CHAPTER 15

Multiple Choice

1. Suppose only one resident owns all the wells in town. Which of the following statements is most likely going to
be true of the market for water?
a. The price of a gallon of water will be driven to equal its marginal cost.
b. The price of a gallon of water will exceed its marginal cost.
c. Since water is a necessity of life, there will be no decline in the quantity of water consumed, regardless of
how high the price is raised.
d. The seller will be able to earn unlimited profit.

2. If the monopoly firm is NOT allowed to price discriminate, then the deadweight loss amounts to
a. $50.
b. $100.
c. $500.
d. $250

3. To maximize total surplus, a benevolent social planner would choose which of the following outcomes?
a. 100 units of output and a price of $10 per unit
b. 150 units of output and a price of $10 per unit

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 c. 150 units of output and a price of $15 per unit
d. 200 units of output and a price of $10 per unit

4. To maximize its profit, a monopolist would choose which of the following outcomes?
a. 100 units of output and a price of $10 per unit
b. 100 units of output and a price of $20 per unit
c. 150 units of output and a price of $15 per unit
d. 200 units of output and a price of $20 per unit

5. The monopolist’s maximum profit

a. is $800.
b. is $1,000.
c. is $1,250.
d. cannot be determined from the diagram.

6. Allowing an inventor to have the exclusive rights to market her new invention will lead to
(i) a product that is priced higher than it would be without the exclusive rights.
(ii) desirable behavior in the sense that inventors are encouraged to invent.
(iii) higher profits for the inventor.
a. (i) and (ii)
b. (ii) and (iii)

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 c. (i) and (iii)
d. All of the above are correct.
7. What is the monopolist's profit under the following conditions? The profit-maximizing price charged for goods
produced is $16. The intersection of the marginal revenue and marginal cost curves occurs where output is 10
units and marginal cost is $8. Average total cost for 10 units of output is $6.
a. $20
b. $80
c. $100
d. $160

8. Competitive firms and monopolists differ in which of the following ways?

a. A competitive firm cannot choose its level of output; a monopolist chooses its level of output.
b. A competitive firm’s short-run profit is always zero; a monopolist can have a positive short-run profit.
c. A competitive firm’s marginal revenue curve is horizontal; a monopolist’s marginal revenue curve is
downward sloping.
d. All of the above are correct.

9. A reduction in a monopolist’s fixed costs would

a. decrease the profit-maximizing price and increase the profit-maximizing quantity produced.
b. increase the profit-maximizing price and decrease the profit-maximizing quantity produced.
c. not effect the profit-maximizing price or quantity.
d. possibly increase, decrease or not effect profit-maximizing price and quantity, depending on the elasticity of
demand.

10. A monopolist faces the following demand curve:

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 Price Quantity Demanded
$8 300
$7 400
$6 500
$5 600
$4 700
$3 800
$2 900
$1 1000

The monopolist has fixed costs of $1000 and has a constant marginal cost of $2 per unit. If the monopolist were
able to perfectly price discriminate, how many units would it sell?
a. 400
b. 500
c. 700
d. 900

11. If one were to compare a competitive market to a monopoly that engages in perfect price discrimination, one
could say that
a. in both cases, total social welfare is the same.
b. total social welfare is maximized in the competitive market, but not in the perfectly discriminating monopoly.
c. in both cases, some potentially mutually beneficial trades do not occur.

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 d. consumer surplus is the same in both cases.

12. Discount coupons have the ability to help a grocery store

a. price discriminate.
b. target its customers based on their individual willingness to pay.
c. maximize its profit.
d. All of the above are correct.

13. Price discrimination adds to social welfare in the form of

(i) increased total surplus.
(ii) increased profits to the monopolist.
(iii) increased consumer surplus.
a. (i) and (ii)
b. (ii) and (iii)
c. (i) and (iii)
d. All of the above are correct.

14. For a firm to price discriminate, it must

a. be a natural monopoly.
b. be regulated by the government.
c. have some market power.

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 d. None of the above are correct.

15. When regulating a natural monopoly, one of the problems with setting price equal to average cost is that
a. there is no incentive for the monopolist to lower its costs.
b. consumer surplus is not maximized.
c. total surplus is not maximized
d. All of the above are correct.

