Economics Homework Nine - Model

1. Identify an industry not mentioned in the lecture that is an oligopoly, and explain why.

Video game companies like Nintendo, Sony and X-box (don't know who makes X-box) is an example of an oligopoly, because there is few competitors. It takes a lot of time effort and money to make a new company with its own system and games. And most of the systems are very similar. (Seth)

An example of an oligopoly is the computer business. There are only a few companies, there are very high barriers to entry (it is very expensive to start a new one) and computers are basically similar goods. (Duncan)

2. Order the types of industries from those having the lowest price (due to the greatest competition) to those having the highest price (due to the least competition).

1) Perfect Competition (MC=MR at a lower point P, where P=ATC)

2) Perfectly Contestable Markets

3) Monopolistic Competition

4) Oligopoly

5) Cartel

6) Monopoly (MC=MR is how the price is determined) (Deborah)

3. Explain which specific type of industry (e.g., oligopoly or something else) each of these quotes probably refers to: (1) "She's the finest hair stylist in town; no one has her special style!", (2) "Crazy Eddie ... his low prices are INSANE!", (3) "Don't like his prices? He's the only one in town selling what you need."

1) Monopolistic Competition 2) Perfect Competition 3) Monopoly (Zachary)

4. List how monopolies can be established.

1. Government creates monopolies by operation of law.

2. The licensing of professionals creates a barrier to entry.

3. Control of a valuable resource.

4. Economies of scale can create a monopoly by rewarding the biggest company with the lowest average cost.

5. Government grants of monopoly such as patents and copyrights. (Anna)

5. What prevents a monopoly from increasing its prices without limitation?

A monopoly cannot simply increase its prices without limitation because, like any other firm, it is still subject to the Law of Demand no matter how powerful it becomes. (Trisha)

Honors

6. Where is the Nash equilibrium for this set of options, where (x,y) represents the profits to (Firm A, Firm B)? Explain.

		Firm A Does Not Reduce Output	Firm A Reduces Output
	Firm B Does Not Reduce Output	(50,50)	(100,25)
	Firm B Reduces Output	(25,100)	(75,75)

Teacher's Note: Unfortunately, there is a mistake in the ordering of the paired numbers used in this problem, which I realized only after grading the answers. The numbers were in the wrong order because a firm's profits should increase, not decrease, when it increases output in an oligopoly. All students correctly realized that the equilibrium must be where the profits are equal, either (50,50) or (75,75). As mistakenly written above, we can start from (50,50) and realize that firm B can increase its profits by reducing output, which takes us to (25,100). But then the other firm can increase its profits by reducing output, which takes us to equilibrium at (75,75). Any movement away from that point would start of chain of events that would lead back to that point, so it is a true equilibrium. But that is an uninteresting solution, and unrealistic in a free market.

The chart should have had the ordered pairs reversed:

		Firm A Does Not Reduce Output	Firm A Reduces Output
	Firm B Does Not Reduce Output	(50,50)	(25,100)
	Firm B Reduces Output	(100,25)	(75,75)

In the corrected version above, from the point (50,50) neither firm can increase its own profits by reducing its own output. So that is equilibrium. To check the answer, we can start from (75,75). From there, either firm can increase its profits by increasing its output, and it does. But from the new point the other firm can increase its profits by increasing its output, and the market ends up at where both firms have increased their output, with profits of (50,50). Spend a few minutes trying each approach to confirm that is the equilibrium - the Nash equilibrium. (Teacher)

7. Monopolies: should the government regulate them? Or is regulation worse?

As the Coase theorem illustrates, when government barges into the free market, complications and more transaction costs are the result. The government should let the invisible hand take care of it and not interfere. Great ruckus would occur if the government attempted to end a monopoly. It would cause industries to become bankrupt because the more competition the more difficult it is to survive. (Veronika)

8. Does the "deadweight loss" equal the "consumer surplus"? Explain the relationship.

The question states “does the deadweight loss equal the consumer surplus?” No, it doesn’t: deadweight loss reduces but may not entirely eliminate consumer surplus. However, the deadweight loss is almost the exact opposite of the consumer surplus. With the deadweight loss, consumers may be forced to spend more than they would like to on something, because the monopoly is the only provider of it. With the consumer surplus, the consumer gets to pay less than he is willing. (Addison) [Teacher's note: the deadweight loss also eliminates part of the producer surplus]

9. How does a monopolist maximize his profits?

He raises his price until marginal revenue equals marginal cost .... (Elizabeth)