S2W4

What are the different types of price discrimination and their definitions?

Answer explanation

First-degree price discrimination is where every consumer is charged the highest price they agree

willing to par for each unit. Second-degree is where firms charge different prices to different

units of the good. (Inability to distinguish among various categories of consumers directly.

Third-degree price discrimination involves charging different prices to buyers in different sub

markets. The basic idea of hurdle price discrimination is that the seller sets up a “hurdle” and

makes discount available to people that jump over it.

What is a natural monopoly?

Answer explanation

A natural monopoly is a monopoly that occurs because a firm benefits from economies of scale.

This situation is likely to occur either when the market is small or when fixed costs are necessarily

very large. e.g. Utilities (electricity, water and sanitation, etc.)

What are the conditions for allocative, productive and dynamic efficiency? Which apply to a

classic monopoly?

Answer explanation

Allocative efficiency occurs when P=MC, Productive efficiency occurs when the firm operates

at the minimumpoint of the ATC curve and dynamic efficiency can happen when there are

supernormal profits (so that the firm has the funds to invest and innovate). A typical monopoly

would only be dynamically efficient.

The chapter gives five factors that support the emergence of monopolies.

(1) What are these five factors?

(2) Which do you think is most important?

Answer explanation

(1) The five factors outlined in the textbook are (a) exclusive control over inputs; (b) economies of scale; (c) patents; (d) a network community; and, (e) government licensing.

(2) What is most important is subjective to some extent, but economies of scale could be argued as the most due to your ability to outperform or restrict others who may enter the market. However, patents also provide an exclusive right to monopolise on an input for a long period of time; In the United States, copyright protection for anonymous, pseudonymous, or works made for hire can last up to 120 years from the year of creation.

Why is Marginal Revenue less than the price in a monopolistic market?

Answer explanation

The MR is always less than P within a monopolistic market. This occurs because the monopolist is faced with a downward sloping Marginal Revenue curve, which means it must lower its price to sell additional units - so the extra revenue it receives decreases with each increase in output. Unlike a perfectly competitive firm, monopolists can decide on their price.

A small number of airlines operate a specific regional route, yet none of them seem

able to set prices independently. Ticket prices remain competitive, and any airline that raises

fares loses customers to rivals. Given that there are only a few firms, will they behave as if

they are price takers?

• Yes

• No

• Maybe

Answer explanation

Even with only a few firms, airlines may act as price takers if competition is strong and entry

into the market is relatively easy. If passengers can easily switch airlines and pricing is set

before flights are scheduled, no single firm has significant pricing power. Additionally, if one

airline attempts to raise prices, competitors can quickly undercut them, reinforcing price-taking

behavior.

In the heart of London, there are dozens of dry-cleaning businesses within walking

distance, yet in a small town, there may be only one or two. How does the number of competitors

in these two locations affect pricing? Would you expect dry-cleaning prices to be higher in the

small town or in the city?

• Small Town

• City

• It depends

Answer explanation

In a dense urban area like London, the high number of competitors forces dry cleaners to keep

prices low, as consumers can easily switch providers. In a small town, fewer competitors may allow

businesses to charge higher prices due to limited alternatives. However, higher operating costs

in large cities, especially rent, may counteract competition, sometimes leading to comparable or

even higher prices in urban areas

A firm’s total revenue function is given by T R = aQ−2Q^2. Based on this information,

can the firm be classified as a price taker in a perfectly competitive market? Why or why not?

• Price taker

• Not a Price Taker

Answer explanation

To determine if a firm is perfectly competitive, we check whether its price remains constant as

output changes. The firm’s price is given by P = T R/Q = a − 2Q, which shows that price

declines as output increases. In a perfectly competitive market, firms take price as given and

cannot influence it. Since this firm’s price depends on its own quantity, it is not a price taker

and does not operate in perfect competition.

Suppose Celestial Cinema, a popular independent movie streaming platform, is a perfectly discriminating monopolist that faces market demand $P=100-10Q$ and has constant marginal cost $MC=20$(with no fixed costs). What is the maximum per period license fee the government could charge the firm and have the firm still stay in business?

• 420

• 180

• 320

• 225

Answer explanation

A perfectly discriminating monopolist sells the quantity where marginal cost intersects the demand curve $P=MC$ or $100-10Q=20$ or $10Q=80$ or $Q^*=8$. The monopolist's economic profit is the area under the demand curve down to average cost out to quantity. $PS=(0.5)(100-20)8=320$. The government could charge the firm any fixed fee up to 320.

Answer explanation

To form the Lagrangian one needs to rewrite the constraint $100 = \sqrt{KL}$ in the form $q(K,L) = 0$, i.e.\ $100 - \sqrt{KL} = 0$ or $\sqrt{KL} - 100 = 0$.\\

Multiply it by a new variable called the Lagrange multiplier, and add it to the original objective function. The correct answer is A.\\

More on this on pg 524 of Geoff Renshaw’s \textit{Maths for Economics} (4th edition).