Chapter 15: Monopoly
Questions for Review
1) Give an example of a government-created monopoly. Is creating this monopoly
necessarily bad public policy? Explain.
Sometimes, the government grants a monopoly because doing so is viewed to be in
the public interest. Granting a patent to a firm is an example of such. When a
pharmaceutical company discovers a new drug, it can apply to the government for a patent.
If the government deems the drug to be truly original, it approves the patent, which gives
the company the exclusive right to manufacture and sell the drug for 20 years. Because
these patents give one producer a monopoly, they lead to higher prices than would occur
under competition. But by allowing these monopoly producers to charge higher prices and
earn higher profits, the laws also encourage some desirable behavior. The benefits of the
patent are the increased incentives for creative activity. Thus, this monopoly is not
necessarily a bad public policy.
3) Why is a monopolist’s marginal revenue less than the price of its good? Can marginal
revenue ever be negative? Explain.
A monopolist’s marginal revenue is always less than the price of its good. For a
monopoly, marginal revenue is lower than price because a monopoly faces a downwardsloping demand curve. To increase the amount sold, a monopoly firm must lower the price
it charges to all customers. The marginal revenue can even become negative. Marginal
revenue is negative when the price effect on revenue is greater than the output effect. In
this case, when the firm produces an extra unit of output, the price falls by enough to cause
the firm’s total revenue to decline, even though the firm is selling more units.
5) In your diagram from the previous question, show the level of output that maximizes
total surplus. Show the deadweight loss from the monopoly. Explain your answer.
Cost and
Revenue
Monopoly
Price
Marginal Cost
Average Total Cost
The level of output that maximizes total surplus is where the demand curve and
marginal-cost curve intersect.
7) What gives the government the power to regulate mergers between firms? Give a
good reason and a bad reason (from the perspective of society’s welfare) that two
firms might want to merge.
The antitrust laws give the government various ways to promote competition,
prevent mergers, break up companies, and prevent companies from coordinating activities
that will result to lesser market competition. One good reason why firms want to merge to
lower costs by having efficient cooperative production. On the other hand, a bad reason
why firms want to merge is to reduce competition, giving them more power to manipulate
their pricing. This reason poses consequences to the welfare of society because it will
reduce the economic wellbeing of the country as a whole.