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Lecture 7

REAL 1820 Lecture Notes - Lecture 7: Rent-Seeking, Price Discrimination, Economic Rent

Real Estate and Housing
Course Code
REAL 1820
Emma Allen- Vercoe

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Chapter 13: Monopoly
Monopoly and How It Arises:
Monopoly arises for two reasons:
- No close substitute.
- Barrier to entry .
o Natural barrier to entry
Creates a natural monopoly: a market in which economies of scale
enable one firm to supply the entire market at lowest cost
Ex: firms that supply gas, water, and electricity
o Ownership barrier to entry
Occurs if one firm owns a significant portion of a key resource
E: De Bees otolled up to 90% of old’s diaod suppl % toda
o Legal barrier to entry
Creates a legal monopoly: a market in which competition and entry are
estited  the gatig of a puli fahise, go’t liese, patet, o
Public franchise: exclusive right to supply a good
Go’t liese: otols et ito patiula jos ad idusties
Patent: exclusive right to inventory of a product (20 years)
Copyright: exclusive right to author of a literary/artistic work
There are two monopoly situations that create two pricing strategies:
- Single price
o Single-price monopoly is a firm that must sell each of its output for the same price to
all customers
- Price discrimination
o When a firm sells different units of a good for different prices
o When a firm does this, it looks like its doing customers a favour actually charging the
highest possible price for each unit sold and making the largest possible profit
Single-Price Monopoly’s Output and Price Decision:
- Price setter, not a price taker  dead fo oopol’s output is the aket dead
- To sell a larger output, a monopoly must set a lower price
- For a single-price monopoly, MR < P
- Single-price monopoly never produces and output at which demand is inelastic would be
able to increase TR, decrease TC and increase economic profit by decreasing output
- Profit-maximizing quantity is where MC=MR
- Makes economic profit in the long run bc barriers protect firm from market entry by
- But a monopoly that incurs an economic loss might shut down temporarily in the short run or
exit the market in the long run
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Single-Price Monopoly and
Competition Compared
Price and Output
Compared to perfect
competition, a monopoly
produces a smaller output
and charges a higher price
- At competitive equilibrium, MSB=MSC total surplus maxed; firms produce at lowest long-run
AC; resource use is efficient
- Monopoly produces smaller output than PC and faces no competition, so it does not produce at
lowest possible long-run AC
- Result damages social interest by: producing less, increasing cost of production, and raising
price by more than the increased cost of production
Rent Seeking
- Any surplusconsumer surplus, producer surplus, or economic profitis called economic rent
- Rent seeking: pursuit of wealth by capturing economic rent
- Rent seekers pursue their goals in two ways:
o Buy a monopoly transfers rent to creator
of monopoly
o Create a monopoly uses resources in
political activity
Rent Seeking Equilibrium
- Resoues used i et seekig a ehaust the oopol’s
economic profit and the monopoly breaks even
- Rent seeking costs increase to the point at which no
economic profit is made
- ATC, including fixed cost of rent seeking shifts up until it
touches demand curve economic profit = 0
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Price Discrimination:
- Practice of selling different units of goods for a different price
- To be able to price discriminate, must:
o Identify and separate different buyer types
o Sell a product that cannot be resold
- Price differences that arise from cost differences are not price discrimination
- Captures consumer surplus and converts it into economic profit by getting buyers to pay a
price as close as possible to the maximum willingness to pay
Firms price discriminate in two ways:
- Among groups of buyers (ex: business person travelling vs. vacation travelling)
- Among units of goods (ex: quantity discounts BOGO)
Perfect Price Discrimination
- Occurs if a firm is able to sell each unit of output for the highest price anyone is willing to pay for
- MR is now also the demand curve
- With perfect price discrimination:
o The profit-maximizing output increases to the quantity at which MR=MC
o Economic profit increases above that made by a single-price monopoly
o Deadweight loss is eliminated
Efficiency and Rent Seeking with Price Discrimination
- The more perfectly a monopoly can price discriminate, the closer its output is to the competitive
output and the more efficient is the outcome
- This outcome differs from the outcome of perfect competition in two ways:
o The monopoly captures the entire consumer surplus
o The increase in economic profit attracts even more rent-seeking activity leading to
Monopoly Regulation
- Regulatio: adiistated  go’t age to ifluee pie, uatit, et, et
- Deregulation: process of removing regulation
Two theories about how regulation works:
- Social interest theory political and regulatory process relentlessly seeks out inefficiency and
regulates to eliminate deadweight loss
- Capture theory regulation serves the self-interest of the producer, who captures the
Efficient Regulation of a Natural Monopoly
- When demand and cost conditions create natural monopoly, quantity produced is < the efficient
- Regulating a natural monopoly in the social interest sets the quantity where MSB=MSC
- Marginal cost pricing rule: regulation that sets the price equal to the oopol’s agial ost
o With this regulation, quantity produced is efficient
o But AC exceeds price, so the firm incurs an economic loss
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