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Monopoly & Efficiency Deadweight Loss Analysis Efficiency Analysis • Allocative Efficiency is when P = MC – No DWL, socially optimal – Monopolies fail as P > MC Competitive Firms always pass P = MC • Production Efficiency is when P = min. of ATC – Monopolies fail as P > min of ATC – Competitive Firms achieve it only in long run Monopoly Perfect Competition P > MC Costs and Revenue Price P = MC MC (always) B Monopoly price ATC P = min of ATC P > min of ATC Average total cost (long run) A P1 Demand Marginal cost Marginal revenue 0 Quantity 0 Q QMAX Q Quantity Deadweight Loss • Deadweight loss is caused by a monopoly, a tax or subsidy and an effective price floor/ceiling – Unless the tax/subsidy is correcting a market failure! • There is never a deadweight loss when P = MC (MB = MC) – if P > MC => market is too small • Example: misplaced tax or monopoly (or price ceiling…) – if P < MC => market is too big • Example: misplaced subsidy Identical Market Demand Curve • The market demand curve for a good/service is exactly the same whether an industry is a monopoly or a competitive industry. • Therefore the market demand curve below for T-Shirts could be for a monopoly or a competitive industry 1 Firm In a competitive industry market demand = MR Monopoly: market demand > MR Market Inefficiency of Monopoly Price MC DWL Monopoly price Competitive EM P > MC Allocative Efficiency P = MC EC For competitive industry P = D= MR Market demand is MR So @ Ec MR = MC Price D= Market Demand Curve MR 0 Monopoly Competitive quantity quantity Quantity Deadweight Loss Analysis • Revenue from a tax is transferred from producer/consumer => to Government • Revenue from a subsidy is transferred from Gov’t => to producer/consumer • Monopoly excess profit is a transfer of consumer surplus => to private firm Excess profit => some consumer surplus turns into monopoly profit Costs and Revenue Monopoly Price as P > MC Marginal cost 0 Q ------------------------ ------------------------------------PC --------------------------- Competitive Price Deadweight Loss PM QM Q Q C Average total cost Demand Marginal revenue Quantity Collusion & Cartels • Collusion – An agreement among firms about Qty to produce or price to charge – Antitrust laws prohibit this behavior in USA • Cartel – A group of firms acting in unison – Example: OPEC, DeBeers OPEC Meeting How to become a price setter DeBeers Video • http://www.youtube.com/watch?v=uRGp0x 8ZE8w DeBeers Video Analysis Demand D1 Supply Graphing Supply & Demand S2 S1 ---------- P1 --------------- E1 D1 --------------------------- P2 ------------------ E2 S1 P1 --------------- E1 Q1 D1 D2 Q1 Q2 • Demand is kept artificially high & inelastic through advertising • Supply is kept artificially low by DeBeers • End Result: Higher prices paid & larger quantity sold