C h a p t er

13 MONOPOLY

A n s w e r s to th e R e v i e w Q u i z z e s
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1. How does monopoly arise?
Monopoly arises if a firm is selling a good that has no close substitutes and if the firm is protected
from competition by a barrier to entry. As a result, a monopoly is the only firm in its market.
2. How does a natural monopoly differ from a legal monopoly?
The barrier to entry protecting a natural monopoly is the firm’s cost. For a natural monopoly, the costs
are such that one firm can supply the entire market at lower cost than could two or more firms. The
barrier to entry protecting a legal monopoly is a legal prohibition preventing competitors from entering
the market. Copyrights, patents, government licenses, and public franchises are legal barriers to entry.
3. Distinguish between a price-discriminating monopoly and a single-price monopoly.
A single-price monopoly charges every consumer the same price for each unit of the good or service
the consumer buys. A price-discriminating monopolist might charge different consumers different
prices for the same good or service or charge the same consumer different prices for different units of
the good or service. When a firm practices price discrimination, it sells different units of a good or
service for different prices.

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1. What is the relationship between marginal cost and marginal revenue when a single-
price monopoly maximizes profit?
A single-price monopoly firm maximizes profit by producing an amount of output so that marginal
cost equals marginal revenue (MR = MC).
2. How does a single-price monopoly determine the price it will charge its customers?
The market demand curve is the monopolist’s demand curve. The demand curve shows the
maximum price at which the monopoly can sell its profit-maximizing level of output. So the
monopoly finds the quantity it will produce and then uses its demand curve—the market demand
curve—to determine the price it will charge.
3. What is the relationship between price, marginal revenue, and marginal cost when a
single- price monopoly is maximizing profit?
MR < P for every level of output. A profit-maximizing monopoly firm produces the amount of output
that sets MR = MC. As a result, MC must be below price: MC = MR < P.

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4. Why can a monopoly make a positive economic profit even in the long run?
Barriers to entry prevent the monopoly firm from enduring the pressure of competition, and allow it to
choose the quantity of output that is associated with the profit-maximizing market price. This allows a
monopoly firm to potentially enjoy positive economic profit, even in the long run.

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1. Why does a single-price monopoly produce a smaller output and charge more than the
price that would prevail if the market were perfectly competitive?
The market supply curve for a competitive market is the horizontal sum of the individual firm’s
marginal cost curves. Equilibrium output in this competitive market is determined where the market
supply curve intersects the market demand curve, and at this point price equals marginal cost, that is P
= MC. Equilibrium output for a single-price monopoly is determined at the intersection of its marginal
cost curve and its marginal revenue curve. Marginal revenue is less than price, which means that MR
= MC at less output than that for which P=MC, so the monopoly produces less than a perfectly
completive market. For a monopoly price exceeds marginal revenue which, in turn, equals marginal
cost. Therefore for a monopoly, P > MC which means the monopoly price exceeds the price in a
perfectly competitive market.
2. How does a monopoly transfer consumer surplus to itself?
The monopoly raises price by lowering the quantity offered for sale. This raises the price consumers
must pay for the good compared to the competitive market price. This difference in price multiplied
by the quantity the monopolist sells represents the amount of consumer surplus that is transferred to
producer surplus.
3. Why is a single-price monopoly inefficient?
In a competitive market, the supply curve is the marginal social cost curve for society, and the
demand curve is the marginal social benefit curve to society. The perfectly competitive market is
efficient because production occurs where the quantity supplied equals the quantity demanded so that
MSB = MSC. The monopolist is inefficient because price exceeds marginal cost at the quantity of
output the monopoly produces. When the monopoly equates MC = MR to choose the profit-
maximizing level of output, it charges a price from the demand curve that is greater than marginal
cost, which means MSB > MSC. Consumer and producer surplus are not maximized and society
suffers a deadweight loss.
4. What is rent seeking and how does it influence the inefficiency of monopoly?
Rent seeking is the pursuit of wealth by capturing economic rent. Any surplus—consumer surplus,
producer surplus, or economic profit—is called economic rent. There are two forms of rent seeking
activity to pursue a monopoly status: i) Buying a monopoly, where a person expends resources
seeking to purchase monopoly rights for a price slightly less than the monopoly profit, or ii) Creating
a monopoly, where a person expends resources seeking political influence, such as lobbying
legislators to provide preferential market status by restricting domestic or international competition.
The resources expended in rent seeking will be equal to the economic profit that a monopoly status
would create for the owner.
Economic profit is zero because it has been lost in rent seeking. The cost of rent seeking is a fixed cost
so the marginal cost does not change, which means the monopoly does not change its (inefficient)
amount of output. Consumer surplus is unaffected. But the deadweight loss of monopoly has increased
because it now includes the original deadweight loss triangle plus the lost producer surplus.

