Welfare Effects of Monopoly

• Monopoly vs. Perfect Competition (Surplus)

  • Assume a downward sloping demand curve for both monopoly and prefect competition with a constant MC as well as ATC

  • In a monopoly, the marginal revenue will be below the demand curve.

  • Consumer surplus is reduced and deadweight loss (DWL) is created

  • Graph

  

• Summary

  • By holding output level below the level at which marginal cost is equal to the market price, a monopolist increases profits but decreases consumer surplus

  • Mutually beneficial transactions do not occur, but a monopolist is (naturally) looking out for its own interests.

  • Perfectly competitive firms also profit-maximize, but they produce where P = MC, which is also MR = MC

  • Monopolists produce at MR = MC, but P > MC

  • This creates deadweight loss or DWL

Public Ownership of Monopolies

• Many countries opt for public ownership of natural monopolies (economies of scale)

• In theory, the government can set prices based on efficiency (P = MC) rather than profit maximization (MR = MC)

• In practice, publicly owned firms have less incentives to keep costs down or offer high quality

• Electricity, local phone service, water and gas are examples of regulated monopolies

• Should the government regulate cable TV?

Unregulated vs. Regulated Natural Monopoly

• Assume a demand curve for both situations with a demand intersecting ATC on downward-sloping portion

• Unregulated monopoly charges MR = MC (econ profit)

• Regulated monopoly charges (normal profit)

Monopoly Practice Problem

• Assume an unregulated monopoly.

  • The monopolist's quantity produced

    • where MR = MC, at point c

    • Answer: Q1

  • The monopolist's price

    • above point c, at point a

    • Answer: P3

  • The economic profit of the monopolist

    • between ac and the y-axis

    • Answer: acP1P3

  • The area of deadweight loss

    • between ac and demand

    • Answer: acf

• Assume the monopolist can perfectly price discriminate

  • The quantity produced

    • where MR = MC = D, at point f

    • Answer: Q3

  • The total revenue of the monopolist

    • asking for revenue, not profit

    • Answer: P4fQ3O

• Assume a monopolist is regulated to maximize total surplus

  • The socially efficient quantity

    • socially efficient = allocatively efficient = when P equals MC = maximum of consumer surplus and producer surplus

    • Answer: Q3

  • The consumer surplus at the socially efficient quantity

    • Answer: P4P1f

  • Is the monopolist facing regulation earning a positive economic profit, earning zero economic profit, or incurring a loss? Explain your answer.

    • at point f, where price = marginal cost = average total cost

    • Accounting profit = TR - TC = Q* (P - ATC) = 0

  • Is point f in the elastic, inelastic, or unit elastic portion of the demand curve? Explain.

    • MR > 0, elastic

    • MR < 0, inelastic

    • MR = 0 , unit elastic

More Monopoly Practice Problem

• Zachrail, the only provider of train services between two cities, is currently incuring economic losses

  • Show Zachrail's loss-minimizing price and quantity

    • loss-minimizing = profit-maximizing

    • the point on demand curve above the point where MR = MC

  • Show the area of economic loss

    • the point on ATC curve above the point where MR = MC

  • Identify the allocatively efficient quantity

    • the point where D = MC

  

• If Zachrail raised the price above the profit-maximizing price, would total revenue increase, decrease or not change? Explain.

  • If elastic, P↑, TR↓

  • If elastic, P↓, TR↑

  • If inelastic, P↑, TR↑

  • If inelastic, P↓, TR↓

• Would a per-unit tax or per-unit subsidy be advisable in this situation if the goal is to produce at the allocatively efficient point? Explain why.

  • Answer: Per-unit subsidy

  • Explanation: lead towards allocatively efficient point

  

• Assume instead that a lump-sum subsidy is provided to Zachrail. In the short run, will deadweight loss increase, decrease of not change? Will Zachrail's economic losses increase, decrease or not change?

  • Lump-sum subsidy lowers FC, which lowers the ATC

  • Answer: the deadweight loss will not be changed, the losses will decrease