Slide 1Knowledge RecapWelfare Effects: Deadweight LossWelfare Effects: Deadweight LossWelfare Effects: Price DiscriminationWelfare Effects: Price DiscriminationPublic Policy Towards MonopoliesPublic Policy Towards MonopoliesPublic Policy Towards MonopoliesPublic Policy Towards MonopoliesECON 203: Principles of MicroeconomicsClass 17: Welfare Effects of Monopolies 1Knowledge Recap•Monopoly.–One firm is the only seller of a product without substitutes.–Monopolists are price-makers  an increase in Q leads to a decrease in P (downward sloping demand).–Since an increase in Q leads to a fall in P of all units MR < P.•Profit maximization under a monopoly.–Profits maximized where MC = MR.–The firm makes positive economic profits in equilibrium.–Since MR < P, in equilibrium MC < P  value to consumers higher than cost of production.2Welfare Effects: Deadweight Loss•Total Surplus.–Consumer Surplus (CS) + Producer Surplus (PS)–In a monopoly, PS high but CS low.•Deadweight loss (DWL) of a monopoly.3Quantity DrugPrice TR(P*Q)MR(ΔTR/ΔQ)TC MC(ΔTC/ΔQ)ATC Profit0 $250 $0 $1,000 -$1,00010 $225 $2,250 $225 $1,450 $45 $145 $80020 $200 $4,000 $175 $1,900 $55 $95 $2,10030 $175 $5,250 $125 $2,550 $65 $85 $2,70040 $150 $6,000 $75 $3,300 $75 $82.5 $2,70050 $125 $6,250 $25 $4,150 $85 $83 $2,10060 $100 $6,000 -$25 $5,100 $95 $85 $900Welfare Effects: Deadweight Loss•Monopoly vs. efficient allocation.–QM < QE–PM > PE–CSM < CSE–PSM > PSE–CSM + PSM < CSE + PSE –DWLM = (CSE + PSE) – (CSM + PSM)•The deadweight loss reflects the reduction in total surplus and well-being from a monopoly. – Inefficient allocation of resources  production could be increased for a cost that is below its value.4Welfare Effects: Price Discrimination•Price discrimination.–The business practice of selling the same good at different prices to different customers.•Example: hard-cover book editions.–Readers of Dan Brown’s book divided into two types:•Type A: 20,000 fans willing to pay $60 per book.•Type B: 30,000 casual readers willing to pay $20 per book.–To sell to all simultaneously publisher needs to set P at $20.•Profit from P = $20  $1 million•Profit from P = $60  $1.2 million•Price set at $60; 30,000 readers left with no book.–Alternative: sell hard-cover first at $60 followed by paperback for $20.•Profit increases to $1.8 million and everyone gets a book.5Welfare Effects: Price Discrimination•Perfect price discrimination.–Describes a situation in which the monopolist can charge each customer exactly the customer’s willingness to pay.–Graphically, this gives the producer ability to extract all CS. •Consequences of perfect price discrimination.–Firm doesn’t need to decrease price of all units to sell one additional unit  continue selling until price = MC.–Quantity sold increases and DWL decreases.–PS increases at the expense of CS.•Caveat to welfare effects.–Total surplus increases only if discrimination is not costly.–When price discrimination is costly (e.g. different printing machines) the effect on total surplus is unknown. 6Public Policy Towards Monopolies•Antitrust Laws.–U.S. antitrust laws first described in the Sherman Act of 1890.–The Clayton Act addresses specific practices of the Sherman Act such as mergers.•Mergers are only deemed illegal and blocked by the DOJ if they can effectively decrease consumers’ well-being.•Mergers that lead to cost efficiencies are sometimes approved.–Section 2 of the Sherman Act:“Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony”7Public Policy Towards Monopolies•Antitrust Laws.–The Sherman and Clayton Acts do not prohibit every restraint on trade and does not specifically outlaw monopolies.•Monopolies are only illegal if they have been gained or maintained through “improper conduct.”•Examples of improper conduct outlined in the Clayton Act:–Exclusive dealing agreements.–Tying arrangements.–Mergers and acquisitions that “substantially” reduce market competition.–Examples of antitrust cases.•Microsoft’s “tying” (or bundling) Internet Explorer case. •Opposition to insurance mergers.8Public Policy Towards Monopolies•Regulation.–Common solution to natural monopolies.–Natural monopolies:•High FC and low MC  decreasing ATC.•High scale of production improves cost-efficiency.–Problem: how to regulate (where to set Q and P).•If Q set where MC = P, monopolist makes losses and will not operate.–Common solution: set Q where ATC = P.•Zero economic profits for the monopolist.9Public Policy Towards Monopolies•Public Ownership.–Alternative to regulation.–Example: DWP.–Not very common in the present in the U.S.•Doing Nothing.–Avoids drawbacks of public