ECO206 – Microeconomic Theory
1. Midterm III Structure
Based on analysis of past midterms, there are four main topics that are covered in the third midterm of
ECO206: Monopoly, Price Discrimination, Game Theory and Strategic Thinking and Oligopoly. The
midterm is usually about 2 hours long and consists of 3 to 5 questions with 3 to 5 sub-questions per
question. The total number of questions, including sub-questions, is roughly 12 to 15.
2. Midterm II Statistics
Monopoly 3 4
Price 1 1
Game Theory and 5 4
Oligopoly 4 3
Total 13 12
Midterm III Questions - Statistics
Game Theory and Price
Strategic Thinking 8%
Figure 1 - Midterm III Statistics Topic 1: Monopoly
Monopoly is a market structure that is defined by one seller/producer in a market
Can make decisions over how much to produce or what price to charge
The industry’s market demand curve is the same as the monopolist’s demand curve
(unlike perfect competition – firm’s demand curve is perfectly elastic and industry’s
demand curve is downward sloping)
The marginal revenue of a monopolist is not equal to the price it charges because in order
to sell more output, the monopolist has to lower its prices
Monopolists are price makers whereas perfectly competitive firms are price takers
(understanding the differences between perfect competition and monopoly will help in
understanding the main fundamentals of monopoly structure).
The marginal revenue curve of a monopolist has the same intercept as the monopolist’s
demand curve, but twice the slope.
Price elasticity of demand is
greatly related to marginal revenue of
a monopolist and what prices it should
charge. If a monopolist finds itself on
an inelastic portion of the demand
curve, it can increase profits by raising
prices and lowering quantity. If it
finds itself on the elastic portion of the
demand curve it can increase profits
by lowering prices and decreasing
Keep in mind that the goal of a
At red star: MR =0, revenue is maximized at
this point and PED=-1 monopolist, for our purposes, is to
On a linear demand curve, consumer spending and thus monopolist revenue is maximized
when the price elasticity of a good is equal to -1 (i.e. it is unitary elastic). This is the point
where marginal revenue is equal to 0 (i.e. where total revenue is maximized, since marginal
revenue is the first derivative of the total revenue curve). But, recall the objective of a
monopolist is to profit maximize not revenue maximize. So it will not choose to operate
where MR=0 but instead where MR=MC (at yellow star). At this point monopolist is
producing restricted output at a higher price creates a deadweight loss. The only time
MR=0 is a profit maximizing point is if MC=0 where MC is marginal cost. Fixed costs must
be accounted for in the case where MC = 0. Examples from past tests on the next page will
elaborate on this. Why is MC=MR the profit maximizing quantity? Because we know that: Profit = Total
Revenue – Total Cost. Suppose this expression is a function of quantity (x). The first
derivatives of the RHS will be MR and MC respectively. Setting it equal to 0 we have:
Useful formula for MR: MR = P (1 + ) where P(x) is price as a function of quantity,
and PED is price elasticity of demand.
Can also use: MR = price + (change in price)x(quantity sold at old price)
Using the first formula and letting x=1, we can say:
Rearranging we get:
, where PED is a negative number. P – MC is known as the monopoly mark up, or
how much the monopolist marks up in price above the perfectly competitive price level (which is
And is the monopoly mark up ratio (or the Lerner’s index).
Summary of Questions to be Asked:
What is the profit maximizing level of output and price level?
Calculating fixed costs under positive profit levels
Illustrating monopoly profits and profit maximizing output and price level
Demand under different pricing policies (form of price discrimination, will be covered in
Topic 2 but intertwined with monopolies)
To calculate the Lerner index/ mark up ratio
Related Past Test Questions:
2013 Midterm III Question 2 Topic 2: Price Discrimination
We are going to focus on three main types of price discrimination:
1. First degree price discrimination: also known as “perfect” price discrimination because it
assumes that the monopolist is aware of the reservation price of every single consumer.
i.e. it is an individualized price. One way to achieve this is by using a two-part tariff:
includes a lump sum fee and a per unit cost. The demand curve becomes the marginal
revenue curve when a monopolist uses perfect price discrimination because each
consumer is offered a different price (based on their reservation price). Therefore, the
monopolist will produce an efficient level of supply but it will accrue the entire consumer
surplus. Why is supply efficient? Because the monopolist will produce quantity at which
MC= D (=MR).
Notice that the economic profit (green area) under price discrimination is much larger
than under a single price policy.
2. Third degree price discrimination: also known as “imperfect” price discrimination.
It involves offering per unit prices (no fixed fees) to different consumers who want to buy
multiple units of the good. It is unrealistic to think that a producer can perfectly
discriminate among its consumers. In this pricing strategy, the producer will identify
different marginal curves based on different consumers and produce quantity at MR=MC.
This gives rise to different price levels and deadweight loss because the monopolist is
restricting quantity at MR=MC.
3. Second degree price discrimination: type of pricing strategy that allows a monopolist to
“infer” the type of consumer it is facing. It is often hard to tell who is a “high demander”
versus a “low demander” so will try to give consumers an opportunity to ‘self-identify’ themselves. This involves a single nonlinear price schedule, or offering different
quantities of a good at different prices.
Example: airline tickets – business versus economy.
In conclusion: no deadweight loss under first degree pricing strategy (although this
strategy is unrealistic) but deadweight loss is expected under second and third degree
Summary of Questions to be Asked:
Calculating and illustrating the largest fixed fee that a monopolist could impose on
Derive prices under first, third and second degree price discrimination
Graphically show consumer and producer surplus under different pricing strategies
Justify optimal pricing strategies
Related Past Test Questions:
2012 Midterm II Question 2 Topic 3: Game Theory and Strategic Thinking
Games are going to be defined in terms of the following:
2. Order of play: simultaneously versus sequentially
4. Informational Environment: complete versus asymmetrical information
Simple game: 2 players with a finite number of strategies – involves a payoff matrix
Players: A and B, Order of play: simultaneous, Choices: A – Top, Bottom; B – left, right,
Informational environment: complete, Payoffs: matrix below (A, B).
Player Left Right
A Top 1,2 0,1
Bottom 2,1 1,0
Dominant strategy is the choice/action that always gives a higher payoff to a player. In
the example above, the dominant strategy for player A is to play bottom. The dominant