IB Economics Welker Unit Pure Monopoly Price Discrimination and Natural Monopoly - Practice Activity. Part 1 - Natural Monopoly:

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1 IB Economics Welker Unit Pure Monopoly Price Discrimination and Natural Monopoly - Practice Activity Part 1 - Natural Monopoly: 1. On the graph to the left below, illustrate a regular, profit-maximizing monopoly earning economic profits. On the graph to the right, illustrate a natural monopoly, producing at its profit maximizing level and earning economic profits a. What is the difference between a regular monopolistic firm and a natural monopoly? b. Give an example of an industry that tends to be naturally monopolistic.

2 2. Redraw the graph for the natural monopoly below. a. Assume the government wished to regulate the natural monopoly above to assume that it charged no higher than the price at which society s marginal benefit equaled the firm s marginal cost. Draw a horizontal line at this price on your graph above. i. Explain why this price would be considered socially optimal? Shade the area on the graph above representing the natural monopolist s economic profits or losses when forced to charge the socially optimal price by the government. i How will the imposition of the price ceiling affect the firm in the long-run? iv. Is a price ceiling at the socially optimal price an effective means of regulating a natural monopolist? Why or why not?

3 b. Next assume that the government chose to impose a price ceiling which required the firm to sell its output at a price no higher than its average total cost (where demand = ATC). Re-draw the natural monopoly graph below and indicate the new price ceiling. i. How does the new price ceiling affect the firm s economic profits or losses? How does the firm s level of output under this new price ceiling compare to the level of output it would produce if left unregulated? i How does the firm s level of output under this new price ceiling compare to the socially optimal level of output?

4 iv. Is a price ceiling set at the firm s ATC effective at achieving a socially optimal level of output of the natural monopolists product? Why or why not? c. If the government wishes to promote a socially optimal level of output by a natural monpolist producing a necessary good (such as water, electricity, natural gas, garbage collection or sewage treatment), should it tax the firm or subsidize the firm? Explain your answer. d. Re-draw the natural monopoly on the graph below and indicate the effect of a governmentlevied tax or subsidy aimed at achieving a more socially optimal level of output.

5 Part 2 - Price Discrimination: 3. Define price discrimination and give three examples of firms practicing price discrimination that you have witnessed personally: a. Definition: b. Example 1: c. Example 2: d. Example 3: 4. Briefly identify the three conditions that must be met in order for a firm to price discriminate a. Condition 1: b. Condition 2: c. Condition 3: 5. Briefly describe the three degrees of price discrimination and provide one example of a firm practicing each type: a. Third degree:

6 b. Second degree: c. First degree: 6. On the graph to the left below, illustrate a regular, single-price, profit-maximizing monopoly earning economic profits. On the graph on the right, illustrate a perfectly price discriminating monopolist. a. Describe the relationship between Marginal Revenue and Price for: i. The single-price monopolist: The perfectly-price discriminating monopolist: b. Explain how the ability to price discriminate affects each of the following: i. The monopolist s level of economic profits: The amount of consumer surplus in the market:

7 i The level of output in the market: iv. The amount of total welfare in the market: v. Allocative efficiency in the market: 7. Which degrees of price discrimination are most common? Why? 8. Who are the winners and losers from price discrimination? a. Winners: b. Losers:

A. a change in demand. B. a change in quantity demanded. C. a change in quantity supplied. D. unit elasticity. E. a change in average variable cost.

1. The supply of gasoline changes, causing the price of gasoline to change. The resulting movement from one point to another along the demand curve for gasoline is called A. a change in demand. B. a change