Describe a scenario where having one firm (i.e., a monopoly) would be more
technically efficient than many smaller firms.
A natural monopoly would have lower AC than if the market were divided
up into several smaller firms. Given the increasing returns to scale
of a natural monopoly, ATC can be minimized only if one firm were allowed
to supply the entire market.
Explain how price discrimination affects the allocative efficiency of a
monopoly.
A price discriminating monopoly can increase their profits by charging
different prices to different customers. It is worth charging a lower
price to some customers as long as P>MC. This is also the condition
for allocative efficiency--a good should be produced only so long as its
price covers its marginal cost. The perfectly price discriminating
monopolist will be allocatively efficient because the last unit sold will
have a price equal to marginal cost.
If P > AC for a monopolistically competitive firm, what will happen to
supply and demand in this industry? How will this affect the firm?
If P>AC, profits will cause an increase in supply in the market. These
competitors will draw customers away from the firm, decreasing its demand.
Price will decrease until all profits are eliminated.
If marginal costs are decreasing, will this cause total costs to decrease?
Will it cause average costs to decrease? Explain.
As long as marginal costs are positive, they will cause total costs
to increase. If MC > AC, AC will increase. If MC < AC, AC will
decrease. The issue of whether MC is increasing or decreasing is
not relevant to these to questions.
Can an oligopoly earn profits in the long run? Why or Why not?
An oligopoly can earn profits in the long run because there are
barriers to other firms entering the market to compete for those profits.
In the Kinked Demand Curve model for an oligopolist, why is the demand curve
kinked? How does this affect the shape of the MR curve? What is the
significance of the MR curve’s shape?
It is kinked because competitors follow a price
decrease but not a price increase. The associated marginal revenue curve
has two kinks with a vertical section in between. When MC falls
along the vertical part of MR, MC can increase or decrease slightly
without affecting the profit-maximizing price and quantity.
What is the allocatively efficient price for a pure public good? Explain.
Since the good is non-excludable, customers could not be charged any price.
Even if a price could be charged, the allocatively efficient price would
be zero ( allocative efficiency requires P = MC).. Since the good is non
rival, the marginal cost of providing the good to one more customer is
zero. As long as somebody can benefit in the slightest amount,
it would be inefficient to exclude them from using that good by charging
any price.
Given the following information, what is the market price and quantity? What
is the socially optimal level of output? How large of a Pigouvian tax is
needed to correct the problem? How much total tax revenue would be collected?
What would be the new price paid by consumers? What would be the new (net)
price received by sellers? What are the gains to society from improving
allocative efficiency?
The market would produce a profit-maximizing level of 5 units where
MB = MPC.
The socially optimal level
would be 4 units (MB =
MSC). A $2 per
unit tax would correct the problem. This would generate $8 in tax revenue (4
units each taxed $2).
Consumers would pay $7 and producers would receive a net of $5. Selling
a level of output where the additional social costs are greater than the
additional benefits would be allocatively inefficient and would generate a dead weight
loss. Correcting
this inefficiency would, in this case, increase the net benefits to society
by $1. (1/2 B*H or 1/2*1*2) (THIS LAST PART WONT BE ON THE TEST, don't
worry if you don't understand it).