Chapters 15& 16 Study Guide

AP Microeconomics

Key Concepts
monopoly

natural monopoly

price discrimination

oligopoly

monopolistic competition

collusion

cartel

Nash equilibrium

game theory

prisoner’s dilemma

dominant strategy

Questions
1. Are the monopolist’s profits part of the social cost of monopoly? Explain.

2. What are the four ways that policymakers can respond to the problem of monopoly?

3. Should antitrust laws be utilized to stop all mergers? Why?

4. What are some of the problems associated with regulating the price charged by a natural monopoly?

5. Is perfect price discrimination efficient? Explain. Who receives the surplus?

6. What is the necessary condition for a monopolist to be able to price discriminate?

7. What are the advantages and disadvantages of patents?

8. Why can a monopoly earn an economic profit in the long run but a perfectly competitive firm cannot?

9. How does the quantity produced and the price set by a single-price monopoly compare to set in a perfectly
competitive market? Does a monopoly produce the allocatively efficient quantity of output?

10. Explain the effect of price discrimination on consumer surplus and economic profit.

11. a. What are the three sources of the barriers to entry that allow a monopoly to remain the sole seller of a product?

b. What is the entry barrier that is the source of the monopoly power for the following products or producers? List some
competitors that keep these products or producers from having absolute monopoly power.
i. United States Postal Service

ii. Perrier Spring Water

iii. Prozac (brand name drug)

iv. DeBeers Diamonds

v. Principles of Economics, by N. Gregory Mankiw (your textbook)

vi. Edison Power Company

12. Suppose a firm has a patent on a special process to make a unique smoked salmon. The following table provides
information about the demand facing this firm for this unique product.
Pounds of Salmon Price Total Revenue Marginal Revenue
0 $20
1 18
2 16
3 14
4 12
5 10
6 8
7 6

a. Complete the table above.

b. Plot the demand curve and marginal revenue curve below.
 c. Suppose that there are no fixed costs and that the marginal cost of production of smoked salmon is constant at
$6 per pound. (Thus, the average total cost is also constant at $6 per pound) What is the quantity and price
chosen by the monopolist? What is the profit earned by the monopolist? Show your solution on the graph you
created in part (b) above.

d. What is the price and quantity that maximizes total surplus?

e. Compare the monopoly solution and the efficient solution. That is, is the monopolist’s price too high or too low?
Is the monopolist’s quantity too high or too low? Why?

f. Is there a deadweight loss in this market if the monopolist charges the monopoly price? Explain.

g. If the monopolist is able to costlessly and perfectly price discriminate, is the outcome efficient? Explain. What is
the value of consumer surplus, producer surplus, and total surplus? Explain.

13. a. What type of market is represented in the graph below: perfect competition, monopoly, or natural monopoly?
Explain.
b. Show the profit or loss generated by this firm in the graph below assuming that the firm maximizes profit or minimizes
loss.
c. Suppose government regulators force this firm to set the price equal to marginal cost in order to improve efficiency in
this market . Show the profit or loss generated by this firm below.
d. In the long run, will forcing this firm to change a price equal to its marginal cost improve efficiency? Explain.

14. What is a barrier to entry? What are the three sources of barriers to entry that allow a monopoly to remain the sole
seller in a market?

15. If a natural monopoly is forced through regulation to charge a price equal to its marginal cost, will the outcome be
efficient? Why?

16. Does a monopolist charge the highest possible price for its output? Why? How does a monopolist choose the price it
will charge for its product?

17. Why does a monopolist produce less than the socially efficient quantity of output?

18. If oligopolists would be better off if they collude, why do they so often fail to cooperate?

19. Is it better for society as a whole if oligopolists cooperate? Explain. What measures do we take to try to prevent
cooperation between oligopolists?

20. Compare the quantity and price of an oligopoly to those of a monopoly.

21. Compare the quantity and price of an oligopoly to those of a competitive market.

22. What is the prisoner’s dilemma and what does it have to do with oligopoly?

23. In which market structure would you place each of the following products-monopoly, oligopoly, monopolistic
competition , or perfect competition? Why?
a. Retail market for electricity

b. Principles of economics textbooks

c. Principles of Economics, by Gregory Mankiw

d. Photographic film

e. Retail market for gasoline

f. Restaurants in a large city

g. Auto tires

h. Trash collection

i. Legal services in a metropolitan area

j. Breakfast cereal

k. Gold bullion

l. Air travel from any one airport

24. What are the two types of imperfect competition? Describe them.

25. The market for vitamins and dietary supplements is dominated by five firms. What type of market structure does it
represent? Explain.

