Question 2 (25 marks)

As discussed in the talk, if you are starting a business, you should aim to be a monopoly. In other words, monopoly is the market structure that is optimal from the firm's owner point of view. What about the social point of view? Is monopoly unequivocally good or bad? Let's start addressing this question by considering a simple example.

Suppose that the demand curve is given by P = 100 Q and the marginal cost curve is given by MC = 10. This means that marginal cost is constant and does not depend on the quantity produced. Assume that the production process does not involve any fixed cost (F = 0).

(a) Suppose this market is perfectly competitive. Compute the equilibrium price and quantity, producer and consumer surplus, and total surplus in this market. Illustrate your answer with a graph. Make sure you label all relevant axes, lines and areas. Hint: What is the relationship between the marginal cost and the supply function for a competitive firm? (10 marks)

(b) Now suppose that this market is monopolised by a single firm. Compute the equilibrium price and quantity, producer and consumer surplus, and total surplus in this market. Illustrate your answer with a graph. Make sure you label all relevant axes, lines and areas. Hint: As we have seen in Lecture 5, the Marginal Revenue function of a monopolist in this case is given by: MR = 1002Q. (10 marks)

(c) Compare the value of total surplus in (a) and (b). Which market structure is better from the social point of view? Why? (5 marks)