16. Antitrust laws allow the government to

a. prevent mergers.
b. break up companies.
c. promote competition.
d. All of the above are correct.

17. Which of the following statements is correct?

a. The benefits that accrue to a monopoly firm’s owners are equal to the costs that are incurred by consumers of
that firm’s product.
b. The deadweight loss that arises in monopoly stems from the fact that the profit-maximizing monopoly firm
produces a quantity of output that exceeds the socially-efficient quantity.
c. The deadweight loss caused by monopoly is similar to the deadweight loss caused by a tax on a product.
d. The main social problem caused by monopoly is monopoly profit.

18. Monopoly firms exert their market power by charging a price that is

6
 a. above average revenue.
b. below average total cost.
c. above marginal cost.
d. below marginal cost.

19. The difference in total surplus between a socially efficient level of production and a monopolist's level of
production is
a. offset by regulatory revenues.
b. called a deadweight loss.
c. usually small and insignificant.
d. All of the above are correct.

20. A monopolist faces the following demand curve:

Price Quantity Demanded

$10 5
$9 10
$8 16
$7 23
$6 31
$5 49
$4 52

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 $3 60

The monopolist has total fixed costs of $40 and a constant marginal cost of $5. At the profit-maximizing level of
output, the monopolist’s average total cost is
a. $9.00
b. $7.50
c. $6.74
d. $5.82

21. Authors are allowed to be monopolists in the sale of their books in order to
a. encourage authors to write more and better books.
b. correct for the negative externalities that the internet and television impose.
c. satisfy literary advocacy groups that exercise their lobbying power.
d. promote a society in which people think for themselves and learn from whichever books they please.

22. For a monopolist, when does marginal revenue exceed average revenue?
a. never
b. when output is less than the profit-maximizing level of output
c. when output is greater than the profit-maximizing level of output
d. when price is subject to the Law of Demand

23. What happens to the price and quantity sold of a drug when its patent runs out?
(i) The price will fall.
(ii)The quantity sold will fall.
(iii) The marginal cost of producing the drug will rise.
a. (i) and (iii)
b. (i) and (ii)
c. (ii) and (iii)
d. All of the above are correct.

24. For a monopoly firm, the shape and position of the demand curve play a role in determining
(i) the profit-maximizing price.
(ii)the shape and position of the marginal cost curve.
(iii) the shape and position of the marginal revenue curve.
a. (i) and (ii)
b. (ii) and (iii)
c. (i) and (iii)
d. All of the above are correct.

25. For a profit-maximizing monopolist,

a. P > MR = MC.
b. P = MR = MC.
c. P > MR > MC.
d. MR < MC < P.

Problems

1. Suppose that a natural monopolist was required by law to charge average total cost. On a diagram, label the
price charged and the deadweight loss to society relative to marginal cost pricing.

2. A small town is served by many competing supermarkets, which have constant marginal cost.
a. Using a diagram, show consumer surplus, producer surplus and total surplus.
b. Now suppose that the independent supermarkets combine into one chain. Using a new diagram, show
the new consumer, producer, and total surplus.

3. Johnny has just finished recording his latest CD. The demand function is given by P=26-Q/5000. The record
company can produce the CD with no fixed cost and a variable cost of 5$ per CD.

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 a. Find TR, MR.
b. What’s the profit maximizing quantity? What would be the price and the profit?
c. If you were Johnny’s agent, what recording fee would you advise Johnny to demand from the record
company? Why?
4. A company is considering building a bridge across a river. The bridge would cost $2 million to build and
nothing to maintain. The demand for bridge is given by
P=8-(Q/100,000)
a. If the company were to build the bridge, what would be its profit maximizing price? Would that be
the efficient level of output?
b. If the company is interested in maximizing profit, should it build the bridge? What would be its profit
or loss?
c. If the government were to build the bridge, what price should it charge?
d. Should the government build the bridge?

