Question

a. Draw a graph for a monopoly, labeling all curves. Label the monopolist’s profit-maximizing quantity and price Q1 and P1. (Hint: Draw the graph fairly big so that you can answer part b more easily).

2. Now the government regulates the monopoly by putting a price ceiling on the good. Choose a level for the price ceiling (call it P2) and on your graph show what quantity the monopolist will produce (label it Q2). What will happen in the market?

Answer 1

a) Equilibrium in a monopoly is attained at a point where MR = MC

Thus, Q1 represents the equilibrium quantity and the corresponding point on the demand curve - P1 represents the equilibrium price charged.

The shaded area represents monopoly profits.

b) When the government regulates a monopoly, it requires the firm to produce at a point where MC = Demand i.e. where the MC curve intersects the demand curve. At this point, equilibrium and socially optimum quantity = Qc and equilibrium price = Pc

However, the monopoly incurs a loss since P < ATC and ceases to operate.

Hence, the most likely choice for price ceiling is the point where P = ATC.

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