This question has you compare the outcomes of a monopolized market with that of a competitive market. Suppose that market inverse demand is given by P = 120 – 2Q. The technology used to produce the good in this market requires using 1 unit of labor (at a wage of $10) and 1 unit of capital (at a rental rate of $30) per unit of output.
a. Suppose the industry has a single firm. Write the long run total cost function for this firm, and its long run average total cost and marginal cost:
Total cost = $________
ATC = $________
MC = $________
b. Suppose that this monopolist has a patent which protects it from competition in this industry. Find the profit maximizing price and output level, and calculate the maximum profit the firm can earn.
Price: $________
Quantity: ________
Profit: $________
c. On the diagram on the next page, show the optimal price and quantity you found above by filling in the appropriate boxes along the diagram’s axes. Consumer surplus shows the value or benefit consumers receive over and above the price paid. Find consumer surplus in this monopolized market.
Consumer surplus: $__________
Now mark the area on your diagram that shows consumer surplus with the letter “A”. Mark the area on your diagram that shows monopolist profit with the letter “B”. Mark the area on your diagram that shows the firm’s total cost with the letter “C”.
d. A competitive market drives the price to the marginal cost of production. Suppose the monopolist’s patent expires and many firms enter the market using the same technology, making the market perfectly competitive. Find the competitive market price and the total quantity that will be produced, along with the consumer surplus and firm profits in a competitive setting. Show these along the axes of the diagram as well.
Competitive market price: $__________
Competitive market quantity: __________
Competitive market consumer surplus: $__________
Competitive market total firm profits: $__________
Now mark the area on your diagram that shows the additional cost of resources the firms in this competitive market use (over and above those used by the monopolist) with the letter “D”.
e. Economists refer to the “damage” done by monopolists as deadweight loss, which specifically refers to the consumer and producer surplus that a competitive market would generate that the monopolist fails to generate. In the monopolized version of this market, how much is the deadweight loss of monopoly?
Deadweight loss: $__________
Mark this area on your diagram with the letter “E”.