Download Competition vs. Monopoly: Allocative efficiency

In this segment we want to
examine the theoretical
implications of
market structure for market
performance
Theory predicts that “competitive”
markets lead to socially
efficient resource allocation.
By contrast, imperfectly competitive
market structures result
in resource misallocation. We want
to lay out this argument in a formal
way.
Definitions
•P is market price measured in dollars, yen, lira, . . .
•Q is market quantity measured in units, tons, bushels, . .
.
•TR is total revenue from the sale of goods or services
•AR is average revenue
•MR is marginal revenue--the increment to total revenue
attributable to the last unit sold.
Note that:
TR  P  Q
P  Q TR
AR 

Q
Q
(1)
(2)
and
TR
MR 
Q
(3)
Definitions, part 2
•TC is total cost--the total cost of producing a given
quantity of output measured in dollars, yen , lira, . . .
•ATC is average total cost or cost per unit of output
produced.
•MC is marginal cost--the increment to total cost
attributable to the last unit produced.
Note that:
and
TC
ATC 
Q
TC
MC 
Q
(4)
(5)
Definitions, part 3
•Pc is the competitive price--the price that would prevail
in equilibrium in a competitively structured market.
•Qc is the competitive output-the output that would
prevail in equilibrium in a competitively structured
market.
•PM is the monopoly price--that price that would prevail
in equilibrium in a monopolistically structured market.
•QM is the monopoly output-- the output that would
prevail in equilibrium in a monopolistically structured
market.
Definitions, part 4
•CS is consumer surplus--the difference between what
consumers are willing to pay to get a given quantity of a
good or service and what they actually pay for that
quantity
•PS is producer surplus--the difference between the total
revenue received by sellers and the minimum revenue
that would be sufficient to induce sellers to offer that
quantity for sale on the market.
•TS is the total surplus--the sum of CS and PS, that is:
TS  CS  PS
Resource allocation is socially
efficient, or Pareto optimal, if a
reallocation of existing resources
could not make any one person
better off without making at least
one other person worse off.
The necessary condition
for allocative (Pareto)
efficiency is:
in all markets
P = MC
Price/bushel ($)
Demand curve as schedule of marginal benefits (MB)
Market price is an index
of the benefits derived
from the
production/consumption
of the marginal unit.
13
•The 51st bushel
adds $13 to
society’s benefits.
9
0
51
117
Quantity/bushels
•The 117th
bushels adds $9 to
society’s benefits
from apples.
PS = CPCE
CS = PCAE
TS = PS + CS = CAE
Price
S =  MC
A
F
PC
Vertical distance FK is
the excess of benefits
over costs for the
marginal unit when
Q = Q1
E
K
C
D = AR = MB
0
Q1 Q2 QC
Quantity
Price, Cost
K
Competitive
supply curve
A
PM
E
PC
ATC = MC
B
MR
0
QM
D = AR
QC
Quantity
Competition Monopoly
Price
PC
PM
Quantity
QC
QM
CS
PCKE
PMKA
Econ. 
zero
PcPMAB
DWL
Zero
AEB