Check Yourself Solutions for Chapter 13 through Chapter 16

Chapter 13-1

1. As a firm with market power moves down its demand curve, the price it can charge on all units moves down as well.

2. A firm with market power prefers to face an inelastic demand curve because the more inelastic the demand curve, the more the firm with market power can raise its price above marginal cost. See Figure 13.4 for a display of this.

Chapter 13-2

1. A monopolist always prices its product above the price of an equal cost-competitive firm.

2. A monopolist always produces less than an equal cost-competitive firm because this way it produces more profit than a competitive firm.

Chapter 13-3

1. Apple has market power and plausibly it encourages innovation. Pharmaceutical companies have an incentive by the patent system to use market power to innovate. One can argue that many utilities have market power but do not seem to be great innovators. The U.S. Postal Service has market power but does not seem to innovate much.

2. The prize for a new cancer drug should be calculated by taking the number of people expected to die of cancer over a long period, then multiplying this by the presumed willingness of people with cancer to pay for a cure, discounted for payments received over a long period, minus the probable cost of research and the low marginal cost of producing the drug. The size of the prize is likely to be enormous.

Chapter 13-4

1. If regulators controlled the price at P = AC (and AC is at point a), the monopolist would produce where the AC curve crosses the demand curve. At this price, the monopolist would make zero (normal) profits and the quantity would be greater than the monopoly quantity, although still not as high as the efficient quantity.

2. Telephones used to be a natural monopoly because it was much cheaper for one firm to lay one set of lines and serve everyone than to have competing phone companies. Today, cell phones have broken the natural landline monopoly because cell towers cost much less to create than telephone poles and wires so it makes sense to have multiple, competing operators. In this way, technology can quickly abolish what was once a natural monopoly.

Chapter 13-5

1. Major league baseball and professional football restrict the entry of competitors in local areas, thus supporting the market power of these local teams. With market power, teams raise prices, without the fear that competitors will see the higher prices as opportunities to enter. In this case, prospective teams face more than just barriers to entry in the form of high entry costs: The leagues prohibit the teams’ entry.

   B-11

2. Barriers to entry are strong when they are mandated and enforced: The U.S. Postal Service still has a monopoly on delivering first-class mail because by law other firms must charge three times as much as the Postal Service if they wish to deliver a letter. Of course, the prevalence of e-mail has made this monopoly less valuable. In contrast to this, when Congress took away the U.S. Postal Service’s monopoly on the delivery of parcels, competitors such as UPS and FedEx jumped in and took over much of the market. People still send parcels through the Postal Service, but often not when delivery needs to be fast and guaranteed. NBA basketball restricts entry just as major league baseball does, and that looks to be fairly permanent for the near term, though the league may let additional teams enter over time.

Chapter 14-1

1. If a monopolist segments a market, it can price-discriminate between the different segments and so raise its profits.

2. When demand is more inelastic, the price-discriminating firm would set higher prices. Remember that elasticity = escape. People with inelastic demand find it harder to escape and so will pay more.

3. Arbitrage is taking advantage of price differences for the same good in different markets by buying low in one market and selling high in another market. When the monopolist price-discriminates by setting a low price in one market and a high price in another, it creates a potential arbitrage opportunity. In order to profitably price-discriminate, the monopolist must prevent this arbitrage.

Chapter 14-2

1. The early bird special is a form of price discrimination if people who want to eat at a later time have a more inelastic demand curve. This could be true, for example, if people who want to eat at a later hour are wealthier (perhaps because they are working long hours!). An alternative explanation is that the restaurant’s marginal costs increase as the restaurant becomes more crowded—thus, restaurants charge more during peak hours. In the first case the markup of price over marginal cost increases in the later evening; in the second the firm’s costs and price both increase in the later evening. It’s not obvious which explanation is correct!

2. People who want to see movies right after the movies are released have a more inelastic demand for them than people who are willing to wait for the movies to be released as a DVD. Movie theaters know this and set their prices relatively high for those who cannot wait (have an inelastic demand). For the same reason, books are more expensive when they are first released in hardback than later when they are released in paperback. The increased costs of producing a hardback are trivial compared to the difference in price.

Chapter 14-3

1. Price discrimination is likely to increase total surplus if output increases.

2. Price discrimination helps industries with high fixed costs because profits increase with market size. Simply, having more market segments means that the price-discriminating firm can extract more consumer surplus. This leads to higher prices, which fund the high fixed costs. Universities have high fixed costs. The ability for a university to price-discriminate means it can attract more paying students to its campus and so pay for its high fixed costs.

Chapter 14-4

1. Tying cell phones to service plans is a type of price discrimination whereby high demanders (long talkers) are charged more. If cell phone companies were not allowed to tie cell phones with service plans, the price of cell phones likely would rise and the price of phone calls likely would fall. This would be good for people who want to talk a lot but bad for people who want to use their cell phone only occasionally. Profits for the cell phone companies would also fall, so there would be fewer funds to pay for the fixed costs of building cell phone towers and infrastructure.

2. Bundling is likely to increase total surplus in high fixed cost, low marginal cost industries because without some form of price discrimination, it’s difficult to provide these goods at optimal levels.

Chapter 15-1

1. When Great Britain found oil in the North Sea, it could obtain the benefits of OPEC (the cartel price) without any of the disadvantages of joining the cartel, such as limiting production. Why join?

2. The surprising conclusion of the prisoner’s dilemma is that there are situations when the pursuit of individual interest leads to a group outcome that is in the interest of no one. Think of three cases. First, the invisible hand is a metaphor for the idea that under the right circumstances the pursuit of self-interest can lead to the social interest. Second, theft is an intermediate case where the pursuit of self-interest benefits one’s self but not the social interest. Third, the prisoner’s dilemma reminds us that in some circumstances when everyone pursues his or her self-interest, the result can be against the interest of everyone!

Chapter 15-2

1. Though individual auto firms try to act as if they are monopolies, they do not band together in an attempt to raise prices and cut back on quantities. Such banding together is illegal in the United States. It is not illegal in various other places in the world.

2. When a firm in an oligopoly reduces output, it shares equally in the gains from the reduction with the other firms.

Chapter 16-1

1. Your old cell phone provider prevents you from taking your address list to a new cell phone from a new cell phone provider as a way of setting up high switching costs in an attempt to prevent you from changing your service.

2. Google is in a contestable market because it would be fairly easy for a competitor to enter the search market, as Microsoft has done with its Bing search engine.

Chapter 16-2