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1. What is price discrimination and how is it used to increase a monopoly’s profit?
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 MONOPOLY
Price discrimination is the practice of selling different units of a good or service for different prices. 18
To practice price discrimination, a monopoly must be able to: i) identify and separate different buyer
types,

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and ii) sell a product that cannot be resold. The key idea to price discrimination is to charge
different consumers different prices, according to their willingness to pay for the good. This
transfers potential consumer surplus under the single-price scenario into producer surplus, raising
the monopoly’s profit.
2. Explain how consumer surplus changes when a monopoly price discriminates.
When a monopoly price discriminates, it charges different prices for different units of the product or it
charges different prices to different consumers. Consumer surplus is the value (or marginal benefit) of
a good minus the price paid for it, summed over the quantity bought. When the monopoly price
discriminates, it decreases the consumer surplus on the units for which it charges a higher price to its
initial customers. But it increases the consumer surplus on units for which it charges a lower price to
new customers. If a monopoly is able to perfectly price discriminate, it totally eliminates consumer
surplus because it charges every consumer the highest price the consumer is willing to pay.
3. Explain how consumer surplus, economic profit, and output change when a monopoly
perfectly price discriminates.
Perfect price discrimination occurs when a monopoly charges each consumer the maximum price he or
she is willing to pay. The closer the price paid is to the value placed on the good, the smaller is the
consumer surplus. This transfers the entire consumer surplus to producer surplus. Consumer surplus is
eliminated.
Producer surplus increases because it gains an amount equal to the lost consumer surplus. Producer
surplus also increases because the quantity produced increases to the output at which price equals
marginal cost.
The monopoly increases its economic profit compared to charging a single-price to all customers. This
outcome achieves efficiency by eliminating the deadweight loss.
4. What are some of the ways that real-world airlines price discriminate?
Vacation travelers are willing to pay less than business travelers, so airlines need to sort vacation
travelers from business travelers. Vacation travelers generally know well in advance when their
vacation will occur and so they are able to purchase their tickets in advance. In addition vacation
travelers are often willing to spend a weekend at their destination. Travelers who either buy their
tickets in advance and/or are willing to spend a weekend at the destination are identifying themselves
as vacation travelers and airlines charge them a lower price. The airline companies make airline tickets
non-transferable, preventing the vacation travelers with the lower willingness to pay from reselling
their less expensive tickets to the business travelers with the higher willingness to pay.

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1. What is the pricing rule that achieves an efficient outcome for a regulated monopoly?
What is the problem with this rule?
Regulating the actions of a natural monopoly to achieve an efficient outcome implies setting the level
of output at the quantity where MB = MC, and the monopoly must set its price equal to marginal cost.
This type of regulation is called the marginal cost pricing rule. A marginal cost pricing rule
maximizes total surplus. However, when the monopoly price equals marginal cost, average total cost
exceeds price and the monopoly incurs an economic loss. A monopoly that is required to use a
marginal cost pricing rule will not stay in business because it is not covering its costs. Two possible
ways of enabling the firm to cover its costs are by price discrimination and by using a two-part price
(called a two-part tariff). The government might also grant the firm a subsidy. But this subsidy must
be raised through imposing taxes on other economic activity, which creates deadweight loss and
prevents efficient resource allocation in the markets affected by the tax.

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2.
MONOPOLY
What is the average cost pricing rule? Why is it not an efficient way of regulating 18
monopoly? An average cost pricing rule requires that the firm set its price equal to its average total
cost and produce the quantity at which the LRAC curve intersects the demand curve. This pricing rule
leads to an inefficient

