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Monopoly Exercise #3 Answers ( points)
Please limit your answers to the spaces provided. If necessary, write on the back of the page.
Do not attach printout or additional pages. All questions pertain to the Monopoly module in the
SimEcon®
software package.
Make sure that you have read the
“Monopoly Manual”
and “
SimEcon®
Operation
Instructions.” These materials may be found at the Class Web site prior to beginning the exercise. For many of the exercise’s questions, it will be necessary to refer to those instructions.
For many of the exercise’s questions, it will be necessary to refer to your text.
Open the Monopoly module of
SimEcon®
. Write down the initial conditions below:
Total Output:
Total Revenue:
Total Cost:
Total Profit:
10,000,000 units
$ 3,037,000.00
$ 1,802,377.29
$ 1,234,622.71
Price:
Marginal Revenue:
Marginal Cost:
Average Total Cost:
$ 0.3037
$ 0.2369
$ 0.1301
$ 0.1802
Is the above Monopolist maximizing profit? No (Yes, No). Why or why not? Because marginal revenue is greater than marginal cost. Should this monopolist increase production, decrease production, or leave output unchanged?
The monopolist should increase production.
Note that the price is greater than marginal revenue. Is this always the case with a monopolist?
Yes (Yes, No). Why or why not? This is because the monopolist faces the market demand curve. In order to increase output, he or she must lower the price.
Must the monopolist always be earning an economic profit? No (Yes, No). Why or why not? The monopolist’s level of profit also depends on average total cost. Even if a firm has monopoly power, the firm’s costs may still be too high.
Click “Continue.” Set the monopolist’s entry costs at $400,000. Click “Make Decisions.” Set the output level equal to 10,000,000 units, the same as in the initial conditions. Click “See
Results.” Fill in the table below:
Total Output:
Total Revenue:
Total Cost:
Total Profit:
10,000,000 units
$ 3,037,000.00
$ 1,902,377.29
$ 1,134,622.71
Price:
Marginal Revenue:
Marginal Cost:
Average Total Cost:
$ 0.3037
$ 0.2369
$ 0.1301
$ 0.1902
What has happened to profit compared to the last example? It has decreased.
Could this be due to a change in output? No, there was no change in output . What changed besides profit and output? Total cost and average total cost changed.
What did not change? Total

Course
Monopoly Exercise #3 Answers
Page 2 revenue, price, marginal revenue, and marginal cost. What does that mean for the firm’s best (profit maximizing) decision? Since the best decision only involves comparing marginal revenue and marginal cost, there would be no change in the profit maximizing decision.
Is the above monopolist maximizing profit? No (Yes, No). Why or why not? Because marginal revenue is greater than marginal cost. Should this monopolist increase production, decrease production, or leave output unchanged?
The monopolist should increase production.
What must marginal cost be equal to in order for profits to be maximized? Marginal cost must equal marginal revenue. Click “New Output” and enter a new output of your own choice.
Click “Continue.” Observe the results that you obtained. Repeat this process as many times as necessary in order to arrive at the output that you think maximizes profit. Note that the chosen output should be rounded to the nearest thousand, i.e., for 2,352,345 you would enter 2352.
Using the output that you think maximizes profit, fill in the table below:
Total Output:
Total Revenue:
Total Cost:
18,482,000.00 units
$ 4,565,797.72
Price:
Marginal Revenue:
$ 0.2470
$ 0.1236
Total Profit:
$ 2,974,438.68
$ 1,591,359.04
Marginal Cost:
Average Total Cost:
$ 0.1236
$ 0.1609
What is the optimal output? 18,482,000.00. Is the above monopolist earning an economic profit? Yes (Yes, No). Is the above monopolist earning an accounting profit? Yes (Yes, No).
Is having a monopoly a guarantee of economic profit? No (Yes, No). Why or why not? The monopolist does restrict production in order to raise the price. However, the monopolist’s profits depend on costs as well as revenue. No matter how high the price of the product is, the costs may be even higher. Return to the menu and restart the module. This time leave the entry cost unchanged at $300,000. What output do you think will maximize profit considering the change in entry cost? Is it greater than, less than, or equal to, the value you found when the entry cost was $400,000? It is the same as before: 18,482,000.00
. Why? Because there was no change in marginal revenue or marginal cost. What impact did the change in entry cost have on the firm? It gave the firm higher average cost at all levels of production and lower profits at all levels of production.
Click “See Graph”, and draw the resulting graph below. Indicate the current level of output (Q´).
$
Note: Q´ is also the profit maximizing output.
Q´ MR
AC
MC
D Q

