

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    Price Optimization

    The process of setting prices to maximize business profit, sometimes at consumer expense.

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    FTC Monopoly Case

    The court ruled FTC did not prove Facebook was a monopoly and allowed refiling with more evidence.

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    Standard Oil

    An enormous oil company broken up into smaller firms like Chevron and ExxonMobil.

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    AT&T Breakup

    AT&T was split into several smaller companies in 1984 due to monopoly concerns.

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    Natural Monopolies

    Monopolies that cannot be broken up, such as utilities like power plants and bridges.

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    Marginal Cost Pricing

    Regulation method where price is set equal to marginal cost to minimize dead-weight loss.

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    Negative Profit in Monopoly

    With p = MC = c, monopolist's profit becomes negative, leading to potential shutdown.

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    Government Subsidy

    A payment to prevent a regulated monopolist from shutting down due to negative profits.

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    Average Cost Pricing

    A regulation strategy where the monopolist sets price equal to average cost.

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    Optimal Price

    The price set to maximize a monopolist's profit.

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    Monopolist

    A single firm that controls a market without competition.

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    Profit Maximization

    Determining the price and output level to achieve the highest profit.

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    Demand and Total Cost

    Information needed to set optimal prices for a product.

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    Zero Profit Condition

    A situation where Total Revenue (TR) equals Total Cost (TC) for a monopolist, resulting in no profit.

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    Rate of Return Regulation

    A form of average cost pricing used for regulating returns on investment in utilities and monopolistic firms.

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    Solutions to Monopoly Market Failure

    Three potential strategies: Divestment, Marginal Cost Pricing, and Average Cost Pricing to address monopoly inefficiencies.

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    Competitve Price vs Monopolist's Price

    In a monopoly, the price set is typically higher than in competitive markets, leading to a welfare loss.

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    Study Notes

    ECN 453: Pricing and Monopoly

    • This course covers optimal pricing strategies for monopolists
    • The optimal price maximizes profit
    • This is useful for policymakers to understand welfare reduction caused by monopolies
    • Firm strategy seeks to maximize profits when launching new products
    • Most content will be review from previous courses

    Plan

    • Pricing example using a table
    • Pricing using MR = MC
    • Pricing using elasticities
    • Welfare costs of monopoly pricing and regulation

    Pricing: Example Using a Table

    • Tables show demand, total revenue (TR), marginal revenue (MR), total cost (TC), marginal cost (MC), and profit for different prices
    • Optimal price found by raising prices as long as MR > MC
    • Example provided with pricing, demand, TR, MR, TC, MC, and profit
    • Optimal price maximizes profit (in whole numbers)

    Pricing: MR = MC

    • Optimal price occurs where marginal revenue (MR) equals marginal cost (MC)
    • This is a crucial formula
    • The previous example only considered whole numbers of the product
    • When selling fractions, the optimal price occurs when MR = MC

    Pricing: MR = MC: Monopoly Example

    • A monopolist faces a demand curve q = 2 - p/5 and constant marginal cost of 5
    • The optimal price is found by using the formula MR = MC (and double the slope formula)
    • Finding the optimal quantity, q*, gives q* = 0.5
    • Substituting q* into the demand curve provides the optimal price p* = 7.5

    Pricing: MR=MC: Algorithm

    • Steps for finding optimal price for a monopolist given demand and marginal cost
      1. Calculate marginal revenue from demand curve
      2. Use MR = MC to solve for optimal quantity
      3. Substitute optimal quantity into demand curve to get optimal price

    Pricing: MR=MC: Graph

    • Graphs illustrate demand (D), marginal revenue (MR), and marginal cost (MC) curves
    • The optimal price (p*) and quantity (q*) are where the MR and MC curves intersect
    • Optimal price is determined graphically, using the intersection point on the demand curves

