Monopoly - Essay Example

________________________ ID______________ 1303AFE Economics for Decision Making Semester 2 Monopoly Assignment PART A In this section answer the questions relating to each diagram. If you are required to complete a diagram as part of answer you must draw with a pencil or pen. Do not construct electronically. Question 1: The firm in Figure 1 has constant marginal cost at all levels of output. Given its constant marginal cost, explain why the firm’s Average Total Cost (ATC) curve has the shape shown.

Hint: think in terms of all the components of total costs. Do not write outside the space provided below. (1 mark) Question 2(a): A monopolist has been price discriminating by charging two different prices (P1 and P2 in Figure 2 below). In Figure 2 draw and label the areas of total profits, total costs and the level of total output. (1/2 mark). Total Profit Total Costs Level of output Question 2(b): If the monopolist (Fig. 2) charges just one profit maximising price, what is total profit = $68,400 (nearest dollar) and the level of output Qopt =190 units (1/2 mark).

Do not draw these on diagram. Question 3: Show on the figure below any three prices that the price discriminating monopolist can choose that will together yield greater total profits than the two prices shown. (1 mark). Two discussion Questions Discussion questions 1. A Monopolist’s Marginal Cost remains constant at all levels of output (Figure 4). A production process innovation reduces the monopolist’s marginal cost by 25% at all levels of output. The diagram shows the situation before the innovation shown in the diagram.

Discuss what will happen to this profit maximising monopolist’s output, price and profits and why. You are expected to show how profits, revenues, price and costs are changed by the innovation. You do not have to calculate any of these quantities exactly. Maximum 150 words (6 marks) Answer: As shown in the illustration, when marginal costs are decreased due to an innovation, revenues and marginal revenue will remain the same and will be unaffected by this change (note that there are no new graphs for AR and MR).

Moreover, fixed costs would also remain the same. However, the average cost of production will decrease due to a decrease in one of its components (variable cost). This is why in the illustration, the new AC graph is below the original AC graph. Because of this lowering of average costs, total profits will be higher compared to before. Moreover, the maximizing price will decrease while maximizing level of output will increase in this scenario. (114 words) 2. Firms in a perfectly competitive industry are able to form a cartel to increase profits.

Explain in 150 words or less, and using the diagram what will happen if the cartel is formed. As part of your answer indicate under what conditions the cartel will be able to create a long-run equilibrium, and what will happen if it cannot create a long-run equilibrium. Also suggest what will happen to Social welfare as a result of the cartel. note – no calculations of profits etc are needed in your answer (6 marks) Figure 5: A Perfectly Competitive Industry and its Market in Long-Run Equilibrium Answer: The demand curve for a cartel will be kinked because sellers would react asymmetrically to price changes.

Also, firms are able to create larger profits by controlling supply and raising prices as a group. However, the cartel will only be able to create a long run equilibrium if all the members of the cartel are minimized, production costs remain the same for all members, and demand for the product is compulsory. Moreover, since it would be more profitable for the members of the cartel to break their commitment of fixing supply and price, long term equilibrium can only be achieved if each member sticks to this commitment, and instead focuses on non-price competition.

In addition, the existence of a cartel is not desirable for social welfare. This is because supply of the product will be controlled and will thus reduce consumer surplus. (142 words) References: Baumol, W., & Blinder, A. (2009). Economics: Principles and policy. Mason, OH: Cengage Learning. Hall, R., & Lieberman, M. (2007). Economics: Principles and applications. Burlington, MA: Cengage Learning. Hubbard, R. G., Garnett, A. M., Lewis, P., & P, O. A. (2009). Microeconomics. NSW: Pearson Education Australia.