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Lecture notes week 9

Economics for Management Studies
Course Code
Gordon Cleveland

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ECMA04H – Week 9
Efficiency in competitive and monopolistic markets. Regulating natural monopoly.
Objectives this week:
i Review Consumer Surplus and Producer Surplus
i Define Gain to Society (GTS) as a summary measure of net economic benefits
i Discuss allocative efficiency in competitive and monopolistic markets
i Discuss ways to regulate natural monopolies, including marginal cost pricing and average cost pricing
First, complete our discussion of monopoly
What about the long run?
Same as short run
Is the monopolist efficient?
Several perspectives:
Does the monopolist minimize costs?
Yes, should be on the AC curve
Does the monopolist produce at qMES?
Nothing that encourages monopolist to produce at qMES , but will choose to produce wherever MC = MR, which could lead to qMES or not
Is marginal benefit equal to marginal cost at the monopolist’s equilibrium output?
Marginal benefit is given by the demand curve
Does the monopolist’s output maximize the Gain to Society?
How do we measure Gain to Society (GTS)?

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What about the distribution of the benefits of production? Different from allocative efficiency.
Some of the consumer surplus becomes profit for the monopolist, some becomes deadweight loss
Does the monopolist transfer potential CS into profit for the producer?
Yes, potential CS transfers into profit for the producer
What about dynamic efficiency?
Joseph Schumpeter – “waves of creative destruction”
2 kinds of innovation:
x product innovation—more utility
x process innovation—cost savings
Classic view is that monopoly distorts resource allocation and causes deadweight efficiency loss. Monopolist produces too little output
(uses too few resources). In practice, there are other considerations, to judge on a case by case basis.
Where does monopoly come from?
a) cost advantage—economies of scale which are large relative to size of market (“natural monopoly”)
b) government licence or restriction (patent)
— patent owner gets 20 years guaranteed market that the owner is the only producer
— created by us
c) ownership of scarce but essential resource
d) some other barrier to entry (e.g., huge advertising costs, manipulation of access to market)
e) Cartel—Joint monopoly
An excise tax on a monopoly. Solve it graphically.
Solve it algebraically. Place a $15 tax on the monopoly problem we had before. What is the effect on equilibrium price and equilibrium
Demand: P = 100 – 0.02Q
TC = 0.01Q2 + 10Q + 432
P0 = $70 Q0 = 1500 Profit = $67 068
MC = 0.02Q + 10
Tax of $15/unit MC + T = 0.02Q + 25 TC + T = 0.01Q2 + 25Q + 432
MR = 100 – 0.04Q = 0.02Q + 25
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