Quiz 14: Monopoly

Business

Natural monopoly: Natural monopoly arises when a single firm provides good or service to a entire market at a lower cost than other firms. Hence, a natural monopoly firm can be considered as an economically efficient firm. Therefore, if the firm produces more goods or services, then it will lead to reduce in total cost of production. Hence, option 'd' is correct.

a) To find the profit earned at different price levels, calculate the total revenue and total costs incurred. Total revenue: Total revenue is calculated by multiplying price with quantity of novels demanded. The following table shows the total revenue earned at different price levels: img Total Cost: It is given that the author was paid $2,000,000 for writing the novel and the publisher is incurring a $10 marginal cost per every copy sold. Thus, the $2,000,000 paid to the publisher will be the fixed cost and the variable component is the MC multiplied with quantity of novels. The following table shows the total costs incurred by the publisher: img The total profit can be found by the difference between total revenue and total cost. img img From the above table, observe that, profit is maximum at a price of $60 or $50. Thus, to maximize profit, the publisher can chose to supply 400,000 or 500,000 novels. b) Marginal revenue can be calculated by using the formula: img The following table shows the marginal revenue of novels at different price levels: img Observe that the marginal revenue is always less than the price. This can be explained by the downward sloping demand curve. The price falls when quantity rises due to the downward sloping demand curve, and the marginal revenue falls even more than price because the firm loses revenue on all the units of the good sold when it lowers the price. For example, when the price is $60, it can sell 400,000 copies, now by reducing the price to $50 though it is selling 500,000 copies but the revenue received on each copy also gets reduced, reducing the marginal revenue. c) Based on the following table MR, MC and demand curve can be plotted: img See that MC is constant at $10 so it will be a horizontal line and the MR and MC curve will intersect at $10. img d) Dead weight loss is the loss incurred in the total surplus of the economy, when a company sells a products at a price higher than the marginal cost incurred. The area under the points 'abc' gives the deadweight loss which is marked "DWL" in the following figure. Dead weight loss is incurred as the monopolist produces lower than the socially efficient level. img e) If the author were paid $3 million, instead of $2 million, the publisher will not change the price. This is because the author's fee will be a fixed cost component that cannot alter the marginal cost. Marginal cost can only be altered, if there are changes in the variable cost component. Thus, as there are no changes in the marginal revenue and marginal price, the profit maximizing level of output remains the same at 500,000 units. However, increase in fixed costs will reduce the total profit earned. f) Economic efficiency is achieved when the product is sold at a price equal to its marginal cost. Thus, to maximize economic efficiency, the publisher should sell at the marginal cost of $10 per book. At this price, the publisher will have negative profits equal to the amount paid to the author.

Government-created monopolies are the firms, which have the exclusive right to sell a particular good in the market. Government restricts the entry of other firms by giving these firms the license, or patent and copyright to produce goods or services. Government-created monopoly includes postal system, electricity, telecommunications, railways etc. Furthermore, patent holders of different products will also come under the government created monopolies; for instance, pharmacy, and technology companies. Creating a monopoly is not necessarily a bad policy because it has its own benefits and costs. The benefits of Government-created monopoly include: • State owned companies: If the industry setup requires high fixed costs with large retail distribution pool, then, inevitably a state sponsored company can venture. Private firms cannot venture, as the fixed costs and cost of logistics were very high. Therefore, a state owned enterprise would be licensed for conducting the activity. For instance, majority of the water supply and electric power generation and distribution companies are either state owned or controlled by a single large company; inevitably, making it a monopoly. • Patenting for inventions and innovation: Government grants patents and copyrights to new inventions and original taught. By giving a patent, the inventor is benefitted and gets incentive for their hard work and creativity. Therefore, patenting gives an exclusive right for the patent holder to manufacture and sell the product making it a monopoly. However, if the government do not give a patent or protect the private rights of the inventor, then there will not be any incentive for the innovator to put efforts for creating a new product. Therefore, by giving patent the government creates a monopoly; however, if there are no patents, then there will no longer be any inventions.