5. Larry, Curly and Moe run the only saloon in town. Larry wants to sell as many drinks as possible without
losing money. Curly wants the saloon to bring in as much revenue as possible. Moe wants to make the largest
possible profits. Using a diagram of the saloon’s demand curve and it’s cost curves, show the price and
quantity combinations favored byeach of the three partners.

6. The Best Computer Company just developed a new computer chip, on which it immediately acquires a patent.
a. Draw a diagram that shows the consumer surplus, producer surplus, and total surplus in the market for
this new chip.
b. What happens to these three measures of surplus if the firm can perfectly price discriminate? What is
the change in deadweight loss? What transfers occur?

7. Explain why a monopolist will always produce a quantity at which the demand curve is elastic.

8. Napster allowed people to use the internet to download copies of their favorite songs from other people’s
computers without cost. In what sense did Napster enhance economic efficiency in the short run? In what
sense might Napster have reduced economic efficiency in the long run?

9.
Many schemes for price discriminating involve somecost. For example, discount coupons take up time and
resources from both the buyer and the seller. This question considers the implications of costly price
discrimination. To keep things simple, let’s assume that our monopolist’s production costs are simply
proportional to output, so that average total cost and marginal cost are constant and equal to each other.
a. Draw the cost, demand, and marginal-revenue curves for the monopolist. Show the price the
monopolist would charge without price discrimination.
b. In your diagram, mark the area equal to the monopolist’s profit and call it X. Mark the area
equal to consumer surplus and call it Y. Mark the area equal to the deadweight loss and call it Z.
c. Now suppose that the monopolist can perfectly price discriminate. What is the monopolist’s profit? (Give your
answer in terms of X, Y, and Z.)
d. What is the change in the monopolist’s profit from price discrimination? What is the change in total surplus
from price discrimination? Which change is larger? Explain. (Give your answer in terms of X, Y, and Z.)
e. Now suppose that there is some cost of price discrimination. To model this cost, let’s assume that the
monopolist has to pay a fixed cost C in order to price discriminate. How would a monopolist make the decision
whether to pay this fixed cost? (Give your answer in terms of X, Y, Z, and C.)
f. How would a benevolent social planner, who cares about total surplus, decide whether the monopolist
should price discriminate? (Give your answer in terms of X, Y, Z, and C.)
g. Compare your answers to parts (e) and (f). How does the monopolist’s incentive to price discriminate differ
from the social planner’s? Is it possible that the monopolist will price discriminate even though it is not socially
desirable?

10.
Singer Madonna has a monopoly over a scarce resource: herself. She is the only person who can produce a
Whitney Houston concert. Does this fact imply that the government should regulate the prices of her concerts?
Why or why not?

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11.
For many years AT&T was a regulated monopoly, providing both local and long-distance telephone service.
a. Explain why long-distance phone service was originally a natural monopoly.
b. Over the past two decades, many companies have launched communication satellites, each of which
can transmit a limited number of calls. How did the growing role of satellites change the cost structure of long-
distance phone service?
After a lengthy legal battle with the government, AT&T agreed to compete with other companies in the long
distance market. It also agreed to spin off its local phone service into the “Baby Bells,” which remain highly
regulated.
c. Why might it be efficient to have competition in long-distance phone service and regulated monopolies in local
phone service?

12.
The Placebo Drug Company holds a patent on one of its discoveries.
a. Assuming that the production of the drug involves rising marginal cost, draw a diagram to illustrate Placebo’s
profit-maximizing price and quantity. Also show Placebo’s profits.
b. Now suppose that the government imposes a tax on each bottle of the drug produced. On a new diagram,
illustrate Placebo’s new price and quantity. How does each compare to your answer in part (a)?
c. Although it is not easy to see in your diagrams, the tax reduces Placebo’s profit. Explain why this must be true.
d. Instead of the tax per bottle, suppose that the government imposes a tax on Placebo of $10,000 regardless of
how many bottles are produced. How does this tax affect Placebo’s price, quantity, and profits? Explain.

13.
In 1969 the government charged IBM with monopolizing the computer market. The government
argued (correctly) that a large share of all mainframe computers sold in the United States were produced by IBM.
IBM argued (correctly) that a much smaller share of the market for all types of computers consisted of IBM
products. Based on these facts, do you think that the government should have brought suit against IBM for
violating the antitrust laws? Explain.

