Monopoly, Monopolistic Competition, Oligopoly, and Optimal Choice ...

Name _________________________
Principles of Micro
Lance Howe, SPRING 2007
Monopoly, Monopolistic Competition, Oligopoly, and Optimal Choice of Inputs
Instructions: Answer each question completely. This HW is worth 20 points total.
I. (5 points) Monopoly and Monopolistic Competition
In 1971 Nike co-founder and Oregon track coach, Bill Bowerman, created the modern distance running shoe – using a waffle
iron. The 1972 Olympic trials were Nikes real debut and by 1979 Nike controlled over 50% of the running shoe market. For
our purposes suppose that Nike was a perfect Monopoly and faced demand and cost conditions described below (in millions
of dollars):
Output Price Total Cost
0 120 1950
10 110 2000
20 100 2100
30 90 2250
40 80 2450
50 70 2700
60 60 3000
70 50 3400
80 40 3950
90 30 4700
100 20 5700
a.) The level of output Nike would choose to produce is ______. The selling price at this level of output is ______ and the
corresponding profit is ______. [Hint: remember marginal is change in total over change in quantity – in this problem
quantity changes by more than 1 unit]
b.) Suppose that Nike demand falls after Reebok, New Balance and several other competitors enter the market. Assume that
this monopolistically competitive market is in long-run equilibrium. Assuming that Nike’s costs don’t change (but note
that demand has changed), Nike finds that profit is maximized by
producing Q = 30. What is Nike’s price at this level of output?
What is their profit?
c.) Illustrate the movement from monopoly (part a) to monopolistic
competition (part b) in the figure at right. Draw average cost and
marginal cost curves and then the demand and marginal revenue
curves associated with monopoly (part a) and monopolistic
competition (part b). [Hint: as with other cost and revenue curves
we have drawn, approximations are fine]
d.) If this were a perfectly competitive industry and all firms had cost
curves similar to Nikes, the long-run price would be _____(round to the nearest tenth). The corresponding level of profit
would be _______.
e.) Which form of industrial organization would be better for society in terms of cost and output? Which would be better in
terms of variety? Is society better off or worse off relative to the case when Nike was a pure monopoly?
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II. (5 points) Monopolistic Competition
In Santa Monica there are seven bathing suit stores, each with the same schedule of costs and each facing an
identical demand curve. Swim N Style is a typical store that faces the demand schedule and total costs shown
below.
Output Price Total
Cost
1 68 70
2 66 80
3 64 85
4 62 90
5 60 100
6 58 115
7 56 136
8 54 164
9 52 200
10 50 245
a. Using the blank columns, calculate total cost, marginal cost, average cost, total revenue, and marginal revenue
at each level of sales.
b. If Swim N Style is a profit maximizer, it sells ___ suits per hour. It’s price will be ___ and the corresponding
profit will be ___.
c. Is the Santa Monica bathing suit industry in long run equilibrium? Why or why not?
d. What will happen in the industry over the next few years?
Now suppose that seventeen new bathing suit stores enter the market, joining the seven that already existed. As a
consequence, the demand schedule facing Swim N Style (and all other stores) falls, while the cost schedules
remain constant.
Output Price Total
Cost
1 31.5 70
2 28.5 80
3 25.5 85
4 22.5 90
5 19.5 100
6 16.5 115
7 13.5 136
8 10.5 164
9 7.5 200
10 4.5 245
d. What number of suits will Swim N Style sell now?
e. What price will Swim and Style charge? What will the level of profits be?
f. Is the market in long-run equilibrium now? Explain.
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III. (5 points) Oligopoly and Game Theory
United and Continental are competing for holiday travelers on the Los Angeles-Chicago airline route. This is a
market that can be described as oligopolistic: it has high barriers to entry and low variable costs of production. If
each firm charges a high price each firm will earn profits of $300 million each. However, if one airline charges a
low price while the other charges a high price the airline charging the low price earns profits of $440 million
while the airline charging a high price earns profits of $100 million. If both airlines charge low prices they will
make profits of $125 million.
a. In the space below set up a payoff matrix for Continental and United.
b. If United knows that Continental will charge a high price, and it has no reason to be concerned about
retaliation, what is United’s best response?
c. If Continental knows that United will charge a high price, and it has no reason to be concerned about
retaliation, what is Continental’s best response?
d. Find the Nash equilibrium for the game described above and briefly explain why it provides a solution to the
game.
e. From the results above, is (High Price, High Price) a stable equilibrium? What does this imply about the ability
of firms to collude?
f. How could your answers be different if this game were repeated several times?
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IV. (5 points) Monopoly and Monopoly Power
Suppose that Marlin, of Marlin’s Monster Fish Trips, is a the single provider of local fish trips in the city of
Oxnard. His company provides day-long fish trips at the following prices and costs:
Q S TC MC
New
MC
AC P Q D TR MR
0 40 100 0
1 48 90 1
2 62 80 2
3 110 70 3
4 170 60 4
5 240 50 5
a. The number of trips Marlin would choose to provide is ____. The selling price at this level of output is _____
and the corresponding profit is ______.
b. If all firms have cost curves similar to Marlin’s and this industry were characterized by perfect competition,
what would be the long-run price?
c. Suppose that Oxnard city counsel members are upset at Martin’s monopoly primarily because he is restricting
the number of fishing trips relative to the number the counsel believes would be optimal. After some consultation
the counsel decides to tax Marlin’s profits a flat 50%. They reason that he will need to provide more trips in order
to increase his profits to the level they were before the tax. How many trips does Martin now provide? What will
be the daily amount of Oxnard’s tax revenue? Does the counsel succeed in its goal of increasing Marlin’s output?
d. After reviewing Marlin’s behavior, the city decides to eliminate the flat tax and imposes a “fishing tax” of $50
per boat trip on Marlin. What is Marlin’s new level of output and price (Hint: Marlin’s cost per trip is increased
by the amount of the tax)? What is the amount of the new tax revenue for the city? Again, has the city achieved
its goal of increasing Marlins output?
e. Disheartened in the effectiveness of the taxes the counsel decides to adopt a proposal that encourages entrants
into the Oxnard fishing industry. All taxes are eliminated, and by the next year several fishing companies have
opened. Suppose that the industry is now best characterized by monopolistic competition and is in long-run
equilibrium. If Marlin is producing at a profit maximizing output level of 1 trip what price is he charging? What
are his profits?
f. What does this simple problem indicate about the key to monopoly power?
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