Question

1. Answer the following questions:

a. Why is the demand curve for a monopolist downward-sloping, while the demand curve for the perfectly competitive firm is horizontal?

b. Suppose a perfectly competitive industry is suddenly transformed to a monopoly industry. What will happen to price, output, consumer and producer surplus, and deadweight loss?

c. If the wireless phone industry is dominated by four large firms, each with 20% of market share, and 2 small firms, each with 10% market share, what is the four-firm concentration ratio and what is the Herfindahl–Hirschman Index (HHI)? Show your calculation.

2. This figure shows a monopolistically competitive firm in the short run. Use the figure to answer the following:

- МС ATC Price and Cost ($) - d=P 30 — 20 - 10 MR 0 100 200 300 400 500 600 700 800 900 Output

a. What is the profit-maximization price and quantity for the firm?

b. How much profit does that firm make at that price and quantity? Show your calculation.

c. What should happen in the long run?

Answer 1

Q1)

(a) The demand curve for a perfectly competitive firm is infinitely elastic. This means that a small increase in price by a firm will result in 0 demand for the firm as the consumers will substitute away to thee lower-priced firms as the products are homogeneous. Thus, the demand curve is horizontal. In a monopoly, this is not the case. There is a single seller of the product so he has some pricing power. The demand is not infinite. But since it is still negative, in order to sell more, the monopolist will have to reduce the price it charges. Thus, the demand curve is downward sloping

(b) When the perfectly competitive industry is transformed into a monopoly, there is a decrease in suppliers from many to one. The demand curve that was horizontal is now downward sloping. Thus, the profit maximization quantity for a seller is such that MR = MC. At this point, the quantity is lower than the perfectly competitive output and the price is higher. As a result the consumer surplus decreases and the producer surplus increases.

(c) Four firm concentration ratio = Total Market share of the 4 largest firms = 0.20+0.20+0.20+0.20 = 0.8

HHI index = 0.2² + 0.2² + 0.2² + 0.2² + 0.1² + 0.1² = 0.18