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quantity of output. Allocative efficiency requires that the quantity produced be the amount for which
the marginal social benefit, shown on the demand curve, equal marginal social cost, which is shown
on the marginal cost curve. Efficiency requires that P = MC. When a natural monopoly is regulated
using an average cost pricing rule, P = LRAC and at the quantity produced LRAC > MC. Combining
these results shows that P > MC, which means that the firm is producing an inefficient amount of
output.
3. What is a price cap? Why might it be a more effective way of regulating monopoly than
rate of return regulation?
A price cap is a price ceiling, a regulation that sets the maximum price the regulated firm can charge.
This type of regulation might be a more effective method of regulation than rate of return regulation
because rate of return regulation gives managers the incentive to inflate their costs. Price cap
regulation, however, gives the regulated firm the incentive to operate efficiently and not inflate its
costs.
4. Compare the consumer surplus, producer surplus, and deadweight loss that arise from
average cost pricing with those that arise from profit-maximization pricing and marginal cost
pricing.
For a natural monopoly, marginal cost is less than average total cost at all levels of output in the
market. Compared to an average cost pricing rule a marginal cost pricing rule generates greater
consumer surplus and less producer surplus because P = MC (which determines production with the
marginal cost pricing rule) at a larger level of output than when P = LRAC (which determines
production with an average cost pricing rule). With a marginal cost pricing rule the monopoly market
will be efficient (MSB = MSC) and not experience a deadweight loss. However, the firm’s average
total cost exceeds its price and the monopoly suffers an economic loss. The monopoly will stay in
business only if it receives a subsidy to make up for the economic loss, returning it to a normal profit.
Yet this subsidy must be provided through taxing other markets, causing inefficient resource
allocations in those markets. So with a marginal cost pricing rule the other markets affected by the tax
will experience an increase in deadweight loss. The average cost pricing rule generates a deadweight
loss in the monopoly market because MSB no longer equals MSC. This result occurs because the
monopoly produces where P = LRAC and LRAC exceeds MSC at this level of output.
Finally, compared to a profit-maximizing firm, a firm regulated with an average cost pricing rule has
greater consumer surplus, smaller producer surplus, and smaller deadweight loss.

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Answers to the Study Plan Problems and Applications

1. The U.S. Postal Service has a monopoly on non-urgent First Class Mail. Pfizer Inc.
makes LIPITOR, a prescription drug that lowers cholesterol. Cox Communications is
the sole provider of cable television service in some parts of San Diego. Are any of these firms
protected by a barrier to entry? Do any of these firms produce a good or service that
has a substitute? Might any of them be able to profit from price discrimination?
Explain your answers.
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 has a natural barrier to entry because it is a
natural monopoly. It also has a legal barrier to entry because it has been given the public franchise to
be the only cable provider in its area.
Substitutes for the U.S. Postal Service include email, fax, and private delivery services, such as FedEx
or UPS. Substitutes for Lipitor are generic Lipitor, other statin drugs, such as Zocor, non-statin drugs
that also lower cholesterol, and exercise. Substitutes for Cox Communications include satellite
television services, Hulu, and other Internet provided television service.
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.
Use the following table to work Problems 2 to 4.
Minnie’s Mineral Springs is Price Quantity Total cost
a demanded
single-price monopoly. Columns (dollars per bottle) (bottles per hour) (dollars per hour)
1 and 2 of the table set out
the market demand schedule
for Minnie’s water and
columns 2 and 3 set out
Minnie’s total cost schedule.
2. Calculate Minnie’s
marginal revenue
schedule

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10 0 1
8 1 3
6 2 7
4 3 13
2 4 21
0 5 31
and draw a graph of the market demand curve and Minnie’s marginal revenue curve. Explain
why Minnie’s marginal revenue is less than the price.
To calculate Minnie’s marginal revenue, we first need to calculate the total revenue. Minnie’s total
revenue schedule lists the total revenue at each quantity sold. For example, Minnie’s can sell 1 bottle
for $8 a bottle, which is $8 of total revenue at the quantity 1 bottle. Minnie’s entire total revenue
schedule is in the table on the next page.
The marginal revenue schedule lists the marginal revenue that results from increasing the quantity
sold by 1 bottle. For example, Minnie’s can sell 1 bottle for total revenue of $8. Minnie’s can sell 2
bottles for $6 each, for total revenue of $12. So by increasing the quantity sold from 1 bottle to 2
bottles, marginal revenue is $4 a bottle ($12 minus $8). In the table on the next page, this marginal
revenue is placed midway between the quantities 1 bottle and 2 bottles.
Minnie’s demand curve and marginal revenue curve are in Figure 13.1 The demand curve intersects
the vertical axis at a price of $10 and intersects the horizontal axis at a quantity of 5. The marginal
revenue curve intersects the vertical axis at a price of $10 and intersects the horizontal axis at a
quantity of 2.5.

