Microsoft word - solutions12.doc

C h a p t e r 12 MONOPOLY
S o l u t i o n s t o t h e O d d - N u m b e r e d P r o b l e m s
1. a. Substitutes for the U.S. Postal Service include email, fax, and private delivery services, such as FedEx or UPS. Substitutes for Lipitor are other statin drugs, such as Zocor, non-statin drugs that also lower cholesterol, and also exercise. Substitutes for Cox Communications include satellite television services. b. The U.S. Postal Service and Pfizer are protected by legal barriers to entry. The Postal Service has the legal right given to it by the Private Express Statutes to be the only first class non-urgent mail service and Pfizer has a patent on Lipitor. Cox Communications definitely has a natural barrier to entry because it is a natural monopoly. c. Cox Communications is the only natural monopoly. Its cost curve will look similar to Figure 12.1. Cox communications has a large fixed cost of creating a massive infrastructure and then a small marginal cost when it increases the quantity of its customers. As a result, its economies of scale means that its average cost curve is downward sloping when it crosses the demand curve. d. Both the U.S. Postal Service and Pfizer are legal monopolies. The Postal Service has the legal right given to it by the Private Express Statutes to be the only first class non-urgent mail service and Pfizer has a patent on Lipitor e. All three of the firms practice price discrimination. The second ounce in a first class letter is less expensive to mail than the first ounce. Lipitor’s price varies according to the insurance policy a customer has. Cox Communications bundles packages of services that have a lower price than each item taken separately so that additional units of service are less expensive than the initial units. 3. a. Marginal cost is the increase in total cost that results from increasing output by 1 unit. When Minnie’s increases output from 1 bottle to 2 bottles, total cost increases by $4, so the marginal cost is $4 a bottle. b. Minnie’s profit-maximizing output is 1.5 bottles and her profit-maximizing price is $7a bottle. The marginal cost of increasing the quantity from 1 bottle to 2 bottles is $4 a bottle ($7 minus $3). That is, the marginal cost of the 1.5 bottles is $4 a bottle. The marginal revenue of increasing the quantity sold from 1 bottle to 2 bottles is $4 ($12 minus $8). So the marginal revenue from 1.5 bottles is $4 a bottle. Profit is maximized when the quantity produced makes the marginal cost equal to marginal revenue. The profit-maximizing output is 1.5 bottles. The profit-maximizing price is the highest price that Minnie’s can sell the profit-maximizing output of 1.5 bottles. Minnie’s can sell 1 bottle for $8 and 2 bottles for $6, so it can sell 1.5 bottles for $7 a bottle. Economic profit equals total revenue minus total cost. Total revenue equals price ($7 a bottle) multiplied by quantity (1.5 bottles), which is $10.50. Total cost of producing 1 bottle is $3 and the total cost of producing 2 bottles is $7, so the total cost of producing 1.5 bottles is $5. Profit equals $10.50 minus $5, which is $5.50. 5. a. La Belle Pizza is price discriminating, which increases the firm’s profit. It is price discriminating along two dimensions. First, it is charging consumers a second price on the second pizza they buy. This sort of price discrimination essentially is moving downward along a consumer’s demand curve and increasing the quantity the consumer purchases. Second, it is giving away coupons that lower the price on a stand-priced pizza. La Bella must have consumers with different willingness to pay and the coupon enables La Bella to increase its sales to the coupon users who have a lower willingness to pay for the pizza. On both counts, La Belle is increasing its sales and, because its marginal revenues from these additional sales exceed its marginal cost of $2, the additional sales increase La Belle’s profit. b. The figure will look like Figure 12.9, where some consumers buy pizzas at a price of $14.99, others buy pizzas at a price of $9.99 (the $14.99 regular price minus the $5 coupon), and still other pizzas are sold for a price of $4.99. c. La Belle could increase its price discrimination even more. For instance, it might sell a third pizza for $3.99, which, given the marginal cost of $2, would still be profitable for La Belle. d. A firm that can price discriminate increases its production relative to what it would produce if it could not price discriminate. So the quantity of pizza La Bella produces is closer to the efficient quantity with the price discrimination that it would be if La Bella did not price discriminate. 7. a. If Calypso is unregulated, it produces 2 cubic feet a day and sells it for 6 cents a cubic foot. The consumer surplus is 4 cents, the producer surplus is 8 cents, and the deadweight loss is 4 cents. The consumer surplus is the triangular area under the demand curve and above the price. The price is 6 cents, so consumer surplus equals (10 cents minus 6 cents) multiplied by 2/2 cubic feet a day, which is 4 cents. The producer surplus is the rectangular area under the price and above the MC curve. The price is 6 cents, so producer surplus equals (6 cents minus 2 cents) multiplied by 2 cubic feet a day, which is 8 cents. The efficient output is 4 cubic feet, at which marginal cost equals price (marginal benefit). The deadweight loss is the triangular area between the demand (or marginal benefit curve) and the marginal cost curve from the equilibrium quantity to the efficient quantity. So the deadweight loss equals (4 minus 2 cubic feet) multiplied by (6 minus 2 cents)/2, which is 4 cents a day. b. If Calypso is regulated to make zero economic profit, it produces 3 cubic feet a day and sells it for 4 cents a cubic foot. The consumer surplus is 9 cents, the producer surplus is 6 cents, and the deadweight loss is 1 cent. The consumer surplus is the triangular area under the demand curve and above the price. The price is 4 cents, so consumer surplus equals (10 cents minus 4 cents) multiplied by 3/2 cubic feet a day, which is 9 cents. The producer surplus is the rectangular area under the price and above the MC curve. The price is 4 cents, so producer surplus equals (4 cents minus 2 cents) multiplied by 3 cubic feet a day, which is 6 cents. The efficient output is 4 cubic feet, at which marginal cost equals price (marginal benefit). The deadweight loss is the triangular area between the demand (or marginal benefit curve) and the marginal cost curve from the equilibrium quantity to the efficient quantity. So the deadweight loss equals (4 minus 3 cubic feet) multiplied by (4 minus 2 cents)/2, which is 1 cent a day. c. If Calypso is regulated to be efficient, it produces 4 cubic feet a day and sells it for 2 cents a cubic foot. The consumer surplus is 16 cents, the producer surplus is 0 cents, and the deadweight loss is 0 cents. The consumer surplus is the triangular area under the demand curve and above the price. The price is 2 cents, so consumer surplus equals (10 cents minus 2 cents) multiplied by 4/2 cubic feet a day, which is 16 cents. There is no producer surplus because the price equals the marginal cost. And there is no deadweight loss because the quantity produced is the efficient quantity.

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