2 . Monopoly outcome versus competition outcome

Consider the daily market for hot dogs in a small city. Suppose that this market is in long-run competitive equilibrium with many hot dog stands in the city, each one selling the same kind of hot dogs. Therefore, each vendor is a price taker and possesses no market power.

The following graph shows the demand (D) and supply (S = MC) curves in the market for hot dogs.

Place the black point (plus symbol) on the graph to indicate the market price and quantity that will result from competition.

Competitive Market

PC Outcome

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PRICE (Dollars per hot dog)

QUANTITY (Hot dogs)

D

S=MC

Assume that one of the hot dog vendors successfully lobbies the city council to obtain the exclusive right to sell hot dogs within the city limits. This firm buys up all the rest of the hot dog vendors in the city and operates as a monopoly. Assume that this change doesn't affect demand and that the new monopoly's marginal cost curve corresponds exactly to the supply curve on the previous graph. Under this assumption, the following graph shows the demand (D), marginal revenue (MR), and marginal cost (MC) curves for the monopoly firm.

Place the black point (plus symbol) on the following graph to indicate the profit-maximizing price and quantity of a monopolist.

Monopoly

Monopoly Outcome

Deadweight Loss

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PRICE (Dollars per hot dog)

QUANTITY (Hot dogs)

D

MR

MC

Consider the welfare effects when the industry operates under a competitive market versus a monopoly.

On the monopoly graph, use the black points (plus symbol) to shade the area that represents the loss of welfare, or deadweight loss, caused by a monopoly. That is, show the area that was formerly part of total surplus and now does not accrue to anybody.

Deadweight loss occurs when a monopoly controls a market because the resulting equilibrium is different from the competitive outcome, which is efficient.

In the following table, enter the price and quantity that would arise in a competitive market; then enter the profit-maximizing price and quantity that would be chosen if a monopolist controlled this market.

Market StructurePriceQuantity(Dollars)(Hot dogs)CompetitiveMonopoly

Given the summary table of the two different market structures, you can infer that, in general, the price is lower under a , and the quantity is lower under a .

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