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Price Quantity demanded Total revenue Marginal

(dollars per (bottles per hour) (dollars) revenue (dollars
bottle) per bottle)
10 0 0
8
8 1 8
4
6 2 12
0
4 3 12
−4
2 4 8
−8
0 5 0
.
Minnie’s marginal revenue is less than her price
because to sell an additional unit of output,
Minnie must lower her price on all units sold. So
when Minnie sells an additional unit of output,
her revenue consists of the price she receives for
this extra unit minus what she loses on all
previous units she sells now at the new, lower
price.
3. At what price is Minnie’s total revenue
maximized and over what range of prices is
the demand for water elastic? Why will
Minnie not produce a quantity at which the
market demand is inelastic?
Interpolating along the demand curve, Minnie’s
total revenue is maximized at a price of $5. At
this price she sells 2.5 bottles an hour for total
revenue of $12.50.
The demand for Minnie’s Mineral Springs
water is elastic between $5 per bottle and $10
per bottle.
Minnie will not produce a quantity at which the demand for her water is inelastic because producing
at such a price does not maximize her profit. If Minnie is producing where her demand is inelastic,
she can decrease the quantity she produces and 1) increase her total revenue, and 2) decrease her
total cost.
Because her total revenue increases and her total cost decreases, Minnie’s total profit increases.
Anytime Minnie’s production is at a quantity at which demand is inelastic, she can always increase
her total profit by decreasing her production.
4. Calculate Minnie’s profit-maximizing output and price and economic profit.
Minnie’s profit-maximizing output is 1.5 bottles and her profit-maximizing price is $7a bottle.
To maximize profit Minnie’s needs to produce the quantity at which marginal revenue equals
marginal cost. 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 at 1.5 bottles of water is $4 a bottle. The marginal revenue of
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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. 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.

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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. Minnie’s
economic profit equals
$10.50 minus $5, which is $5.50.
5. Use the data in Problem 2 to work Problem 5.
a. Use a graph to illustrate the producer surplus generated from Minnie’s Mineral
Springs’ water production and consumption.
Figure 13.2 shows Minnie’s producer surplus.
The producer surplus equals the area of the grey
polygon on the figure.
b. Is Minnie’s an efficient producer of
water? Explain your answer.
Minnie’s is not an efficient producer of water.
Efficiency requires that the amount of
production sets the marginal cost of water equal
to its marginal benefit. The marginal benefit is
measured by the demand curve, so in Figure
13.2 the efficient quantity of water to produce is
the quantity where the marginal cost curve
intersects the demand curve, which is 2 1/9
bottles per hour.
c. Suppose that new wells were
discovered nearby to Minnie’s and
Minnie’s faced competition from new
producers. Explain what would happen
to Minnie’s output, price, and profit.
Competition would force Minnie’s to lower its price. Minnie’s output would decrease as would its
economic profit.
6. LaBella Pizza can produce a pizza for a marginal cost of $2. Its price of a pizza is $15.
a. Could La Bella Pizza make a larger economic profit by offering a second pizza for $5?
Use a graph to illustrate your answer.
La Bella Pizza is price discriminating, which
increases its profit. It is charging consumers a
second price for 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. On both counts, La Bella is
increasing its sales and, because its marginal
revenue from these additional sales, $5 per
pizza, exceeds its marginal cost of $2, the
additional sales increase La Bella’s profit.
Figure 13.3 illustrates La Bella Pizza’s
situation. With no price discrimination La Bella
produces 300 pizzas and sells them at a price of
$15 a pizza. With the price discrimination, La

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Bella still sells 300 pizzas at a price of $15 and
also sells an additional 200 pizzas at a price of
$5. The

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 MONOPOLY 19

economic profit when La Bella sells at one price is equal to the large, light grey area. When La Bella
price discriminates, it makes additional economic profit equal to the darker grey rectangle.
b. How might La Bella Pizza make even more economic profit? Would La Bella Pizza
then be more efficient than it would be if it charged $15 for each pizza?
La Bella could further price discriminate. For instance, it might sell a third pizza for $4, which, given
the marginal cost of $2, would still increase economic profit. 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.
Use the following figure to work Problems 7 to
9. Calypso, a U.S. natural gas distributor, is a
natural monopoly that cannot price discriminate.
The figure shows Calypso’s costs and the market
demand for
natural gas. What quantity will Calypso produce, what
price will it charge, and what will be the total
surplus and deadweight loss if Calypso is:
7. An unregulated profit-maximizing firm?
As shown in Figure 13.5, Calypso will produce 2
million cubic feet a day and sell it for 6 cents a cubic
foot. The marginal revenue curve will run from 10
cents on the y-axis to 2.5 cubic feet on the x-axis.
The profit-maximizing output is 2 million cubic
feet at which marginal revenue equals marginal
cost. The price charged is the highest that people
will pay for 2 million cubic feet a day, which is 6
cents a cubic foot. The consumer surplus is
$40,000, the producer surplus is $80,000, and the
deadweight loss is $40,000. 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 million cubic feet/2, which is $40,000. 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 million cubic feet a day,
which is
$80,000. 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 social
benefit) curve and the marginal cost curve
between the equilibrium quantity and the efficient
quantity. So the deadweight loss equals (4 million
cubic feet minus 2 million cubic feet) multiplied
by (6 cents minus 2 cents)/2, which is $40,000 a
day.
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8. Regulated to make zero economic profit?

