Download Lecture2.monopoly

ECMC02H – Week Two
Objectives:
a. Finish off material from last week on price
ceilings, price floors. Examine sources of
inefficiency.
b.
The monopoly model. How does monopolist
behave? What are the results?
c.
Inefficiency and monopoly. Natural
monopoly. Dynamic efficiency vs. allocative
efficiency.
d.
Lerner Index of market power.
e.
Excise tax on a monopoly
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Consumer surplus is the net benefit to consumers
from consumption. Producer surplus is the net
benefit to producers from production (SR).
Use loss of CS or PS to analyze economic wellbeing (i.e., economic welfare).
1. Price Ceiling
E.g., rent controls
Example:
D: P = 60 - .1Q
S: P = 11 + .04Q
Equilibrium at P = $25, Q = 350
What happens if government enforces price ceiling
of P = $15
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Price
$60
$50
Supply
$30
$25
$15
$11
0
Demand
100
200
300
350
450 475
Quantity
Per month
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Excess Demand
B and C are lost from CS and PS
A is transferred from PS to CS
ΔCS = +A –B (could be gain or loss)
ΔPS = -A –C (loss)
Δoverall economic welfare = -B –C
Even this calculation assumes that it is those who
value the good most who consume the reduced
supply
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2.
Price floor (minimum price) (e.g., minimum
wage, agricultural support price) Assume
suppliers do not supply in excess.
Price
$60
$50
Supply
$30
$25
$15
$10
0
Demand
100
200
300
5
350
450 475
Quantity
Per month
Excess supply
B and C are lost from CS and PS
A is transferred from CS to PS
ΔCS = -A –B (loss)
ΔPS = +A –C (could be gain or loss)
Δoverall economic welfare = -B –C
Even this calculation assumes that it is those who
value the good most who consume the reduced
supply
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3.
Price floor (but producers continue to supply
perishable good)
Price
$60
$50
Supply
$30
$25
$15
$11
0
Demand
100
200
300
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350
450 475
Quantity
Per
month
B and C are lost from CS and PS, but so is D
(not a loss if output can be stored)
Δoverall economic welfare = -B –C -D
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4. Price floor enforced by government purchases
Price
$60
$50
Supply
$30
$25
$15
$11
0
Demand
100
200
300
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350
450 475
Quantity
Per
month
No Excess Supply (all purchased)
ΔCS = -A –B (loss)
ΔPS = +A +B +D (gain)
Wasted government resources = cost of purchases
Δoverall economic welfare = +D –cost of purchases
Note: assistance to farmers is A+B+D but cost of
giving assistance is much higher than this.
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5. Production quota to keep price up
Price
$60
$50
Supply
$30
$25
$15
$11
0
Demand
100
200
300
11
350
450 475
Quantity
Per
month
Milk Marketing Board
Taxicab Medallions
ΔCS = -A –B (loss)
ΔPS = +A -C
Δoverall economic welfare = -B -C
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6. Pay farmers to restrict supply (keeping prices
up)
Price
$60
$50
Supply
$30
$25
$15
$11
0
Demand
100
200
300
13
350
450 475
Quantity
Per
month
ΔCS = -A –B (loss)
ΔPS = +A –C + payment to farmers
Payment to farmers must be at least B + C + D
Therefore ΔPS =
Δoverall economic welfare = -B –C
Which alternatives do producers favour?
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The Monopoly Model
Only one supplier. Entry to market is blocked.
Could be:
(a) cost advantage – economies of scale which
are large relative to the size of the market
(known as “natural monopoly”
(b) government licence or restriction (patent)
(c) ownership of scarce but essential resource
(d) some other barrier to entry (e.g., huge
advertising costs)
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Single seller faces entire market demand curve
(price maker, not price taker)
Graphically:
Price
per unit
quantity
MC
AC
Demand
MR
0
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Quantity
produced
per unit of
time
Algebraic example
Market Demand: P = 100 - .02Q
So, total revenue = TR = PxQ = 100Q - .02Q2
Marginal Revenue = dTR/dQ = 100 - .04Q
(the rate at which total revenue is changing as
output increases)
Total cost function of monopoly firm:
TC = .01q2 + 10q + 432 or .01Q2 + 10Q + 432
So, MC = .02Q + 10
(the rate at which total cost is changing as output
increases)
AC = .01Q + 10 + 432Q-1
We can solve by forming the profit function and
maximizing with respect to Q
Π = TR – TC = 100Q - .02Q2 - .01Q2 + 10Q + 432
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Or we can set MC = MR and solve for Q
Substitute into the demand curve to find P*
How much is the profit of the monopolist?
Where is the monopolist’s supply curve?
What about the long run?
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Is the monopolist efficient?
Several perspectives:
Does the monopolist minimize costs?
Is marginal benefit equal to marginal cost at the
monopolist’s equilibrium output?
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Does the monopolist’s output maximize the sum of
producer and consumer surpluses?
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A distributional concern (not allocative efficiency):
Does the monopolist transfer potential CS into PS?
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What about natural monopoly?
What about dynamic efficiency?
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Classic view is that monopoly distorts resource
allocation and causes deadweight efficiency loss.
Monopolist produces too little output (uses too few
resources). In practice, there are other
considerations, to judge on a case by case basis.
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