Monopoly and Public Policy Micro: Econ: 26 62 Module Monopoly and Public Policy KRUGMAN'S MICROECONOMICS for AP* Margaret Ray and David Anderson

What you will learn in this Module: How do monopolies impact society? How do societies respond to monopolies? The purpose of this module is to show that, when compared to perfect competition, the existence of monopoly reduces output and raises prices to consumers, while earning economic profit for the firm. By producing at an output below that where P=MC, monopoly causes a loss of total welfare: deadweight loss. In order to mitigate the negative consequences for consumers, government can adopt policies to regulate a monopoly firm.

The Welfare Effects of a Monopoly [don’t copy!] The previous module showed that, when we compare monopoly to perfect competition: Qm < Qc, Pm > Pc, and Monopoly profit is greater than zero.   This sounds bad for consumers and good for the firm. But is it bad for economic efficiency? We need to compare total welfare under perfect competition and compare it to total welfare under monopoly. We use the assumption that MC=ATC and is a horizontal line. Perfect Competition: The perfectly competitive output is Qc and the price is Pc=MC=ATC. Total welfare is the sum of consumer and producer surplus. In this case, PS=0 so the entire surplus goes to the consumers. The area of this large triangle will be used as the benchmark so we can compare this triangle to the total surplus under monopoly. The monopoly output is Qm and the price is Pm>MC=ATC. Total welfare is still the sum of consumer and producer surplus. But we see that CS has shrunk while PS (profit) has increased. This PS is a transfer from consumers to the firm. However there is an area that used to belong to CS, but now belongs to nobody. This deadweight loss shows us that total surplus under monopoly is less than under perfect competition. Total surplus under perfect competition is equal to: CSc Total surplus under monopoly is equal to: CSm + PSm Because of the deadweight loss, we can see that CSc > CSm + PSm Economists see this loss of total welfare as a major drawback to monopoly and is an argument for regulation or prevention of monopolies. What exactly is the deadweight loss? It represents transactions (between Qc and Qm) that could have been made, but are not made under monopoly. This will always occur when the level of output restricted such that Pm >MC.

Preventing Monopoly Power Antitrust Laws: legislation to control market power (will go into more detail later) Natural Monopoly: ATC is much lower if one firm exists than if several companies existed. DOJO: What causes this?   Some monopolies arise due to mergers and acquisitions of rival companies or due to ownership of a critical production input. The government has Antitrust Laws to deal with the harmful effects of these types of monopolies. But other monopolies are created by massive economies of scale. These natural monopolies exist when the average total cost of producing the entire market demand is lower if one firm exists, than they would be if several smaller firms existed. If this is the case, it’s more efficient to allow the natural monopoly to exist, but with regulation to prevent abuse of pricing power and sizeable deadweight loss. Brian Smith/Zuma Press

Dealing With A Natural Monopoly Public ownership possible diseconomies – communication and/or corruption Price regulation Natural monopolies exist when the average total cost of producing the entire market demand is lower if one firm exists, than they would be if several smaller firms existed (e.g. economies of scale). If this is the case, it’s more efficient to allow the natural monopoly to exist, but with regulation to prevent deadweight loss. The government can purchase and operate the firm. Because the government is not in the business of maximizing profit at Qm,Pm, prices should be lower for consumers. If the government could operate the market where Pc=MC, there would be no deadweight loss.   Downsides exist however. The government, as a very large bureaucracy with many other issues to deal with, is not always the best at keeping costs low. Waste and political favors may cause prices to rise and taxpayer money to be wasted.

Price Regulation Why not at MC = D? What profit do they earn now? Options for regulating a natural monopoly: 1. Regulated to the perfectly competitive outcome. Output would be Qc and price Pc. Consumer surplus would be maximized. There would be no deadweight loss as Pc=MC. The firm would suffer losses as Pc<ATC. Because society does not want to bankrupt the only electricity provider in the area, this regulation, while efficient would not be chosen.   2. Regulated such that the firm earns a normal profit. Output would be Qr and price Pr. Economic profit is zero as Pr=ATC. Consumer surplus is larger than without regulation. Some deadweight loss exists as Pr>MC, but not as much as would exist if the firm were unregulated. Option 2 is a compromise between the unregulated monopoly outcome (worst for consumers and the most deadweight loss) and the perfectly competitive outcome (best for consumers, zero deadweight loss, but bankrupts the firm). Why not at MC = D?

But why not sell to these people? The previous module showed that, when we compare monopoly to perfect competition: Qm < Qc, Pm > Pc, and Monopoly profit is greater than zero.   This sounds bad for consumers and good for the firm. But is it bad for economic efficiency? We need to compare total welfare under perfect competition and compare it to total welfare under monopoly. We use the assumption that MC=ATC and is a horizontal line. Perfect Competition: The perfectly competitive output is Qc and the price is Pc=MC=ATC. Total welfare is the sum of consumer and producer surplus. In this case, PS=0 so the entire surplus goes to the consumers. The area of this large triangle will be used as the benchmark so we can compare this triangle to the total surplus under monopoly. The monopoly output is Qm and the price is Pm>MC=ATC. Total welfare is still the sum of consumer and producer surplus. But we see that CS has shrunk while PS (profit) has increased. This PS is a transfer from consumers to the firm. However there is an area that used to belong to CS, but now belongs to nobody. This deadweight loss shows us that total surplus under monopoly is less than under perfect competition. Total surplus under perfect competition is equal to: CSc Total surplus under monopoly is equal to: CSm + PSm Because of the deadweight loss, we can see that CSc > CSm + PSm Economists see this loss of total welfare as a major drawback to monopoly and is an argument for regulation or prevention of monopolies. What exactly is the deadweight loss? It represents transactions (between Qc and Qm) that could have been made, but are not made under monopoly. This will always occur when the level of output restricted such that Pm >MC.