14.
Suppose the Clean Springs Water Company has a monopoly on bottled water sales in California. If the price of tap
water increases, what is the change in Clean Springs’ profit-maximizing levels of output, price, and profit?
Explain in words and with a graph.

15.
Consider the delivery of mail. In general, what is the shape of the average-total-cost curve? How might the shape
differ between isolated rural areas and densely populated urban areas? How might the shape have changed over
time? Explain

16.
A publisher faces the following demand schedule for the next novel by one of its popular authors:
PRICE QUANTITY DEMANDED
100 0
90 100,000
80 200,000
70 300,000
60 400,000
50 500,000
40 600,000
30 700,000
10 800,000
10 900,000
0 1,000,000

The author is paid $2 million to write the book, and the marginal cost of publishing the book is a constant $10 per
book.
a. Compute total revenue, total cost, and profit at each quantity. What quantity would a profit-maximizing
publisher choose? What price would it charge?

10
b. Compute marginal revenue. How does marginal revenue compare to the price? Explain.
c. Graph the marginal-revenue, marginal-cost, and demand curves. At what quantity do the marginal
revenue and marginal-cost curves cross? What does this signify?
d. In your graph, shade in the deadweight loss. Explain in words what this means.
e. If the author were paid $3 million instead of $2 million to write the book, how would this affect the
publisher’s decision regarding the price to charge? Explain.
f. Suppose the publisher were not profit-maximizing but were concerned with maximizing economic
efficiency. What price would it charge for the book? How much profit would it make at this price?

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ANSWERS
Multiple Choice
1. b
2. d
3. c
4. b
5. d
6. d
7. c
8. c
9. c
10. d
11. a
12. d
13. a
14. c
15. d
16. d
17. c
18. c
19. b
20. b

Price Quantity Demanded TR MR

$10 5 50
$9 10 90 8
$8 16 128 38/6
$7 23 161 33/7
$6 31 186 25/8
$5 49 245 59/18
$4 52 208
$3 60 180
This question is not a very good question, and I will not hold you responsible for a similar question in the exam, but
let’s try to reason about it anyways.
Profit maximizing output occurs when MR=MC.
MC is 5. MR is 5 somewhere between quantities 16 and 23.
For Q=16, ATC is (40+5*16)/16=7.5.
For Q=23, ATC is (40+5*23)/16=6.74
Now if we have to make a choice between Q=16 and Q=23, the profit will be higher for Q=16, that’s why in the
answer key the correct answer is b. But then again, it’s not a very good question, because if we had a more detailed
table we would choose a quantity that was greater than 16 and less than 23.

21. a
22. a
23. a
24. c
25. a

Problems

1. Figure below illustrates a natural monopolist setting price, PATC, equal to average total cost. The equilibrium
quantity is QATC. Marginal cost pricing would yield the price PMC and quantity QMC. For quantities between
QATC and QMC, the benefit to consumers (measured by the demand curve) exceeds the cost of production
(measured by the marginal cost curve). This means that the deadweight loss from setting price equal to
average total cost is the triangular area shown in the figure.

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2.
a. Figure below illustrates the market for groceries when there are many competing supermarkets with
constant marginal cost. Output is QC, price is PC, consumer surplus is area A, producer surplus is
zero, and total surplus is area A.

b. If the supermarkets merge, figure below illustrates the new situation. Quantity declines from QC to
QM and price rises to PM. Consumer surplus is now area B + C, producer surplus is area D + E, and
total surplus is area B + C + D + E. Consumers transfer the amount of area D + E to producers and
the deadweight loss is area F.