If Calypso is regulated to make zero economic profit, it produces the output at which price equals
average total cost—at the intersection of the demand curve and the LRAC curve. Calypso will
produce 3 million cubic feet a day and charge 4 cents a cubic foot. The consumer surplus is $90,000,
the producer surplus is
$60,000, and the deadweight loss is $10,000. 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 million cubic feet/2, which is $90,000. 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 million cubic feet, which is $60,000. The efficient output is 4 million
cubic feet, at which marginal cost equals price (marginal benefit). The deadweight loss is the
triangular area between the demand (or marginal social benefit) curve and the marginal cost curve
between the equilibrium quantity and the efficient quantity. So the deadweight loss equals (4 million
cubic feet minus 3 million cubic feet) multiplied by (4 cents minus 2 cents)/2, which is $10,000 a day.
9. Regulated to be efficient?
If the firm is regulated to be efficient, it will produce the quantity at which price (marginal social
benefit) equals marginal social cost—at the intersection of the demand curve and the marginal cost
curve. Calypso will produce 4 million cubic feet a day and charge 2 cents a cubic foot. The consumer
surplus is $160,000, the producer surplus is $0, and the deadweight loss is $0. 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 million cubic feet/2, which is $160,000. 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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Answers to Additional Problems and Applications

Use the following list, which gives some information about seven firms, to answer Problems 10 and
11.
 Coca-Cola cuts its price below that of Pepsi-Cola in an attempt to increase its market share.
 A single firm, protected by a barrier to entry, produces a personal service that has no
close substitutes.
 A barrier to entry exists, but the good has some close substitutes.
 A firm offers discounts to students and seniors.
 A firm can sell any quantity it chooses at the going price.
 The government issues Nike an exclusive license to produce golf balls.
 A firm experiences economies of scale even when it produces the quantity that meets
the entire market demand.
10. In which of the seven cases might monopoly arise?
The second, sixth, and seventh cases suggest that a monopoly might be a possibility.
11. Which of the seven cases are natural monopolies and which are legal monopolies? Which
can price discriminate, which cannot, and why?
It is not possible to determine if the second case is a legal barrier or natural barrier to entry because
we do not know the type of barrier. The sixth case describes a legal barrier to entry because Nike has
been given an “exclusive license” by the government. The seventh case is a natural monopoly
because it describes the firm as having economies of scale over the entire market demand.
Coca-Cola in the first case cannot price discriminate because there are not separate classes of
customers with different willingness to pay. The fifth case, the firm that can sell any quantity it wants
at the going price, is a perfect competitor and cannot price discriminate. The fourth case, the firm
offering discounts to students, and seniors, is price discriminating. The other situations describe firms
that might be able to price discriminate if there are different classes of customers and if the firm can
determine into which class a customer falls.
Use the following information to work Problems 12 to 16.
Hot Air Balloon Rides is a single-price
monopoly. Columns 1 and 2 of the table set Price Quantity Total cost
out the market (dollar demande (dollars
s d
demand schedule and columns 2 and 3 set out
the per ride) (rides per month) per month)
total cost schedule.
12. Construct Hot Air’s total revenue
and marginal revenue schedules.
The table showing Hot Air’s total revenue
schedule and marginal revenue schedule is
on the next page. Total revenue equals price
multiplied by quantity. Marginal revenue

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0 80
200 1 160
180 2 260
160 3 380
140 4 520
120 5 680
equals the change in total revenue divided by the change in quantity. For example, between 1 ride and
2 rides the total revenue increases by $160 and the quantity increases by 1 ride, so the marginal
revenue equals $160/1, which is $160. This marginal revenue is placed midway between the 1 ride
and 2 rides rows.

