The Social Costs of Monopoly Power:Price Regulation, Monopsony

<< Monopoly:Elasticity of Demand and Price Markup, Sources of Monopoly Power

Monopsony Power:Pricing With Market Power, Capturing Consumer Surplus >>

Microeconomics ECO402

Lesson 33

The Social Costs of Monopoly Power

Monopoly power results in higher prices and lower quantities.

However, does monopoly power make consumers and producers in the aggregate better or

worse off?

Deadweight Loss from Monopoly Power

Because of the

Lost Consumer

$/Q

higher

MC rice, consumers

lose

Deadweight

A+B and producer

Loss

gains A-C.

Quantity

Rent Seeking

Firms may spend to gain monopoly power

· Lobbying

· Advertising

· Building excess capacity

The incentive to engage in monopoly practices is determined by the profit to be gained.

The larger the transfer from consumers to the firm, the larger the social cost of monopoly.

Price Regulation

Recall that in competitive markets, price regulation created a deadweight loss.

Question:

What about a monopoly?

153

Microeconomics ECO402

Price Regulation

Marginal revenue curve

when price is regulated

$/Q

to be no higher that P1.

P2 = PC

If price is lowered to P3 output

decreases and a shortage exists.

If left alone, a monopolist

Qm Q1

Q'3

Quantity

produces Qm and charges Pm.

Natural Monopoly

A firm that can produce the entire output of an industry at a cost lower than what it would

be if there were several firms.

Regulating the Price

of a Natural Monopoly

$/Q

Natural monopolies occur

because of extensive

economies of scale

Quantity

154

Microeconomics ECO402

Unregulated, the monopolist

would produce Qm and

$/Q

charge Pm.

If the price were regulate to be PC,

the firm would lose money

and go out of business.

Setting the price at Pr

yields the largest possible

output;excess profit is zero.

Quantity

Regulation in Practice

It is very difficult to estimate the firm's cost and demand functions because they change

with evolving market conditions

An alternative pricing technique---rate-of-return regulation allows the firms to set a

maximum price based on the expected rate or return that the firm will earn.

· P = AVC + (D + T + sK)/Q, where

P = price, AVC = average variable cost

D = depreciation, T = taxes

s = allowed rate of return, K = firm's capital stock

Monopsony

A monopsony is a market in which there is a single buyer.

Monopsony power is the ability of the buyer to affect the price of the good and pay less than

the price that would exist in a competitive market.

Competitive Buyer

Price taker

P = Marginal expenditure = Average expenditure

D = Marginal value

Competitive Buyer: Compared to Competitive Seller

Buyer

Seller

$/Q

AR = MR

ME = AE

MR = MC

P* = MR

ME = MV at

P* = MC

D = MV

ME = P*

P* = MV

Quantity

155

Microeconomics ECO402

Monopsonist Buyer

The market supply curve is the monopsonist's

average expenditure curve

$/Q

Monopsony

·ME > P & above

S = AE

Competitiv

P*m

·P = PC

·Q = QC

Q*m

Quantity

Monopoly

$/Q

Note: MR = MC;

AR > MC; P > MC MC

Quantity

Monopoly and Monopsony

Monopsony

$/Q

Note: ME = MV;

ME > AE; MV > P

S = AE

Quantity

156

Microeconomics ECO402

Monopoly

Monopsony

MR < P

ME > P

P > MC

P < MV

Qm < QC

Pm < PC

157

Table of Contents: