1. Suppose that the market for rollerblades is now monopolized with A = 100, w = $4, and f = $100. What is the profit-maximizing quantity? What are monopoly profits?

2. Canned cantaloupe is produced by a monopoly firm, Cantacon. Unfortunately, in producing its product, Cantacon incinerates the cantaloupe rinds and releases through its smokestacks an unsavory smoke which drifts into neighboring towns and annoys people. The annoyance of people is reflected by a social marginal cost curve, SMC, which is above Cantacon's private marginal cost, PMC. Figure 2.7 contains the relevant information about the market for canned cantaloupe.

(a) Indicate the monopoly output and price on your graph. Does the public think too much, not enough, or just the right amount of canned cantaloupe is being produced? Explain. Do you think that this result generalizes, i.e., holds for all cases where monopoly and an externality coexist?

(b) Redo (a), but now imagine that the government levies a tax on each unit of output equal to the difference between SMC and PMC.

(c) Now imagine that instead of levying a tax, the government breaks up Cantacon's monopoly and canned cantaloupe is henceforth produced by a competitive industry. Indicate on your graph the competitive output and price. Does the public think too much, not enough, or just the right amount of canned cantaloupe is being produced? Explain.

(d) From this example, what can you conclude about the welfare effects of breaking up a monopoly or using a tax to curtail an externality when a monopoly is responsible for a negative externality? Is a policy that sounds good always a good thing? How is this related to the theory of the second best?