Monopoly
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AP Microeconomics › Monopoly
If government regulators require a natural monopoly to set its price equal to its marginal cost, the monopoly will likely...
earn positive economic profits and increase its production level.
incur economic losses because price will be below average total cost.
earn zero economic profit, also known as a fair return.
produce less output than it would if it were unregulated.
Explanation
For a natural monopoly, the long-run average total cost (LRATC) is downward sloping, which means the marginal cost (MC) curve must lie below the LRATC curve. If regulators enforce a socially optimal price where $$P = MC$$, the price will be less than the average total cost ($$P < ATC$$). This will cause the firm to suffer economic losses and, without a subsidy, it may shut down in the long run.
For a firm to successfully engage in price discrimination, which of the following conditions must be met?
The firm must incur marginal costs that are lower for some customer groups than for others.
The firm must be a natural monopoly with continuously decreasing average total costs.
The firm must face a perfectly elastic demand curve from all its identifiable customer groups.
The firm must have some degree of market power and be able to prevent the resale of its product.
Explanation
To practice price discrimination, a firm must first have market power to control the price. Second, it must be able to segment its customers into groups based on their willingness to pay (i.e., different price elasticities of demand). Third, it must be able to prevent arbitrage, or the resale of the product from the low-price group to the high-price group.
A primary difference between a single-price monopoly and a perfectly competitive firm is that the monopolist's marginal revenue is...
constant and equal to price, regardless of the quantity sold.
less than the price of its product because it must lower the price on all units to sell more.
equal to the price of its product because it is the only seller.
greater than the price of its product because it has significant market power.
Explanation
A monopolist faces the entire downward-sloping market demand curve. To sell an additional unit, it must lower the price not just for that unit, but for all previously sold units as well (this is the price effect). Consequently, the marginal revenue gained from selling one more unit is less than the price charged for that unit. In contrast, a perfectly competitive firm faces a perfectly elastic demand curve, so its marginal revenue is equal to the market price.
When a perfectly competitive market becomes a single-price monopoly, part of the original consumer surplus is transferred to producer surplus, while another portion...
is lost to society and becomes deadweight loss.
is used to cover the monopoly's higher production costs.
is transferred to the government in the form of tax revenue.
remains as consumer surplus, but is enjoyed by fewer consumers.
Explanation
The transition from perfect competition to monopoly leads to a restriction of output and an increase in price. This creates two main effects on surplus: 1) a transfer of surplus from consumers to the producer (the monopolist), and 2) a loss of surplus from trades that no longer occur due to the higher price and lower quantity. This lost surplus, which benefits neither the producer nor the consumer, is called deadweight loss.
At a single-price monopolist's profit-maximizing level of output, the marginal benefit to society is...
equal to the marginal cost, indicating that the market achieves allocative efficiency.
equal to zero, because the monopolist produces where marginal revenue is maximized.
less than the marginal cost, indicating that the market overproduces the good.
greater than the marginal cost, indicating that the market underproduces the good.
Explanation
In a market, the price consumers are willing to pay for a unit of a good represents its marginal benefit to society. The marginal cost of production is the marginal cost to society. A monopolist produces where $$P > MC$$. This means that for the last unit produced, the marginal benefit to society (P) is greater than the marginal cost (MC), which signifies an under-allocation of resources to the good's production and results in deadweight loss.
Which of the following is the most significant reason that a monopoly can earn positive economic profits in the long run?
The complete absence of fixed costs in its production process.
The firm's ability to set its price equal to its marginal revenue.
A perfectly elastic demand for the firm's unique product.
The presence of substantial barriers to entry that prevent competition.
Explanation
High barriers to entry—such as patents, control of a key resource, or significant economies of scale—are the defining feature that allows a monopoly to exist and persist. These barriers prevent potential competitors from entering the market, which in turn allows the monopolist to maintain its market power and sustain long-run economic profits.
Suppose a profit-maximizing monopoly is earning a positive economic profit. If the government imposes a lump-sum tax on the firm, how will the monopoly's price and output be affected in the short run?
Price will increase, and output will decrease.
Price will decrease, and output will increase.
Price and output will not change.
Price will increase, but output will not change.
Explanation
A lump-sum tax is a fixed cost, as it does not vary with the level of output. An increase in fixed costs will increase average total cost but will not affect marginal cost or marginal revenue. Since the profit-maximizing output is determined by the intersection of the marginal revenue and marginal cost curves ($$MR = MC$$), neither the optimal output nor the corresponding price will change. The tax will, however, reduce the firm's total profit.
To maximize its profit, a single-price monopolist will produce the quantity of output at which...
marginal revenue equals average total cost, which maximizes per-unit profit.
price equals marginal cost, and then set price according to the marginal revenue curve.
price equals average total cost, which guarantees zero economic profit.
marginal revenue equals marginal cost, and then set price according to the demand curve.
Explanation
The universal rule for profit maximization for any firm is to produce at the quantity where marginal revenue equals marginal cost ($$MR = MC$$). Once this quantity is determined, the monopolist sets the highest possible price for that quantity, which is found by going up to the demand curve. The other options describe conditions for allocative efficiency ($$P=MC$$), zero economic profit ($$P=ATC$$), or are not standard profit-maximizing rules.
A single-price monopoly results in a deadweight loss because the firm...
produces an output level where the price charged is greater than its marginal cost.
faces a downward-sloping demand curve, which causes marginal revenue to be negative.
often fails to produce at the minimum point of its average total cost curve.
can earn positive economic profits both in the short run and the long run.
Explanation
Deadweight loss represents a loss of total economic surplus due to inefficiency. Allocative efficiency occurs when resources are distributed such that the marginal benefit to society (represented by price) equals the marginal cost ($$P = MC$$). A profit-maximizing monopolist produces where $$P > MR = MC$$. This inequality ($$P > MC$$) indicates that society values the last unit produced more than it cost to make, and a deadweight loss arises because mutually beneficial trades do not occur.
If a monopolist is able to practice perfect price discrimination, which of the following outcomes will occur?
The firm will produce less output than a single-price monopolist but capture all consumer surplus.
The marginal revenue curve will lie below the demand curve, and deadweight loss will increase.
The firm will produce the socially optimal quantity, but all surplus will be distributed to consumers.
Consumer surplus and deadweight loss will both be zero, and producer surplus is maximized.
Explanation
With perfect price discrimination, the monopolist charges each consumer their maximum willingness to pay. This means the firm's demand curve also becomes its marginal revenue curve. The firm produces up to the point where $$P = MC$$, which is the allocatively efficient quantity. Because each consumer pays exactly their willingness to pay, there is no consumer surplus. All the potential surplus becomes producer surplus, and deadweight loss is eliminated.