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Price Quantity Total revenue Marginal

(dollar demande (dollars revenue (dollars
s d per month) per ride)
per ride) (rides per month)
220 0 0
200
200 1 200
160
180 2 360
120
160 3 480
80
140 4 560
40
120 5 600
13. Draw a graph of the market demand curve
and Hot Air’s marginal revenue curve.
Figure 13.6 illustrates Hot Air’s demand curve
and marginal revenue curve.
14. Find Hot Air’s profit-maximizing output
and price and calculate the firm’s economic
profit.
Hot Air’s marginal cost equals marginal revenue
at 2 1/2 rides a month, where both equal $120.
From the demand curve, the price is $170 a ride.
Economic profit equals total revenue minus
total cost. The total cost of 2 1/2 rides a month
is $320. Hot Air’s total revenue equals the
number of rides multiplied by the price per
ride, which is (2 1/2 rides per month)  ($170)
= $425. So the economic profit is total revenue
minus total cost, which is
$425  $320 = $105.
15. If the government imposes a tax on Hot
Air’s profit, how do its output and price
change?
As a result of the tax, Hot Air’s fixed cost changes, but its marginal cost does not. The profit-
maximizing level of output is still 2 1/2 rides a month and the price still equals $170. The tax decreases
Hot Air’s economic profit but does not change its output or price.
16. If instead of taxing Hot Air’s profit, the government imposes a sales tax on balloon rides
of $30 a ride, what are the new profit-maximizing quantity, price, and economic
profit?
A $30-a-ride tax increases Hot Air’s marginal cost by $30 at every level of output. With the
increase in the marginal cost, Hot Air now sells 2 rides a month because this is the level at which
the new marginal cost equals the marginal revenue (both equal $140). From the demand curve,
Hot Air sets a price of $180 a ride. Economic profit equals total revenue minus total cost. The
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total revenue is 2 rides  $180 which is
$360. The total cost is $260 plus the tax of $60, which is $320. So the new economic profit is $360 
$320 = $40.

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17. Figure 13.7 illustrates the situation facing

the publisher of the only newspaper
containing local news in an isolated
community.
a. On the graph, mark the profit-
maximizing quantity and price and the
publisher’s total revenue per day.
Profit is maximized when the firm produces the
output at which marginal cost equals marginal
revenue. As Figure 13.8 shows, the marginal
revenue curve runs from 100 on the y-axis to 500
on the x-axis. The marginal revenue curve cuts the
marginal cost curve at the quantity 267
newspapers a day. The highest price for which the
publisher can sell 267 newspapers a day is read
from the demand curve. So the profit-maximizing
quantity is 267 newspapers a day and price is 73
cents a paper. The daily total revenue is $194.91
(267 papers at 73 cents each). This amount is
equal to the rectangular
area C in Figure 13.8.
b. At the price charged, is the demand for
this newspaper elastic or inelastic?
Why?
Demand is elastic. Along a straight-line
demand curve, demand is elastic at all prices
above the midpoint of the demand curve. The
price at the midpoint is 50 cents. So at 73
cents a paper, demand is elastic.
18. Show on the graph in Problem 17 the
consumer surplus from newspapers and the
deadweight loss created by the monopoly.
Explain why this market might encourage
rent seeking.
Figure 13.8 shows the consumer surplus, area A,
and the deadweight loss, area B. The consumer
surplus is $36.05 a day and the deadweight loss
is
$8.65 a day. The consumer surplus is the area
marked A in Figure 13.8 and the deadweight loss
is the darker area marked B in the figure.
The consumer surplus is the area under the demand
curve and above the price. The price is 73 cents, so consumer surplus equals (100 cents minus 73
cents) multiplied by 267/2 papers a day, which is $36.05 a day. Deadweight loss arises because the
publisher does not produce the efficient quantity. Output is restricted to 267 newspapers rather than
400, and the price is increased to 73 cents rather than 60 cents. The deadweight loss equals (73 cents
minus 46.6 cents) multiplied by 133/2, $17.56.
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Any surplus—consumer surplus, producer surplus, or economic profit—is called economic rent. Rent
seeking would occur in this industry because new entrepreneurs would hope to capture some of the
consumer surplus currently being earned.

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 MONOPOLY 19

19. If the newspaper market in Problem 17 were perfectly competitive, what would be
the quantity, price, consumer surplus, and producer surplus? Mark each on the
graph.
The quantity would be 400 newspapers a day and the price would be 60 cents a newspaper. The
consumer surplus is the triangular area under the demand curve and above the price, marked as area A in
Figure
13.9. The price is 60 cents, so consumer
surplus equals (100 cents minus 60 cents)
multiplied by 400/2 papers a day, which is $80
a day. The producer surplus is the triangular
area under the price and above the supply
curve, marked as area B in Figure 13.9. The
price is 60 cents, so producer surplus equals
(60 cents minus 20 cents) multiplied by 400/2
papers a day, or $80 a day.

