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INSTRUCTOR’S MANUAL
CHAPTER 5
COMPETITION AND MONOPOLY:
VIRTUES AND VICES
CHAPTER GOALS
This chapter deals with the market structures of perfect competition and monopoly. After reading this chapter, students should be able to:
• Identify the characteristics of a perfectly competitive market.
• Analyze profit maximization and loss minimization in the short run for a perfectly competitive firm.
• Discuss the long-run adjustments that occur in a perfectly competitive industry.
• Identify the characteristics of a monopoly, including barriers to entry.
• Discuss how a monopolist goes about achieving a combination of price and output that yields maximum profits, and when applicable, minimum losses.
• Summarize the behavior of near-monopolies, including the Crane Company, Central Office Supply System, U.S. Government Printing Office, and the U.S. Postal Service.
LECTURE HINTS AND IDEAS
This chapter covers the two extremes of market structure: perfect competition and monopoly. The perfect competition model, using a fishing company for the example, displays the profit-maximization process. Marginal revenue is first defined here, and then students learn the MR = MC approach, along with how to actually calculate profits. Students learn that the long-run outcome, due to the entry or exit of firms, is that perfectly competitive markets are efficient and economic profits are zero in the long run. The monopoly model begins with a discussion of barriers to entry and covers the basic profit-maximization and loss-minimization process. There are a number of monopoly examples included, such as the U.S. Postal Service, DeBeers, and Crane.
You can help students keep their bearings as they go through Chapters 5 and 6 by drawing a line on the blackboard representing the continuum of market structures. Put perfect competition at one end of the blackboard and monopoly at the other for visual impact. Because the perfect competition model involves keeping track of both the market and the individual firm’s behavior, and because this is the first introduction to profit-maximization techniques, relatively more class time will need to be spent on this topic. The monopoly section moves more quickly and students can easily be engaged in discussions on barriers to entry and examples of monopoly.
BREAK-THE-ICE DISCUSSION STARTERS
1. “Is the stock market an example of perfect competition?” Walk the students through the characteristics. There are many buyers and sellers, but the product is not homogeneous and information is not always perfect.
2. “Why don’t perfectly competitive firms advertise their products?” Each seller’s output is insignificant relative to the market. An individual wheat farmer who advertised for people to “Eat Wheat” would likely face much higher costs and minimal gains.
3. “If you wanted to start your own automobile company, what barriers to entry would you experience?” This is a good question to get students to volunteer the types of barriers to entry.
4. “Why is it beneficial to have just one supplier of paper for U.S. currency? What are the costs?” The benefits are that it is harder to counterfeit and there may be economies of scale in production. The costs are that in the absence of competition, the government may be paying a monopoly price.
5. “Would the privatization of local police departments help to improve efficiency?” There would be a free-rider problem if one person hired a police department for protection and the neighbor did not. The neighbor would be safer and not have to pay for it. But if everyone tried to free-ride, there would be no police protection.
BRIEF ANSWERS TO STUDY QUESTIONS AND PROBLEMS
1. Profit per unit = $2, total profit = $600
2. Profit per unit = $2, total profit = $200
3. The marginal revenue of the tenth diamond = $4750-$4500=$250
4. Decreasing, increasing
5. a. The average total cost curve and marginal cost curve are U-shaped, with marginal cost intersecting average total cost at the minimum point of average total cost. The demand (price) curve and marginal revenue curve are drawn as a horizontal line at P=MR= $10.
b. The firm is a price taker and thus operates in a perfectly competitive market.
c. The profit-maximizing level of output is 60 units, where marginal revenue equals marginal cost. At this (or any other) output level, the firm is receiving a price of $10.
d. Total profit = ($10-$9)(60)=$60
6. a. The average total cost curve and marginal cost curve are U-shaped, with marginal cost intersecting average total cost at the minimum point of average total cost. The demand (price) curve and marginal revenue curve are downward sloping, with the demand curve lying above the marginal revenue curve.
b. The firm is a price maker and thus is a monopoly.
c. Total profits are maximized when the firm sells 4 units of output, where marginal revenue equals marginal cost.
d. Total profit = ($23-$21)(4)=$8
7. a. The average total cost curve, average variable cost curve, and marginal cost curve will be U-shaped, with marginal cost intersecting average total cost and average variable cost at their minimum points. The average fixed cost curve declines as output increases.
b. Output = 6 televisions, total profit = $0
c. Output = 9 televisions, total profit = $2,142
d. Although the firm realizes a loss when the market price of televisions is $160, it should continue to produce 4 televisions because price exceeds average variable cost. If the market price of televisions falls to $120, the firm should shut down because average variable cost exceeds price.
8. a. 9 units, total revenue = $315, total cost = $225, total profit = $90
b. 7 units, total revenue = $140, total cost = $175, total loss = $35. The firm would continue to produce rather than shut down because price exceeds average variable cost.
c. The firm would minimize losses by shutting down. By producing two units of output, where marginal revenue equals marginal cost, average variable cost exceeds price and the firm lies beneath its shut-down point.
9. To maximize profits, the firm should produce and sell at that output level where marginal revenue equals marginal cost. The firm should produce and sell 5 units of output and charge a price of $45.
a. Average total cost = $25, profit per unit = $20
b. Total revenue = $225, total cost = $125, total profit = $100