Question

Suppose the market for Hula Hoops is monopolized by a single firm. a. Draw the initial equilibrium for such a market. b. Now suppose the demand for Hula Hoops shifts outward slightly. Show that, in general (contrary to the competitive case), it will not be possible to predict the effect of this shift in demand on the market price of Hula Hoops. c. Consider three possible ways in which the price elasticity of demand might change as the demand curve shifts: It might increase, it might decrease, or it might stay the same. Consider also that marginal costs for the monopolist might be increasing, decreasing, or constant in the range where \(M R=M C\). Consequently, there are nine different combinations of types of demand shifts and marginal cost slope configurations. Analyze each of these to determine for which it is possible to make a definite prediction about the effect of the shift in demand on the price of Hula Hoops.

Short answer

Answer: The two combinations where the effect of the shift in demand on the price of Hula Hoops can be definitely predicted are: 1. Combination 2: Price Elasticity of Demand (PED) increases and Marginal Cost (MC) decreases. In this case, the price of Hula Hoops may decrease. 2. Combination 4: PED decreases and MC increases. In this case, the price of Hula Hoops may increase.

Step-by-step solution

a. Drawing the initial equilibrium for a monopolistic market

For a monopolist, 1. Draw the Demand curve (D) which is downward sloping, showing the inverse relationship between price (P) and quantity (Q). 2. Draw the Marginal Revenue curve (MR) which is below the demand curve and has twice the slope. 3. Draw the Marginal Cost curve (MC) which intersects the Marginal Revenue curve (MR) at the point of profit maximization. 4. The point of intersection of the MC and MR curves is the profit-maximizing quantity(Qm) and the corresponding price can be found by going up to the demand curve.

b. Showing that it isn't possible to predict the effect on the market price of Hula Hoops

When the demand curve shifts outwards, 1. The new demand curve (D') and the new marginal revenue curve (MR') will also shift outwards. 2. The monopolist's new profit-maximizing output can be found at the intersection of the new Marginal Revenue curve (MR') and the Marginal Cost curve (MC). 3. The effect on price depends on the relative changes in demand, marginal revenue, and marginal cost as the market adjusts to the new equilibrium. So it is not possible to predict the effect on market price in the monopolistic case.

c. Analyzing the possible price changes for Hula Hoops in nine combinations of demand shift types and marginal cost slope configurations

There are 3 possibilities for price elasticity of demand (PED) 1. PED increases 2. PED decreases 3. PED remains the same There are 3 possibilities for marginal cost (MC) slope 1. MC increasing 2. MC decreasing 3. MC constant Considering all these combinations, we get nine possibilities: 1. Combination 1: PED increases, MC increases Price change: Indeterminate 2. Combination 2: PED increases, MC decreasing Price change: Price may decrease 3. Combination 3: PED increases, MC constant Price change: Indeterminate 4. Combination 4: PED decreases, MC increasing Price change: Price may increase 5. Combination 5: PED decreases, MC decreasing Price change: Indeterminate 6. Combination 6: PED decreases, MC constant Price change: Indeterminate 7. Combination 7: PED remains the same, MC increases Price change: Indeterminate 8. Combination 8: PED remains the same, MC decreasing Price change: Indeterminate 9. Combination 9: PED remains the same, MC constant Price change: Indeterminate Thus, we can only make a definite prediction about the effect of the shift in demand on the price of Hula Hoops for combinations 2 and 4. In all other combinations, the price change is indeterminate.

Key concepts

Demand Curve Shift

Understanding the dynamics of the demand curve is crucial in economics, especially in a monopolistic market. When the demand curve shifts, it represents a change in the quantity demanded at every price level. Outward shifts suggest an increase in demand, often due to factors like rising consumer incomes, changes in tastes, or price decreases for complementary goods. Conversely, inward shifts indicate falling demand.

For a monopolist, the impact of a demand curve shift isn't straightforward. Unlike in competitive markets where the outcome is a direct change in quantity sold and price, in a monopolistic market, the new equilibrium price and quantity depend on the relative shifts in both demand and marginal revenue, as well as the position of the marginal cost curve. The monopolist will need to reassess the quantity to supply that maximizes profit, which could result in a new price that doesn't match the direction of the demand shift.

In the case of our Hula Hoop market, an outward shift of demand could lead to several outcomes for price, depending on how marginal cost and price elasticity of demand are affected by the shift. The lack of predictability in these scenarios underscores the complexity a monopolist faces compared to firms in perfectly competitive markets.

Marginal Cost

Marginal cost (MC) plays a pivotal role in determining the equilibrium price and quantity in any market structure, including a monopoly. It represents the additional cost of producing one more unit of a good or service. Typically, the MC curve is upward-sloping, reflecting increasing production costs due to factors like the law of diminishing returns.

In a monopolistic market, the equilibrium occurs where the marginal cost curve intersects the marginal revenue (MR) curve. At this point, the monopolist maximizes profit by ensuring that the additional revenue gained from selling one more unit equals the additional cost of producing that unit. Changes in MC — whether decreasing, increasing, or staying the same — can significantly influence pricing decisions when combined with shifts in the demand curve. For instance, if MC is decreasing, the monopolist may be able to supply more at a lower price following an outward demand shift, but the actual outcome would ultimately hinge on how the MR and demand curves have shifted.

Price Elasticity of Demand

Price elasticity of demand (PED) gauges how sensitively the quantity demanded of a product reacts to a change in its price. A higher PED indicates that consumers are very responsive to price changes, whereas a lower PED suggests that demand is relatively unaffected by price. In practice, the elasticity can change along different points of the demand curve, complicating the analysis for a monopolistic firm.

When we examine shifts in the demand curve in a monopolistic market, the PED becomes a crucial factor. If PED increases, consumers become more price-sensitive, and the monopolist may consider lowering the price to increase sales volume. On the other hand, if PED decreases, the monopolist might raise prices, as consumers would be less prone to reduce consumption in response. However, the existence of other market forces, including adjustments in marginal cost and the shape of the demand curve, means that the impact on the monopoly pricing structure cannot be always predicted straightforwardly. This complexity renders the analysis of price changes multifaceted when the demand curve shifts.

Monopoly Pricing

Monopoly pricing refers to how a monopolist sets prices above the marginal cost to maximize profits, which is possible due to the lack of competition in the market. The price is determined by the point on the demand curve that aligns with the quantity where MR equals MC. Unlike competitive firms that are price-takers, a monopolist has price-setting power and can therefore influence market prices directly.

However, the monopolist's pricing strategy can be nuanced. Any shift in demand or cost conditions requires a reevaluation of the price and quantity to supply. For example, if the demand for Hula Hoops rises (an outward demand shift), the monopolist must determine how to adjust its output and price to continue maximizing profits. The Step by Step Solution in the Hula Hoop exercise shows that only certain combinations of demand elasticity and marginal cost changes yield predictable outcomes for monopoly pricing. This demonstrates the intricate balancing act a monopolist must perform to maintain profit maximization in the face of changing market conditions.