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3.
a. TR= (26-Q/5000)Q
MR=26-Q/2500
b. Set MR =MC
26-Q/2500=5
Q=52500
P=15.5
Profit for the firm (not including the payment the company makes to Johnny)=(15.5-5)52500= 551250
c. As Johnny's agent, you should recommend that he demand $551250 from them, so he instead of the
record company receives all of the profit. Note that the company would still produce the record, since
it makes zero profit after paying Johnny the amount.
4.
a. The profit-maximizing price would be where revenue is maximized, which will occur where marginal
revenue equals zero, since marginal cost equals zero. This occurs at a price of $4 and quantity of 400.
The efficient level of output is 800, since that's where price equals marginal cost equals zero. The
profit-maximizing quantity is lower than the efficient quantity because the firm is a monopolist.
b. The company should not build the bridge because its profits are negative. The most revenue it can
earn is $1,600,000 and the cost is $2,000,000, so it would lose $400,000.

c. If the government were to build the bridge, it should set price equal to marginal cost to be efficient.
But marginal cost is zero, so the government should not charge people to use the bridge.
d. Yes, the government should build the bridge, because it would increase society's total surplus. The
triangle in the figure has area 1/2 x 8 x 800,000 = $3,200,000, which exceeds the cost of building the
bridge.

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5. Larry wants to sell as many drinks as possible without losing money, so he wants to set quantity where price
(demand) equals average cost, which occurs at quantity QL and price PL in Figure 10. Curly wants to bring in
as much revenue as possible, which occurs where marginal revenue equals zero, at quantity QC and price PC.
Moe wants to maximize profits, which occurs where marginal cost equals marginal revenue, at quantity QM
and price PM.

6.

a. The patent gives the company a monopoly, as shown in the figure below. At a quantity of QM and
price of PM, consumer surplus is area A + B, producer surplus is area C + D, and total surplus is area
A + B + C + D.

b. If the firm can perfectly price discriminate, it will produce quantity Q C and extract all the consumer
surplus. Consumer surplus is zero and producer surplus is A + B + C + D + E, as is total surplus.
Deadweight loss is reduced from area E to zero. There is a transfer of surplus from consumers to
producers of area A + B.
7. A monopolist always produces a quantity at which the demand curve is elastic. If the firm produced a
quantity for which the demand curve were inelastic, then if the firm raised its price, quantity would fall by a
smaller percentage than the rise in price, so revenue would increase. Since costs would decrease at a lower
quantity, the firm would have higher revenue and lower costs, so profit would be higher. Thus the firm should
keep raising its price until profits are maximized, which must happen on an elastic portion of the demand
curve.
15
8. Because the marginal cost of the music was virtually zero, Napster enhanced economic efficiency because
those individuals who valued the music more than zero but less than the selling price were able to consume it.
However, in the long run, musicians and record companies would have no incentive to release new music
because everyone could own a copy of it without paying for it.
9.
a. Figure below shows the cost, demand, and marginal-revenue curves for the monopolist. Without price
discrimination, the monopolist would charge price PM and produce quantity QM.

b. The monopolist's profit consists of the two areas labeled X, consumer surplus is the two areas labeled Y, and
the deadweight loss is the area labeled Z.
c. If the monopolist can perfectly price discriminate, it produces quantity QC, and has profit equal to X + Y + Z.
d. The monopolist's profit increases from X to X + Y + Z, an increase in the amount Y + Z. The change in total
surplus is area Z. The rise in monopolist's profit is greater than the change in total surplus, since monopolist's
profit increases both by the amount of deadweight loss (Z) and by the transfer from consumers to the monopolist
(Y).
e. A monopolist would pay the fixed cost that allows it to discriminate as long as Y + Z (the increase in profits)
exceeds C (the fixed cost).
f. A benevolent social planner who cared about maximizing total surplus would want the monopolist to price
discriminate only if Z (the deadweight loss from monopoly) exceeded C (the fixed cost) since total surplus rises
by Z -
g. The monopolist has a greater incentive to price discriminate (it will do so if Y + Z > C) than the social planner
would allow (she would allow it only if Z > C). Thus if Z < C but Y + Z > C, the monopolist will price
discriminate even though it is not in society's best interest.

10.
Though Madonna has a monopoly on her own singing, there are many other singers in the market. If Spears were
to raise her price too much, people would substitute to other singers. So there is no need for the government to
regulate the price of her concerts

11.
a. Long-distance phone service was originally a natural monopoly because installation of phone lines across the
country meant that one firm's costs were much lower than if two or more firms did the same thing.
b. With communications satellites, the cost is no different if one firm supplies them or if many firms do so. So the
industry evolved from a natural monopoly to a competitive market.
c. It is efficient to have competition in long-distance phone service and regulated monopolies in local phone
service because local phone service remains a natural monopoly (being based on land lines) while long-distance
service is a competitive market (being based on satellites).

