Question

Please answer the following questions. (True/False)

1. Price will always exceed marginal cost for the profit-maximizing monopolist, or any price-setter firm for that matter.

2. A price-setting firm prefers to operate in the inelastic portion of its demand curve because total revenue increases when price is increased.

3. So long as a monopolist finds itself in the situation where price is greater than average fixed cost at the profit-maximizing (loss-minimizing) level of output, the firm should continue to operate to minimize its losses.

4. Barriers to entry reduce the likelihood that price-setter firms will see their positive economic profits competed away over time.

5. Price will be higher and output will be lower under monopoly than under perfect competition with the same demand and cost conditions.

Answer 1

Answer

1. TRUE

Reason: Because a monopoly's marginal revenue is always below the demand curve, the price will always be above the marginal cost at equilibrium, providing the firm with an economic profit. It is true for any price-setter firm.

2. FALSE

Reason: A price-setter firm will never produce in the lower half of the demand (AR) curve where demand is price inelastic. In order to increase profits, the firm will raise price (and move towards the upper half of the demand curve where demand is price elastic) which won't only increase revenues (as gain in revenue because of higher price will exceed the reduction in revenue because of lesser quantity sold) but will also lower total cost (as fewer units will be produced and sold at higher price).

3. FALSE

Reason: Price should be greater than AVC at any point of time for a monopolist to continue to operate. Otherwise, it should shut down

4. TRUE

Reason: Barriers to entry help price-setting firms earn high economic profits as the fear of new entrants is reduced and there exists less number of competitors.

5. TRUE

Reason: A monopoly tries to exploit or charge the prices as per the maximum willingness of the buyers to pay. They try to take away the entire consumer surplus. Thus, the prices are higher and quantity supplied is lower as compared to a perfect competition.