What are the welfare impacts of a monopoly on firm (producer surplus), consumer
ID: 1125783 • Letter: W
Question
What are the welfare impacts of a monopoly on firm (producer surplus), consumer (consumer surplus) and society (total welfare) in comparison to perfect competition?
Compare a monopolist with a perfectly competitive firm in terms of price faced by consumer.
How does marginal revenue compare with price for a monopolist and a perfectly competitive firm? Explain how and why.
Explain the profit maximizing condition for a monopolist and describe how it is similar and how it is different from that of a perfectly competitive firm
What are the sources of market power of a monopolist? Explain each one and provide an example
How is market power relate to demand elasticity? Explain.
What does the Lerner Index measure?
Compare the demand faced by a monopolist with the demand faced by a perfectly competitive firm. Explain how and why they are different.
How can a government regulate a monopolist to make it closer or equal to a perfectly competitive firm in terms of welfare?
What is reason rational profit maximizing firms with market power to undertake price discrimination?
What conditions must exist for firms with market power to the undertake price discrimination?
Provide an example of a good or industry that undertakes each type of price discrimination (1st degree, 3rd degree, two-part tariff, pure bundling, mixed bundling)
Explanation / Answer
a. The consumer surplus under Monopoly shrinks in comparison to the Perfectly competitive market as equilibrium price increases and equilibrium quantity decreases. Producer surplus, on the other hand, increases under Monopoly in comparison to the perfectly competitive market. In perfect competition, the producer surplus is effectively 0 as firms charge P= MC. Finally, the societal welfare shrinks under monopoly. Under perfectly competitive market, the social welfare is maximized, i.e. there is no deadweight loss. In a monopoly, the monopolist charges a higher price and sells a lower quantity of goods, thereby creating a deadweight loss.
b. In terms of price, a monopolist charges a higher price to the consumers than the price under perfect competition. Being the only firm in the market, a monopolist has all the incentives to increase its price and thereby increase his profits. Marginal Revenue (MR) under perfect competition is equal to the Price. However, this is not the case for the monopolist. This difference is due to the ways Total Revenue(TR) is represented under each market. TR under perfect competition is simply P*Q. So, when we find the MR, we get MR = P. Under Monopoly, we have TR = P(Q)*Q. (P as a function of Q). So, when we find the MR, we get MR = P'(Q)*Q + P(Q)---->(using chain rule).
c and d. For both, the monopolist and the perfectly competitive firm, the way we solve for the profit-maximizing output and price is same. In both cases, we set MR = MC i.e. the First order condition still holds. The difference is in the way we derive to the MR for both market situations as mentioned above. Under monopoly, we get P* > MR(Q*) = MC(Q*) whereas in perfect competition we have P* = MR = MC (The monopolist marks up its price)
e. Sources of market power include
barriers to entry (ex: patents, trademarks, copyrights, natural monopolies are the best example)
number of competitors (example: OPEC has limited number of competitors in the world giving them a good amount of market power in the industry)
the degree of product differentiation (ex: apple advertises and promotes its product as a very different one from the market thereby reducing the elasticity of demand for its product).
f. The market power is related to the demand elasticity through the Lerner index. Lerner index = 1/|elasticity of demand|. As the elasticity of demand gets bigger i.e. -infinity, the market power dilutes. This is the case of perfect competition.
g. The Lerner index is used to calculate the markup % by a monopolist and to determine how much market power the firm has.
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