20. Supreme Court Rules for Samsung in Smartphone Patent Dispute

In a decision over Samsung’s use of iPhone design elements, the Supreme Court gave Samsung
a chance to recover some of the nearly $400 million it had previously been ordered to pay
Apple.
Source: The Washington Post, December 6,
2016
a. If Samsung and other smartphone producers had been prevented from entering the
market by Apple patents, leaving Apple with a monopoly in the smartphone market,
who would benefit and who would lose?
If Apple became a monopoly, Apple would gain and other suppliers would lose. Consumers would
lose. Society would lose because the total surplus is smaller in a monopoly market than in a perfectly
competitive market.
b. Compared to a smartphone monopoly, who would benefit and who would lose if hundreds
of firms entered the smartphone market, each producing an identical smartphone,
making the market perfectly competitive?
If the smartphone market became perfectly competitive, consumers would gain because they can buy
more smartphones at a lower price. Apple loses because they sell fewer smartphones and receive a lower
price.
Other producers who enter the market gain. Overall, the gains exceed the losses, so society gains
because the total surplus is larger in a perfectly competitive market than in a monopoly market.
c. Explain which market would be efficient: a perfectly competitive one or a

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19 CHAPTE R 1 3
monopoly. A perfectly competitive market is efficient. A monopoly produces less output
than does a perfectly competitive market, thereby creating a deadweight loss. There is no
deadweight loss in a perfectly competitive market.

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19 CHAPTE R 1 3

21. Amazon Kills Unlimited Online Storage Plans

Amazon launched unlimited data storage for $59.99 per year in 2015. In 2017, it replaced
its unlimited deal with a tiered pricing system. Now Amazon offers 100 gigabytes of
storage for
$11.99 yearly and larger storage at $59.99 yearly per terabyte.
Source: USA TODAY, June 8, 2017
a. Explain why Amazon’s new data plans might be price discrimination.
Amazon’s new data plans are price discrimination because users pay a different price per gigabyte of
data stored depending on the quantity of data they store. Amazon’s marginal cost is the same,
regardless of how much data is stored, so the price difference does not reflect a difference in cost.
b. Draw a graph to illustrate the original plan and the new plans.
Figure 13.10 illustrates the original plan and
the new plan. Initially Amazon charged
everyone a fee of $59.99 per year and, based
on the demand curve in the figure, 50 million
people signed up for the plan. Amazon’s total
revenue from these consumers is the area of
the dark gray rectangle in the figure. In 2016
when Amazon also sold 100 gigabytes of
storage for
$12 a year, an additional 40 million purchased
the storage. Amazon’s total revenue from
these additional customers is equal to the area
of light gray rectangle in the figure.

22. Is It Time to Break Up Google?

Google has an 80 percent market share in search advertising. It is a monopoly. In the
early 20th century, Supreme Court Justice Louis Brandeis said, “in a democratic
society the existence of large centers of private power is dangerous to the continuing
vitality of a free people.” He believed that unless it is a natural monopoly it
should be broken up.
Source: The New York Times, April 22, 2017
a. How would we test whether Google is a monopoly in the Internet advertising market?
For Google to be a monopoly, it needs to be the only firm in market, producing a product with no
close substitutes and which is protected by a barrier to entry. The fact that there are other search
providers, which account for 20 percent of search advertising, demonstrates that Google is not a
textbook monopolist.
b. Explain why the Internet advertising market might be a natural monopoly.
The market for Internet advertising might be a natural monopoly because the marginal cost of
displaying another Internet advertisement is virtually zero. Consequently a firm such as Google has

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 MONOPOLY
massive economies of scale so that its long-run average cost curve is downward sloping over a vast 19
range of output.

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19 CHAPTE R 1 3

c. How does Google’s dominant position as a provider of Internet advertising influence

the price and quantity in this market?
Google’s dominant position allows it to determine what price it charges for an Internet advertisement
and the quantity of Internet advertisements it sells.
d. How would breaking Google into two providers of Internet advertising influence the
price and quantity in this market?
The effect depends on whether Google is a natural monopoly. If it is a natural monopoly, breaking it
into two providers will increase the firm’s average costs, so that the price of an Internet advertisement
rises and the quantity decreases. If Google is not a natural monopoly, breaking it into two firms
would bring some competition into the market. The price of an Internet advertisement falls and the
quantity increases.