Course Page 3
Monopoly Exercise #3 Answers
Click the “Back” button to go back to the table, “Results of Output Choice.” Click on the button entitled, “Regulate.” Select the button entitled “Regulate Price” and click. Wait for the progress bar to cycle twice. Fill in the amounts for the table below:
Item Your Monopoly Average Cost Pricing MarginalCost Pricing
Output:
Profit:
Price:
Marginal Cost:
18,482,000.0000 34,121,100.0000 37,829,500.0000
$ 1,691,359.0400 $ 0.0000 - $ 842,839,9000
$ 0.2470 $ 0.1426 $ 0.1178__ _
Average Cost:
_______ $ 0.1236 ______ $ 0.1184 ______ _$ 0.1178
$ 0.1609 $ 0.1426___ _ $ 0.1401___ _
If the regulatory scheme is average cost pricing, how is the legal price determined? The legal price is set at the point where the average cost equals price. If this scheme is applied correctly, what are economic profits for the monopolist? Economic profits are zero. If this scheme is applied correctly, will the monopolist earn an accounting profit? Yes (Yes, No). If the regulatory scheme is marginal cost pricing, how is the legal price determined? The legal price is set at the point where marginal cost equals price.
Which scheme generates the largest total output (pure monopoly, average cost pricing, marginal cost pricing)? Marginal cost pricing (Your Monopoly, Average Cost Pricing, Marginal Cost
Pricing). Which scheme generates the lowest price to the consumer? Marginal cost pricing .
Which regulatory procedure would be most supported by the consumer? Marginal cost pricing .
Which scheme generates the least total output? Your monopoly .
Which regulatory scheme generates the highest price to the consumer? Your monopoly .
Which regulatory scheme would be least supported by the consumer? Your monopoly . In terms of output generated and price charged to the consumer, which regulatory scheme represents a compromise between the two extremes? Average cost pricing .
Click on menu and restart the Monopoly module. For Entry Cost put in $600, then enter the profit maximizing output you found before. Now click “Regulate”, but this time select “Choose
# of Firms.” Enter 15 for the number of firms and click “Continue.” Fill in the amounts for the table below:
Item
Output:
Your Monopoly Average Cost Pricing Marginal Cost Pricing
Profit:
Price:
__ 18,482,000.0000 17,775,000.0000 32,120,700.0000
$ 1,3174,438.68
$ 0.2470
Marginal Cost: _______ $ 0.1236
Average Cost: $ 0.1718
$ 0.0000 - $ 679,496.6000
$ 0.2518__ $ 0.1559
$ 0.1707 $ 0.1559
$ 0.2518 $ 0.4733
Note that the amounts under “Your Monopoly” are identical to the results obtained from the last example. Why is that the case? Your monopoly represents no regulation at all. The monopolist can do whatever he or she wants and you didn’t change your output. In this

Course
Monopoly Exercise #3 Answers
Page 4 example, which scheme generates the largest total output? Marginal cost pricing (Your
Monopoly, Average Cost Pricing, Marginal Cost Pricing).
In this example, which scheme generates the lowest price to the consumer? Marginal cost pricing .
In this example, which scheme generates the highest average cost? Average cost pricing.
Which scheme generates the highest price? Average cost pricing.
Why might your monopoly, be the best scheme under these circumstances? We have divided the industry into 15 firms. That many small firms are not able to take advantage of the economies of scale. That has made average cost price regulation more costly for consumers than the profit maximizing decisions of a monopoly.
At the same time, marginal cost pricing is not really feasible (unless there is more government intervention, e.g., a subsidy) because the firms cannot cover all their costs and all would cease production in the long run.
What is meant by a “natural monopoly”? A natural monopoly occurs in an industry where there is such a high degree of economies of scale that a pure monopoly can produce a better outcome than a competitive industry could, despite that fact that monopolies restrict production to raise the price. Could the above table be an example of a natural monopoly?
Yes (Yes, No). If a firm earns high profits, does that always mean a higher price for the consumer? No (Yes, No).