Are Monopolies Efficient? 46

Monopolies vs. Perfect Competition = MC P CS In perfect competition, CS and PS are maximized. Ppc PS D Q Qpc 47

Monopolies vs. Perfect Competition S = MC P At MR=MC, A monopolist will produce less and charge a higher price Pm Ppc D MR Q Qm Qpc 48

Monopolies vs. Perfect Competition Where is CS and PS for a monopoly? S = MC P CS Total surplus falls. Now there is DEADWEIGHT LOSS Pm DWL PS Monopolies underproduce and over charge, decreasing CS and increasing PS. D MR Q Qm 49

Are Monopolies Productively Efficient? No. They are not producing at the lowest cost (min ATC) Does Price = Min ATC? $9 8 7 6 5 4 3 2 P MC ATC D MR Q 1 2 3 4 5 6 7 8 9 10 50

Monopolies are NOT efficient! Are Monopolies Allocatively Efficient? No. Price is greater. The monopoly is under producing. Does Price = MC? $9 8 7 6 5 4 3 2 P MC ATC Monopolies are NOT efficient! D MR Q 1 2 3 4 5 6 7 8 9 10 51

Because there is little external pressure to be efficient Monopolies are inefficient because they… Charge a higher price Don’t produce enough Not allocatively efficiency Produce at higher costs Not productively efficiency Have little incentive to innovate Why? Because there is little external pressure to be efficient 52

Natural Monopoly One firm can produce the socially optimal quantity at the lowest cost due to economies scale. P It is better to have only one firm because ATC is falling at socially optimal quantity MC Gas network Electricity grid Railway infrastructure Aeroplane manufacture? – At the moment, this is a duopoly so it is not a natural monopoly, but it is close. One manufacture may have even lower average costs than the current two firms. ATC MR D Q Qsocially optimal 53

Lump Sum vs. Per Unit Taxes and Subsidies 54

Lump Sum Per Unit A continuous payment Example: Cigarette companies must pay tax for each carton sold Affects the variable costs Affects AVC and ATC and MC cost curves A one time payment Example: AEP has to pay $500 for environmental cleanup Affects the fixed costs Affects only AFC and ATC cost curves

A lump sum subsidy would be unsuccessful since it would only affect the ATC cost curve. MC P MC w/per unit subsidy Pm P 1 D MR Q Qm Q society wants

2007 FRQ #1