Monopolies and Market Power: Exploring Economic Questions

Question 1: Perfect Competition vs Monopoly

Monopolies are thought of as bad. One reason is that they produce less of an item at a higher price than would be produced under perfect competition.

Let Market Supply for a product be P=$20+.50Q_S

Let Market Demand for the product be P=$170-.75Q_D

a)Using the D and S equations from above, show the validity of the above statement by finding the output level and price for both a perfectly competitive industry and a monopoly. Carefully explain how you know this.  [You should put both points on the same graph, but do it carefully.]

b)Monopolies can charge whatever they want.  True, False, Carefully explain.

Verizon recently instituted a price rise in its phone service. Shortly thereafter, Verizon recently rescinded its decision. Verizon is one of the nation’s 5 largest cellular phone companies.

Read “Smell of Success: Suave Copies Hot Scents to Boost Sales”, “American Airlines Cuts Select Business Fares” and “Verizon Fee Rescinded” to stimulate your thinking.  [Articles on Jupiter site].

a)What sort of competitor is Verizon, i.e. what sort of market is Verizon in (Perfect Competition, Monopoly, Monopolistic Competition, Oligopoly)?

b)What is Verizon’s apparent strategy, and what does that tell you about its perception of its market power?

c)Is Verizon correct in their perception of market power?

Let there be a dilemma facing your company.  Your company can either collude or cheat with a rival over some issue of importance to both.  Payoffs are as follows.  Assume a classic ‘prisoner’s dilemma’ set up.

a)Identify the Nash equilibrium, it one exists.  Explain your reasoning.

b)Identify the equilibrium that would obtain if the game was played repeatedly. Explain your reasoning, and how it may come to pass.  Is there a difference from a)?  Why or why not?

Two soap producers, the Fortnum Company and the Maison Company, can focus on either newspapers or magazines in their forthcoming advertisement campaigns.  The payoff matrix is as follows:  (DO NOT assume a classic Prisoner’s Dilemma’ set up).

Where payoffs are (Fortnum Profits, Maison Profits).

a. Is there a dominant strategy for each firm? If so, what is it?  (This may look like the question above, but there is no reason to do the same question twice).

b. What will be the profit of each firm?

c. Why is this game not an example of the prisoner’s dilemma?

Firm 1 operating in an imperfectly competitive industry knows: price elasticity of demand is -1.8. Firm 2 operating in an imperfectly competitive industry knows: price elasticity of demand is -2.3.

a)Find the optimal price for each firm if MC = $25, $100, and $200.

b)What can you conclude about the market power, thinking of the Lerner Index, of each firm? Why?

A pharmaceutical company wants to charge rich customers more for a product and poor customers less for the same product. This is legal to do.  Neither group is a protected class.

a)What type of economic issue does this example illustrate?

b)Why, from an economic perspective would the company want to do this?

c)Give an example calculating and showing that the firm obtains its goals by doing this pricing practice.

d)Someone suggests that this is a bad thing to do…that everyone ought to pay the same price. Show/calculate how this may be mistaken.

a)I prefer $1,000 for certain over a gamble where I earn an expected value of $1,000. Draw this state of affairs.

b)Determine (estimate/guess) from the graph you draw the value I’d be indifferent between taking for certain compared to the $1,000 from the gamble.  [I’d prefer to get that amount of money for sure and avoid the gamble]. Include this information into the graph from part a)

c)Am I risk averse, risk neutral or risk loving?  Explain.

d)Armed with information from a) and b), determine my Certainty Equivalent Adjustment Factor.

e)How might this sort of information be useful to a company?  Discuss using an appropriate example.

f)Thinking more deeply, from the general concept of expected value and risk (σ), how closely ought you follow this, or any notion of risk analysis?  Discuss in depth. [In this question, there is no indifference curve to calculate.  Simply draw/estimate].