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

    Machine generated alternative text: Cons 瞒 m 疒 HC•ATc 0 0 № po , v 巧

  • 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)

Machine generated alternative text: FIGURE 13 . 9 Unregulated and
Regulated Natural Monopoly (a) Total Surplus with a n Unregu lated (b)
Total Surplus with a Regulated Natural Monopolist Price, cost, marginal
revenue Natural Monopolist Consumer su 5 MR Price, cost, marginal
revenue MC D Quantity Consumer surplus MR D Quantity This figure shows
the case Of a natural monopolist 、 In panel (a), if the monopolist is
allowed to charge PM, it makes a profit, shown by the green area;
consumer surplus IS shown by the blue area. If it is regulated and must
charge the lower price PR, output increases from QM to QR and consumer
surplus increases. Panel (b) shows what happens when the monopolist must
charge a price equal 10 average total cost, the price PR. Output expands
to QR and consumer surplus IS now the entire blL 」 e area. The
monopolist makes ze ro profit. This is the greatest total surpli 」 s
possible when the monopolist is allowed to at least break even, making
PR the best regulated price 、

Monopoly Practice Problem

Machine generated alternative text: MC = AIC Demand Q4QtJANITIY

  • 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

    Machine generated alternative text: t05 , Q\* Q,

  • 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

    Machine generated alternative text: LWMP 巧 “ 斯 L 咖 FC, 纵 ATC = 0

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