Question & Answer

If the shares in a monopoly (such as a water company) were very widely distributed among the population, would the shareholders necessarily want the firm to use its monopoly power to make larger profits?

1. What does this analysis assume about the price elasticity of demand for the new entrant (a) above P_L; (b) below P_L?

2. Can you think of any limitations with the limit price model?

(Looking at the Maths) What is the profit-maximising price if MC = MR = £12 and Pε_D = –2?

Try this brain teaser. A monopoly would be expected to face an inelastic demand. After all, there are no direct substitutes. An yet,  if it produces where MR = MC, MR must be positive and demand must therefore be elastic. Therefore the monopolist must face an elastic demand! Can you solve this conundrum?

Under what circumstances might a new entrant succeed in the market for a product, despite existing firms benefiting from economies of scale?

BT Openreach is responsible for providing and maintaining the fixed-line network connections to customers in the UK. This includes the huge system of telegraph poles and cable ducts (small underground tunnels) that carry telecom lines between BT exchanges and houses/business premises. To what extent do you think this is a natural monopoly?

As an illustration of the difficulty in identifying monopolies, try to decide which of the following are monopolies: BT; a local evening newspaper; food sold in a university outlet; a village post office; Interflora; the London Underground; ice creams in the cinema; Guinness; the board game ‘Monopoly’. (As you will quickly realise in each case, it depends how you define the industry.)

1. What other reasons can you think of why perfect competition is so rare?

2. Why does the market for fresh vegetables approximate to perfect competition, whereas that for aircraft does not?

Using a diagram similar to Figure 7.6 to derive a long-run market supply curve for (a) a constant- cost industry and (b) a decreasing-cost industry.

Illustrate on a diagram similar to Figure 7.4 what would happen in the long run if price were initially below P_L.

Will the industry supply be zero below a price of P₅ in Figure 7.3?

1. Why do economists treat normal profit as a cost of production?

2. What determines (a) the level and (b) the rate of normal profit for a particular firm?

1. It is sometimes claimed that the market for various stocks and shares is perfectly competitive, or nearly so. Take the case of the market for shares in a large company like Apple. Go through each of the four assumptions above and see if they apply in this case. (Don’t be misled by assumption (1). The ‘firm’ in this case is not Apple itself.)

2. Is the market for gold perfectly competitive?

1. Give two more examples in each category.

2. Would you expect builders and restaurateurs to have the same degree of control over price?

How will the size of normal ‘profit’ vary with the general state of the economy?

Use your table to draw diagrams like Figures 6.19 and 6.21. Use these two diagrams to show the profit-maximising output and the level of maximum profit. Confirm your findings by reference to the table you have constructed.

From the information for a firm given in the table below, construct a table like Table 6.10.

1. Fill in the missing figures (without referring to Table 6.8 or 6.9).

2. Why are the figures for MR and MC entered in the spaces between the lines in Table 6.10?

What can we say about the slope of the TR and TC curves at the maximum profit point? What does this tell us about marginal revenue and marginal cost?

Copy Figures 6.17 and 6.18 (which are based on Table 6.8). Now assume that incomes have risen and that as a result two more units per time period can be sold at each price. Draw a new table and plot the resulting new AR, MR and TR curves on your diagrams. Are the new curves parallel to the old ones? Explain.

What would happen to the TR curve if the market price rose to £10? Try drawing it.

What would the isoquant map look like if there were

(a) continuously increasing returns to scale;

(b) continuously decreasing returns to scale?

Will the envelope curve be tangential to the bottom of each of the short-run average cost curves? Explain why it should or should not be.

1. Explain the shape of the LRMC curve in diagram (d) in Figure 6.12.

2. What would the LRMC curve look like if the LRAC curve were ‘flat bottomed’ as in Figure 6.11?

Given the LRAC curve in Figure 6.11, what would the firm’s long-run total cost curve look like?