AP_Krugman_Textbook

competitive industry would produce decreases to 12, but

profits remain unchanged at zero.

Tackle the Test:

Multiple-Choice Questions

1. b


2. c


3. b


4. d


5. d

Tackle the Test:

Free-Response Questions

2. a.

b.Yes, with the help of barriers to entry that keep competi-

tors out.

Module 62

Check Your Understanding

1. a.Cable Internet service is a natural monopoly. So the gov-
   ernment should intervene if it believes that the current
   price exceeds average total cost, which includes the cost of
   laying the cable. In this case it should impose a price ceil-
   ing equal to average total cost. If the price does not exceed
   average total cost, the government should do nothing.

$1,000

200

400

700

600

–200

–400

0

Quantity of

diamonds

Price, cost,

marginal revenue

of diamond

6 81012 16 20

MR

MC 2 = ATC 2

D

MC 1 = ATC 1

Profit-maximizing

quantity falls. QC

MC shifts

upward.

Profit

falls.

QM Quantity

Price, cost,

marginal

revenue ATC

MC

MR

D

PM

b.The government should approve the merger only if it fos-

ters competition by transferring some of the company’s

landing slots to another, competing airline.

2. a.False. Although some consumer surplus is indeed trans-
   formed into monopoly profit, this is not the source of
   inefficiency. As can be seen from Figure 62.1, panel (b),
   the inefficiency arises from the fact that some of the
   consumer surplus is transformed into deadweight loss
   (the yellow area), which is a complete loss not captured
   by consumers, producers, or anyone else.
   b.True. If a monopolist sold to all customers willing to pay
   an amount greater than or equal to marginal cost, all
   mutually beneficial transactions would occur and there
   would be no deadweight loss.


3. As shown in the accompanying diagram, a “smart”
   profit–maximizing monopolist produces QM, the output
   level at which MR= MC.A monopolist who mistakenly
   believes that P=MRproduces the output level at which
   P=MC(when, in fact, P>MR,and at the true profit-
   maximizing level of output, P >MR=MC). This misguid-
   ed monopolist will produce the output level QC,where
   the demand curve crosses the marginal cost curve—the
   same output level that would be produced if the industry
   were perfectly competitive. It will charge the price PC,
   which is equal to marginal cost, and make zero profit.
   The entire shaded area is equal to the consumer surplus,
   which is also equal to total surplus in this case (since the
   monopolist receives zero producer surplus). There is no
   deadweight loss because every consumer who is willing to
   pay as much as or more than marginal cost gets the good.
   A smart monopolist, however, will produce the output
   level QMand charge the price PM.Profit for the smart
   monopolist is represented by the green area, consumer
   surplus corresponds to the blue area, and total surplus is
   equal to the sum of the green and blue areas. The yellow
   area is the deadweight loss generated by the monopolist.

Tackle the Test:

Multiple-Choice Questions

1. a


2. b


3. c


4. a


5. b

D

MC = ATC

MR

Quantity

Price, cost,

marginal

revenue

PC

QM QC

PM

SOLUTIONS TO AP REVIEW QUESTIONS S-39