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Chapter 4

ECON 1010 Chapter 4: Topics 23

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University of Manitoba
ECON 1010
Laura K.Brown

o78P ECON1010 This reduction in price affects every unit that is sold by the monopolist because the monopolist needs to charge all consumers the same price Hence there is an implicit price in increasing the quantity sold, and this leads to an equilibrium production level that is lower than the socially optimal one. What is the socially optimal level of production? In order to find this, expand production until the marginal benefit is equal to the marginal cost. Panel A: socially optimal quantity Panel B: the monopoly equilibrium quantity and the deadweight loss for society due to the fact that the monopolist didnt select the socially optimal quantity. The Invisible Hand Theory does not apply in the case of a monopoly; when the monopolist maximises its profit the result is not socially optimal. GOVERNMENT REGULATION To solve inefficiencies, competition must be stimulated by encouraging new firms to enter the market. Governments worldwide achieve this by establishing competition laws. The final objective of these laws is to ensure that consumers are charged the lowest possible prices. Competition law: denotes laws intended to foster market competition by regulating anti competitive conduct by firms However, in the case of a natural monopoly, this government intervention might prove inefficient. In order to increase the total surplus in the presence of a natural monopoly, governments often regulate the price at which the monopolist is allowed to sell its products. Average Cost Pricing: denotes a policy through which the government forces the monopolist to set the price and quantity at the intersection of the ATC curve and the demand curve. This policy eliminates any positive profit accrued to the monopolist. Allocatively inefficient: price asked for the goods produced exceeds their marginal cos However, average cost pricing is hard to implement because: Government does not know the ATC, it can only estimate them Once this policy is in place, firms have no incentive to inve t in new technology to lower production costs they make zero profits either way When the government uses average cost pricing, the firms output is allocatively inefficient. This is due to the fact that the price usually exceeds the marginal cost. (In
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