Economics 2010Economics 2010

Lecture 13”

Monopoly versus competition

MonopolyMonopoly

Comparing monopoly and competition

Rent seeking? Gains from monopoly? Monopoly in action, monopoly

under regulation

Does a monopoly produce the same quantity and charge the same price as firms in perfect competition?

Let’s look at an example.The firms in a perfectly competitive

industry are bought up by a single firm--a monopoly.

What happens to price and quantity?

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

Begin with a perfectly competitive industry

The demand curve is D and the supply curve is S

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

The industry produces the quantity QC and sells it for the price PC

Now the industry becomes a monopoly

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

The supply curve of the competitive industry becomes the marginal cost curve of the monopoly.

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

The demand curve of the competitive industry becomes the monopoly’s demand curve

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

The monopoly also faces the marginal revenue curve MR

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

The monopoly maximizes profit by producing the quantity QM, which it sells for a price of PM.

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

Compared to perfectly competitive firms, a single-price monopoly restricts output and charges a higher price

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

But suppose the monopoly can price discriminate

Some items are sold for more than PM

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

But some items might be sold for less than PM

The more perfectly a monopoly price discriminates, the closer its output gets to QC, the competitive output

To summarize: A single-price monopoly restricts output and charges a higher price than the firms in a competitive industry

The more nearly a monopoly can perfectly price discriminate, the closer its output gets to that of a competitive industry, but its prices are higher

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

A single-price monopoly restricts output and charges a higher price so it reduces consumer surplus

The monopolist gets a higher profit than the firm in competition (which would eventually just break even!)

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

The monopolist gets a higher profit than the firm in competition

But a monopoly does not recoup all the lost consumer surplus

Some of it is lost and no one gets it.This loss is called deadweight loss

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

Deadweight loss is a measure of the allocative inefficiency caused by monopoly

Let’s study this with the aid of a figure

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

See what happens in a competitive industry

(this is the “BIG PICTURE”)

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

As before, the equilibrium price is PC and the equilibrium quantity is QC

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

The green triangle shows consumer surplus

There is also a producer surplus

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

Producer surplus is the amount received by the producer in excess of the opportunity cost of production

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

To find the producer surplus, we first complete the supply curve, which is also the marginal cost curve

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

Marginal cost is the opportunity cost of the marginal unit produced.

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

Producer surplus is the area above the marginal cost (supply) curve and below the price line

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

Producer surplus

Now let’s see what happens to these surpluses when a monopoly takes over the industry

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

Producer surplus

Under competition, the supply curve is the MC curve

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

Producer surplus

Then, the monopoly sets MC = MR

MC

MR

The profit maximizing quantity is QM and the price is PM

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

Producer surplus

MC

MR

PM

QM

With the higher price, consumer surplus shrinks

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

Producer surplus shrinks too, but the monopoly gains more profit

Producer surplus

But the gain to the monopoly is less than the loss of consumer surplus

There is a deadweight loss

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

Producer surplus

A monopoly always redistributes surplus from consumers to itself

There is always a net gain for the monopoly and a net loss for the consumer

There is always a deadweight lossA waste for everyone!

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

In the special case of a perfectly price-discriminating monopoly, there is no deadweight loss

But there is an even larger redistribution from consumers to the producer

There is no waste: the monopolist takes it all!

Comparing Monopoly and Comparing Monopoly and CompetitionCompetition

Rent SeekingRent Seeking

There are two ways to get rich: Create wealth Transfer wealth

Rent seeking is the activity of searching out opportunities to transfer wealth from others

Seeking monopoly profit is rent-seeking

Rent SeekingRent Seeking

Three ways to try to get rents from monopoly are: Buy a monopoly Collaborate with a monopoly Create a monopoly

Rent SeekingRent Seeking

Buy a monopolyDoes not bring economic profit to the

buyerTransfers economic profit from the

buyer to the creator of the monopoly

Rent SeekingRent Seeking

Buy a monopolyyou can buy a license to operate a taxibuy a pharmacy, buy a concession for a

shop at an airport or at a sports arena, or in campus (at least in Spain)

Rent SeekingRent Seeking

Create a monopoly This form of rent seeking takes two main

forms: Entering politics Seeking the favor of politicians (give them flights

for free, cases of cigars, invite them to go fish with you )

Examples abound: doctors, farmers, broadcasters, magazine producers, … the list is endless

Rent SeekingRent Seeking

When the cost of rent seeking is added to the deadweight loss, the cost of monopoly becomes huge

It equals deadweight loss plus monopoly profit!

Competitive rent-seeking leads to zero profit!

Rent SeekingRent Seeking

Are there any gains from monopoly?Think in dynamic terms! Who

invented Viagra??? Monopoly in action: monopoly under

regulation