26. What is the outcome in an oligopolistic market if the oligopolistic collude and form a cartel? Explain.

27. Suppose a group of oligopolists do not collude but instead reach a Nash equilibrium. What price and quantity will
result in this oligopolist market when compared to the monopolistic or competitive result?
28. The following information describes the demand schedule for a unique type of apple. This type of apple can only be
produced by two firms because they own the land on which these unique trees spontaneously grow. As a result, the
marginal cost of production is zero for duopolists, causing total revenue to equal profit.
a. Complete the following table.
Price per bushel Quantity Total Revenue
(profit)
$12 0
11 5
10 10
9 15
8 20
7 25
6 30
5 35
4 40
3 45
2 50
1 55
0 60

b. If the market were perfectly competitive, what price and quantity would be generated by this market? Explain.

c. If these two firms colluded and formed a cartel, what price and quantity would be generated by this market, what is
the level of profit generated by the market, and what is the level of profit generated by each firm?

d. If one firm cheats and produces one additional increment (five units) of production, what is the level of profit
generated by each firm?

e. If both firms cheat and each produces one additional increment (five units) of production (compared to the
cooperative solution), what is the level of profit generated by each firm?

f. If both firms are cheating and producing on additional increment of output (five additional units compared to the
cooperative solution), will either firm choose to produce an additional increment (5 more units)? Why? What is the
value of the Nash equilibrium in this duopoly market?

g. Compare the competitive equilibrium to the Nash equilibrium. In which situation is society better off? Explain.

h. What would happen to the price and quantity in this market if an additional firm were able to grow these unique
apples?
Use the data from the duopoly example above to fill in the boxes of the prisoners’ dilemma. Place the value of the
profits earned by each duopolist in the appropriate box.
i. What is the solution to this prisoners’ dilemma. Explain.

j. What might the solution be if the participants were able to repeat the “game?” Why? What simple strategy might they
use to maintain their cartel?

29. A monopolist’s demand, marginal revenue, and cost curves are shown in the diagram below.
a. Assume that the monopolist wants to maximize profit. Using the labeling on the graph, indicate the
monopolist’s price.

b. When the output is 8 units, what is the profit per unit?

c. Assume that the monopolist is maximizing profit. Is allocative efficiency achieved? Explain.

d. Between the prices of $16 and $18, is the monopolist in the elastic, inelastic, or unit elastic portion
of its demand curve? Explain.

e. Assume that regulators set an output of 11 units.

i. Is the monopolist earning positive economic profit? Explain.

ii. Is the monopolist earning positive accounting profit?

f. Assume instead that regulators impose a price ceiling of $22.

i. What is the marginal revenue for the eighth unit?

ii. What quantity will be produced?

g. Assume instead that the monopolist practices perfect price discrimination (also called first-degree price
discrimination).
i. What quantity will be produced?

ii. What will be the value of the consumer surplus?

30. The diagram above shows the cost and revenue curves for a bridge to a popular island. The marginal cost of
crossing the bridge is zero and is indicated in the diagram as the horizontal axis. The price is the toll to cross
the bridge, and the output is the number of autos that cross the bridge each day.
a. Assume that a private firm owns the bridge and maximizes profits. Based on the diagram, determine each
of the following.
i. Output
ii. Price

b. Now assume that a municipality owns the bridge and sets the price to achieve allocative efficiency.
Based on the diagram, determine each of the following.
i. Output

ii. Price
c. At a price of $1, is the municipality’s accounting profit positive, negative, or zero? Explain.

d. Suppose that the municipality sets a break-even price that generates revenues to just cover all economic
costs.
i. Based on the diagram, determine the break-even output.

ii. At the output you determined in part (d)(i), is the demand relatively elastic, relatively inelastic,
unit elastic, perfectly elastic, or perfectly inelastic?