2. A business has been created to provide needed services to its market. As the
ID: 1140526 • Letter: 2
Question
2. A business has been created to provide needed services to its market. As the only provider of this service, it functions as a monopoly, with the ability to set prices and having the entire market demand schedule as its demand curve. Because the monopoly is newly formed, there is no government intervention into the monopoly’s pricing actions. Examine Diagram 2 and answer each of the following with complete explanations:
a. What is quantity a and why is it important?
b. What is the value at point b and why is it important?
c. What is the value at point c and why is it important?
d. What is the value at point d and why is it important?
e. What is the meaning of the rectangle labeled e?
f. If there were no monopoly and this was a perfectly competitive market, what would quantity at point fbe and why is it important?
g. If there were no monopoly and this was a perfectly competitive market, what would point g be and why is it important?
h. For the market in which the monopoly now operates, what does the triangle labeled h mean, and why is it important?
3. A governmental regulating agency was created to oversee the monopoly in Question 2’s operations and pricing. Diagram 3 depicts a new price ceiling set by the regulators. Answer each of the following with complete explanations:
a. What is quantity a and why is it important?
b. What is the value at point b and why is it important?
c. At what level was the price ceiling set?
d. What is the value at point c and why is it important?
e. At this price ceiling level, will the monopoly make any monopoly profits?
f. What does the rectangle d indicate about the monopoly being able to cover its costs?
g. At this price ceiling level, will the monopoly continue in business in the long run?
Explanation / Answer
The point a is the profit maximizing output for the monopolist. At tis point the marginal revenue of the monopolist equals the marginal cost. The profits are also maximized at this level of output. The point b indicates the price which is to be charged by the monopolist for the optimum output of “a”. The monopolist charges the highest possible price for the optimum output level. The point c indicates the average cost of production for level of output “a”. That is the cost per unit of output produced. The point d indicates the price actually charged by the monopolist. This price, if greater than the cost of production the firm will earn economic profits. However, the monopolist usually earns economic profits. The “e” represents the rectangle which represents the normal profits for the monopolist. The area “e” is the profits. If the monopoly was a perfectly competitive firm, it would produce a quantity where P=AC. At point “f” the output is higher than the monopolist’s output level and charges a lower price than the monopolist. The point “g” indicates the intersection of the demand curve and the marginal cost curve. The equilibrium of the perfectly competitive firm occurs at P=MC. The triangle labled h is the addition in consumer surplus if the monopoly market was actually a perfectly competitive one.
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