    Pricing: Elasticities

    • A relationship exists between optimal price and demand elasticity
    • This is known as the elasticity rule
    • Elasticity rule is given by: (p-MC)/p = -1/ε
    • ε represents inverse of elasticity

    Elasticity Rule: Math (Optional)

    • The elasticity rule stems from the equation MR = MC
    • Applying the product rule provides the optimal equation used
    • Useful for real-world empirical applications
    • Economists use econometric methods (outside of the course scope) to determine demand elasticity
    • The elasticity rule provides a method to calculate the optimal price when marginal cost and demand elasticity are known

    Elasticity Rule

    • Illustrates relationship between optimal price and demand elasticity
    • Formula: (p − MC)/p = −1/ε
    • ε is inversely related to elasticity
    • Useful for real-world pricing applications

    Using the Elasticity Rule

    • Practical use for real-world pricing applications

    Welfare Costs of Monopoly Pricing

    • Graphs illustrate monopoly's price/quantity vs competitive price/quantity
    • Show producer surplus (area labeled A), consumer surplus (area labeled B), and deadweight loss (area labeled C)
    • Monopoly pricing leads to higher prices and lower quantity than under competitive conditions
    • Deadweight loss is the area between perfect competition and monopoly curves

    Welfare Costs of Monopoly Pricing: Summary

    • Competition tends to produce prices maximizing total surplus
    • A monopolist chooses the firm's optimal and profit maximizing price and quantity
    • Monopoly pricing typically results in a lower quantity sold than would occur under competition.
    • Causes deadweight loss
    • Monopoly represents a market failure

    Regulating Monopolies

    • Methods to correct monopoly market failures
      • Breaking up monopolies
      • Regulating monopolies (anti-trust policy, used in market failures, which are due to a lack of competition)

    Regulating Monopolies: Case Study of Facebook vs FTC

    • Facebook acquired Instagram and WhatsApp
    • The Federal Trade Commission (FTC) sued Facebook for illegal monopolization and divestiture of companies
    • A court dismissed the FTC complaint due to lack of proof that Facebook was a monopoly and that the case was filed too late.
    • Examples of other monopolies such as Standard Oil and AT&T that were broken up for similar reasons given by the court.

    Regulating Monopolies: Other Examples of Breaking Up a Monopoly

    • Standard Oil (broken up into numerous companies)
    • AT&T (broken into smaller firms)
    • Other examples exist, including attempted breakups of Microsoft in 2001.
    • Preventing the creation of new monopolies is a key focus of antitrust policy

    Regulating Monopolies: Marginal and Average Cost Pricing

    • Some monopolies are "natural monopolies" (i.e., power plants, bridges)
    • Regulation is needed to regulate them
    • Two methods, marginal and average cost pricing

    Regulating Monopolies: Marginal Cost Pricing

    • Setting price equal to marginal cost (p = MC)
    • This leads to perfect competition pricing
    • This could potentially lead to a negative profit for the firm
    • A government subsidy is needed if necessary to keep the company from shutting down

    Regulating Monopolies: Average Cost Pricing

    • Setting price equal to average cost (p = AC)
    • Necessary to cover fixed and variable costs
    • This ensures the company is not making a negative profit
    • This is common in regulating privately owned power plants, and is called "rate-of-return regulation".

    Summary of Key Points

    • Recognize the optimal pricing occurs where MR = MC, which maximizes profit
    • Understand how to solve for the monopolist's optimal price and quantity graphically and mathematically
    • Learn the elasticity rule, its application to monopoly market failure, and the key elements involved in this.
    • Be familiar with the three methods of addressing monopoly market failure (divestment, marginal cost pricing, and average cost pricing).

    References

    • Monopoly graph source

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    Description

    This quiz focuses on pricing strategies employed by monopolists, including the crucial principles of maximizing profit through optimal pricing. It covers essential methodologies such as using marginal revenue and cost to determine pricing. Additionally, the quiz discusses the welfare implications of monopoly pricing for policymakers.

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