Economics 2010 Lecture 13” Monopoly versus competition

Monopoly  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 Competition

 Begin with a perfectly competitive industry  The demand curve is D and the supply curve is S

Comparing Monopoly and Competition  The industry produces the quantity Q C and sells it for the price P C  Now the industry becomes a monopoly

Comparing Monopoly and Competition  The supply curve of the competitive industry becomes the marginal cost curve of the monopoly.

Comparing Monopoly and Competition  The demand curve of the competitive industry becomes the monopoly’s demand curve

Comparing Monopoly and Competition  The monopoly also faces the marginal revenue curve MR

Comparing Monopoly and Competition  The monopoly maximizes profit by producing the quantity Q M, which it sells for a price of P M.

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

Comparing Monopoly and Competition  But suppose the monopoly can price discriminate  Some items are sold for more than P M

Comparing Monopoly and Competition  But some items might be sold for less than P M  The more perfectly a monopoly price discriminates, the closer its output gets to Q C, 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 Competition

 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 Competition

 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 Competition

 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 Competition

 See what happens in a competitive industry  (this is the “BIG PICTURE”) Comparing Monopoly and Competition

 As before, the equilibrium price is P C and the equilibrium quantity is Q C Comparing Monopoly and Competition

 The green triangle shows consumer surplus  There is also a producer surplus Comparing Monopoly and Competition

 Producer surplus is the amount received by the producer in excess of the opportunity cost of production Comparing Monopoly and Competition

 To find the producer surplus, we first complete the supply curve, which is also the marginal cost curve Comparing Monopoly and Competition

 Marginal cost is the opportunity cost of the marginal unit produced. Comparing Monopoly and Competition

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

 Now let’s see what happens to these surpluses when a monopoly takes over the industry Comparing Monopoly and Competition Producer surplus

 Under competition, the supply curve is the MC curve Comparing Monopoly and Competition Producer surplus  Then, the monopoly sets MC = MR MC MR

 The profit maximizing quantity is Q M and the price is P M Comparing Monopoly and Competition Producer surplus MC MR PMPM QMQM

 With the higher price, consumer surplus shrinks Comparing Monopoly and Competition  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 Competition 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 loss  A waste for everyone! Comparing Monopoly and Competition

 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 Competition

Rent 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 Seeking  Three ways to try to get rents from monopoly are: £ Buy a monopoly £ Collaborate with a monopoly £ Create a monopoly

Rent Seeking  Buy a monopoly  Does not bring economic profit to the buyer  Transfers economic profit from the buyer to the creator of the monopoly

Rent Seeking  Buy a monopoly  you can buy a license to operate a taxi  buy a pharmacy, buy a concession for a shop at an airport or at a sports arena, or in campus (at least in Spain)

Rent 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 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 Seeking  Are there any gains from monopoly?  Think in dynamic terms! Who invented Viagra???  Monopoly in action: monopoly under regulation