Economics in the News

23. After you have studied Economics in the News on pp. 320–321, answer the following
questions.
a. Why do the European regulators say that Google is misusing its monopoly power?
Do you agree? Explain why or why not.
The European regulators asserted that Google was abusing its power in search to extend its reach to
other markets, such as online shopping, because Google’s search engine highlights links to Google
services that search for the sought after products.
b. Explain why it would be inefficient to regulate Google to make it charge the same
price per keyword click to all advertisers.
Efficiency requires that Google sell the number of clicks so that the marginal social cost of a click
equals the marginal social benefit of a click. The marginal social cost of a click equals the marginal
cost and the marginal social benefit equals the price. Only if the price per click equals the marginal cost
of a click would Google sell the efficient number of clicks. At any other price Google would sell an
inefficient quantity of clicks. So only if the marginal social cost of all clicks is the same and Google is
regulated to charge precisely that price would this regulation be efficient.
c. Explain why selling keywords to the highest bidder can lead to an efficient allocation
of advertising resources.
Selling keywords to the highest bidder allocates the words to those bidders who value them most
highly, which means the words and hence advertising resources, are allocated efficiently. By selling
each click at a separate price to the highest bidder, Google is trying to perfectly price discriminate. If
Google perfectly price discriminates, then the market achieves the efficient outcome, albeit with no
consumer surplus
24. FCC Helps AT&T and Verizon Charge More by Ending Broadband Price Caps
The Federal Communications Commission has eliminated price caps on broadband service in a
county if 50 percent of potential customers live within a half mile of a location served
by a competitive provider or if 75 percent of a county’s census blocks have a cable
provider.
Effectively, the FCC says a local market is competitive even when there is only one broadband
provider.
Source: Wired, April 20, 2017
a. What barriers to entry exist in the broadband Internet service market?
One barrier to entry is a natural barrier to entry. The providers of broadband Internet service, such as
cable providers, are natural monopolies. Firms entering the market will have higher average total
costs if the amount they produce and sell is less than that of the existing firm. So a natural barrier to

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entry exists. A legal barrier to entry creates a legal monopoly—a market in which competition and19
MONOPOLY

entry are restricted by the granting of a public franchise, government license, patent, or copyright.
The government determines which firms can offer broadband Internet service, so a legal barrier to
entry also exists.

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b. How can a price cap on broadband service achieve a more efficient outcome?
If the provider is a natural monopoly and is not regulated, it will set the monopoly price and create a
deadweight loss. Price-cap regulation can help decrease the deadweight loss by lowering the price the
firm sets and increasing the quantity of broadband services it provides.
c. Draw a graph to illustrate the effects of eliminating a price cap in the broadband
Internet service market on the price, quantity, total surplus, and deadweight
loss.
Figure 13.11 shows the effect a price cap has in
the broadband market. The quantity in the market
is the number of cable channels and the price is the
price of a channel. The efficient quantity of
channels is 200 because that is the quantity that
sets the marginal social benefit, measured by the
demand curve, equal to the marginal social cost,
measured by the marginal cost curve. When the
efficient quantity is produced, the total surplus is
equal to the area of triangle ABC. When a price
cap is in place, the price is $1.00 per channel and
the quantity of channels is
150. The deadweight loss is equal to the small,
dark gray triangle. If the price cap is removed and
the firm is free to maximize its profit, it sells 100
channels (the quantity that sets MR = MC) for a
price of $1.50 per channel. The deadweight loss is
larger—it is equal to the area of the gray
quadrilateral plus the dark gray triangle.

25. Intel and Samsung Gang Up on Qualcomm, Backing FTC Monopoly Suit
The Federal Trade Commission says Qualcomm is trying to corner the market for chips
used in smartphones. Qualcomm has a set of patents that Intel says prevent it from
competing in the smartphone chips market. Samsung claims its in-house chip unit is
artificially held back by Qualcomm’s unwillingness to license its technology.
Source: Bloomberg, May 12, 2017
a. What are the barriers to entry in the smartphone chip market?
The major barrier to entry is the patents held by Qualcomm. This legal barrier to entry prevents other
firms from using Qualcomm’s technology to produce chips for use in smartphones.

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 MONOPOLY 19

b. Show in a graph how the price and quantity of smartphone chips are determined.
Presuming that the FTC (and Intel and
Samsung) is correct and Qualcomm has a
monopoly in making chips used in smartphones,
Figure 13.12 shows this market. Qualcomm
produces 2 billion chips per year because that
quantity sets its marginal revenue equal to its
marginal cost.
Qualcomm sets a price of $30 per chip because
that is the highest price that still enables it to sell
2 billion chips.

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Inc.