Question

Part (a) Consider a firm called Health-R-Us that is a monopoly. How does Health-R- Us decide the price to charge and quantity to sell of the good it has a monopoly on? Illustrate your answer using a fully labelled and explained market diagram. Assume Health-R-Us is making monopoly profits and illustrate these on the same diagram. In addition, indicate the area on your diagram that illustrates the efficiency cost (the dead weight loss) of the monopoly, and explain why this dead weight loss arises. Part (b) Assume Health-R-Us is a legal monopoly: it is a monopoly due to legal protection from the government in the form of a patent issued to the company. Imagine that the government withdraws the legal protection for Health-R-Us such that the market becomes competitive. Will a typical individual firm in this competitive market make economic profit in the long run? Why or why not? Use an appropriate firm-level diagram to illustrate and explain your answer. Part (c) Your answers to parts 2a and 2b illustrated different levels of profit made by an individual firm in both a monopoly market structure and a competitive market structure respectively. In part 2a you also indicated the dead weight loss of a monopoly. Assume now that Health-R-Us has discovered a vaccine for coronavirus. Why might the government be willing to grant (and allow to remain in place) a patent to Health- R-Us, despite the dead weight loss and the ensuring monopoly profits caused by such a patent? Explain your answer. For simplicity assume the vaccine is only relevant for the domestic market (i.e., there is no global market for vaccines). [5+5+5 = 15 marks]

Answer 1

In case of Monopoly, a single seller dominates the market and has a significant pricing power as he is selling a good woth no close subsititutes. Health-R-Us is a Monopoly as given in the question.

Part A. Lets see its Market Diagram. The Monopolist Demand Schedule is the aggregate demand for the product in the relevant market. Because of the income effect and the substitution effect, demand is negatively related to price, as usual. The slope of the demand curve is negative and therefore downward sloping.

Marginal revenue(MR) is the change in revenue given a change in the quantity demanded. Because an increase in quantity requires a lower price, the marginal revenue schedule is steeper than the demand schedule.

A monopolist’s supply analysis is based on the firm’s cost structure. Marginal cost(MC) refers to change in cost when an additional output is produced The firms Profit Maximising output will occur when MC=MR

As we can see in the figure presented,the demand and marginal revenue functions are clearly defined by the aggregate market. However, the monopolist does not have a supply curve. The quantity that maximizes profit is determined by the intersection of MC and MR, QDE.

Profit is represented by the difference between the area of the rectangle QDE × PE, representing total revenue, and the area of the rectangle QDE × PC, representing total cost It is shown as shades region in the diagram as you can see the price charge is way higher than the Average Total cost incurred by Health-R-U resulting in profits.

Now Dead Weight loss-Given market demand and marginal revenue, we can compare the behavior of a monopoly to that of a perfectly competitive industry. The marginal cost curve may be thought of as the supply curve of a perfectly competitive industry. The perfectly competitive industry produces quantity QC (where MC=Demand)and sells the output at price PC. The monopolist restricts output to QDE and raises the price to PE. Society would gain by moving from the monopoly solution at Q_m to the competitive solution at Q_c. The benefit to consumers would be given by the area under the demand curve between Q_m and Q_c; it is the area Q_mRCQ_c. An increase in output, of course, has a cost. Because the marginal cost curve measures the cost of each additional unit, we can think of the area under the marginal cost curve over some range of output as measuring the total cost of that output. Thus, the total cost of increasing output from Q_m to Q_c is the area under the marginal cost curve over that range—the area Q_mGCQ_c. Subtracting this cost from the benefit gives us the net gain of moving from the monopoly to the competitive solution; it is the shaded area GRC. That is the potential gain from moving to the efficient solution. The area GRC is a deadweight loss.

Part B) If the Health-R-Us become a competitive market it is no longer a price maker and has now become a price taker as it is accepting a price determined by the market forces of demand and supply. Competitve market is characterized by homogenous product, and low entry to barriers and exit.

In the long run, economic profit will attract other entrepreneurs to the market, resulting in the production of more output. The aggregate supply will increase, shifting the industry supply (S1) curve to the right, away from the origin of the graph. For a given demand curve, this increase in supply at each price level will lower the equilibrium price as can seen in the figure 3.

In the long run, the perfectly competitive firm will operate at the point where marginal cost equals the minimum of average cost, because at that point, entry is no longer profitable: In equilibrium, price equals not only marginal cost (firm equilibrium) but also minimum average cost, so that total revenues equal total costs. The result implies that the perfectly competitive firm operates with zero economic profitThat is, the firm receives its normal profit (rental cost of capital), which is included in its economic costs. Thr figure 2 present the diagram of a long run equilbirum where MR=AR=AC=MC at PC (Price)

Part C- Government would be willing to grant a patent to a monopoly to reward the Health-R-us for their valuable invention and contribution in the development of Vaccine. If there were no patents, then Health-R who invested time and money to create an invention would not necessarily get a return on even a very valuable invention. The reason is that others could imitate his or her invention. If imitators have the same production costs as the inventor, they could compete the price down so that the original inventor covers only production costs, but not invention costs. Potential inventors, knowing this, would be less likely to invest in inventing. But with a patent system in place, potential inventors are more likely to invest because they can expect to have a monopoly on their inventions for as long as seventeen years. Thus, to encourage invention and innovation government is willing to give patets to Health-R for its immense contribution.