At least when our focus is on efficiency, the core problem with monopolies emanates from the monopolist’s strategic under-production of output—not from the fact that monopolists make profits. But policy prescriptions to deal with monopolies are often based on the presumption that the problem is that monopolies make excessive profits.
A: Suppose the monopoly has marginal costs MC = x and faces the demand curve p = 90−x as in exercise 23.1. Unless otherwise stated, assume there are no recurring fixed costs. In each of the policy proposals below, indicate the impact the policy would have on consumer welfare and deadweight loss.
(a) The government imposes a 50% tax on all economic profits.
(b) The government imposes a per-unit tax t on x. (In problem23.7, you should have concluded that it does not matter whether the tax is levied on production or consumption.)
(c) The government sets a price ceiling equal to the intersection of MC and demand.
(d) The government subsidizes production of the monopoly good by s per unit.
(e) The government allows firms to engage in first-degree price discrimination.
(f) Which of the analyses above might change if the firm also has recurring fixed costs.
(g) True or False: In the presence of distortions from market power, price distorting policies can be efficient.
B: Suppose demand and marginal costs are as specified in part A. Unless otherwise stated, assume no recurring fixed costs.
(a) Determine the monopolist’s optimal supply point (assuming no price discrimination). Does it change when the government imposes a 50% tax on economic profits?
(b) Suppose the government imposes a $6 per unit tax on x. Solve for the new profit maximizing supply point.
(c) Is there a price ceiling at which the monopolist will produce the efficient output level?
(d) For what range of recurring fixed costs would the monopolist produce prior to the introduction of the policies in (a), (b) and (c) but not after their introduction?
(e) What is the profit maximizing output level if the monopolist can perfectly price discriminate?
(f) How high a per-unit subsidy would the government have to introduce in order for the monopolist to produce the efficient output level?
(g) For what range of recurring fixed costs does the monopolist not produce in the absence of a subsidy from part (f) but produces in the presence of the subsidy? If recurring fixed costs are in this range, will the monopolist produce the efficient quantity under the subsidy?