12.
a. Figure below illustrates the drug company's situation. They will produce quantity Q1 at price P1. Profits are
equal to (P1 - AC1) x Q1.

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b. The tax on the drug increases both marginal cost and average cost by the amount of the tax. As a result, as
shown in figure below, quantity is reduced to Q2, price rises to P2, and average cost plus tax rises to AC2.

c. The tax definitely reduces profits. After all, the firm could have produced quantity Q2 at price P2 before the tax
was imposed, but it chose not to because this level did not maximize profit before the tax occurred.

d. A tax of $10,000 regardless of how many bottles of the drug are produced would result in the quantity produced
at Q1 and the price at P1 because such a tax does not affect marginal cost or marginal revenue. It does, however,
raise average cost; in fact, profits decline by exactly $10,000.

13.
IBM's monopoly power will be constrained to the extent that people can substitute other computers for
mainframes. So the government might have looked at the demand curve facing IBM, or the divergence between
IBM's price and marginal cost, to get some idea of how severe the monopoly problem was.

14.
If the price of tap water rises, the demand for bottled water increases. This is shown in figure below as a shift to
the right in the demand curve from D1 to D2. The corresponding marginal-revenue curves are MR1 and MR2. The
profit-maximizing level of output is where marginal cost equals marginal revenue. Prior to the increase in the
price of tap water, the profit-maximizing level of output is Q1; after the price increase, it rises to Q2. The profit-
maximizing price is shown on the demand curve: it is P1 before the price of tap water rises, and it rises to P2 after.
Average cost is AC1 before the price of tap water rises and AC2 after. Profit increases from (P1 - AC1) x Q1 to (P2 -
AC2) x Q2.

17
15.
Mail delivery has an always-declining average-total-cost curve, since there are large fixed costs for equipment.
The marginal cost of delivering a letter is very small. However, the costs are higher in isolated rural areas than
they are in densely populated urban areas, since transportation costs differ. Over time, increased automation has
reduced marginal cost and increased fixed costs, so the average-total-cost curve has become steeper at small
quantities and flatter at high quantities.

16.
The following table shows revenue, costs, and profits, where quantities are in thousands, and total revenue, total
cost, and profit are in millions of dollars:

Price Quantity Total Marginal Total Profit

(1,000s) Revenue Revenue Cost
$ 100 0 $0 ---- $2 $ -2
90 100 9 $9 3 6
80 200 16 7 4 12
70 300 21 5 5 16
60 400 24 3 6 18
50 500 25 1 7 18
40 600 24 -1 8 16
30 700 21 -3 9 12
20 800 16 -5 10 6
10 900 9 -7 11 -2
0 1,000 0 -9 12 -12

a. A profit-maximizing publisher would choose a quantity of 400,000 at a price of $60 or a quantity of 500,000 at
a price of $50; both combinations would lead to profits of $18 million.
b. Marginal revenue is always less than price. Price falls when quantity rises because the demand curve slopes
downward, but marginal revenue falls even more than price because the firm loses revenue on all the units of the
good sold when it lowers the price.
c. Figure below shows the marginal-revenue, marginal-cost, and demand curves. The marginal-revenue and
marginal-cost curves cross between quantities of 400,000 and 500,000. This signifies that the firm maximizes
profits in that region.

18
d. The area of deadweight loss is marked “DWL” in the figure. Deadweight loss means that the total surplus in
the economy is less than it would be if the market were competitive, since the monopolist produces less than the
socially efficient level of output.
e. If the author were paid $3 million instead of $2 million, the publisher wouldn’t change the price, since there
would be no change in marginal cost or marginal revenue. The only thing that would be affected would be the
firm’s profit, which would fall.
f. To maximize economic efficiency, the publisher would set the price at $10 per book, since that’s the marginal
cost of the book. At that price, the publisher would have negative profits equal to the amount paid to the author.

19