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
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
The monopolist's price
above point c, at point a
The economic profit of the monopolist
between ac and the y-axis
The area of deadweight loss
between ac and demand
Assume the monopolist can perfectly price discriminate
The quantity produced
where MR = MC = D, at point f
The total revenue of the monopolist
asking for revenue, not profit
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
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