Question

The following exercises will be graded out of 17 points. We should have left enough space for you to answer directly on the handout. This will be due at 10 a.m. on Monday, March 16th 2020. Exercise 1: Monopoly and externalities (12 points) Consider a monopolistic firm and a perfectly competitive firm both of which pollute. In this question, we will compare monopoly outcomes to perfectly competitive ones, and we will see how the existence of a pollution externality affects welfare in each case. When a firm is a monopolist, it reduces its production so that it can increase price although it sells fewer units, the higher price more than makes up for the reduced volume. Consumers lose, and total welfare is reduced, due to the higher price and lower quantity. The pollution problem, in contrast, is excess production You are given the following information with regards to the market: Inverse Demand: P-8- Total (Private) Cost: TC-20 Marginal Revenue : MR-8-20 Marginal Cost : MC2 1. Please plot the competitive firms' supply curve, the monopolist's MC and MR curves, and the demand curve on a single set of axes

Answer 1

1. All the curves are correctly plotted in the question.

10. We know that the net benefit is more in case of perfect competition as compared to the monopoly. This is because there is no dead weight loss in case of perfect competition. On the other hand, there is welfare loss involved in case of monopoly.

Now, the net benefit will be lower when the externalities (say external cost in this case) has been included. This is because when we include the social or external cost, the cost curve becomes higher and this will obviously lead to lesser net benefit as higher costs will be a reduction in welfare of the producer as well as consumer.

Hence, the given options can be ranked in the form of higher net benefit to lower net benefit in the following way:

i. Perfect competition with external cost not internalized.

ii. Perfect competition with external cost internalized.

iii. Monopoly with external cost not internalized.

iv. Monopoly with external cost internalized.

(As the instructions were not clear in the question, I just answered 1 question as per HOMEWORKLIB RULES.)