Chapter #3: Welfare EconomicsContents: General Analysis Overview Welfare under Monopsony Welfare under Monopoly Welfare under MiddlemenGeneral Analysis OverviewWelfare analysis is a systematic method of evaluating the economicimplications of alternative allocations. Welfare analysis answers thefollowing questions:1. Is a given resource allocation efficient?2. Who gains and who loses under various resource allocations? Byhow much?Welfare economics: A methodological approach to assess resourceallocations and establish criteria for government intervention.Partial analysis: Evaluates outcomes in a subset of markets assumingefficiency in others.D = demand curve S = supply curveArea under demand curve ABC0 = gross Area under supply curve 0ELM = costbenefits from consumption. of production.ABP = consumer surplus area between PLM – area between price and supply =demand and price. producer surplus.2When there are no externalities, an efficient outcome occurs where thesum of consumers’ and producers’ surplus is maximized. • Area under demand = gross benefits• Area under supply = gross cost• Social surplus = gross benefit – cost.• A competitive equilibrium is efficient. It maximizes sum ofconsumer and producers surplus.3Welfare under MonopolyA monopoly is the only seller in a market. The basic condition for amonopoly is below: MaximizesQP(Q) Q− C(Q)P(Q) = Inverse demand: price as a function of quantity C(Q) = quantity.Optimality occurs where:P + Q∂P∂Q−∂C∂Q= 0MR(Q)− ML(Q) = 0MR = marginal revenueMC = marginal cost. QC = quantity under competitionPM = price under monopolyPc = price under competitionQM = quantity under monopoly.A monopoly produces too little and charges too much. Welfare lossunder monopoly is ∆ABC.4Linear Example of Monopoly inverse demand = P(Q) = a - bQrevenue = (a - bQ)Q = aQ-bQ2supply = c + dQcompetitive outcome = a - bQ = c + dQQc=a− cb+ dPc= a −ba− bcb + dPc=ad + bcb+ d.Under monopoly,a− 2bQ = c + dQQM=a− c2b+ d5PM= a −b a− c( )2b+ d=a b+ d( )+ bc2b + ddemand= 10 − Qsupply = 1+ QQC=10−12= 4.5 PC=10 +12= 5.5QM=93= 3 PM= 7Welfare under Monopsony A monopsony is the only buyer in a market.6MaximizeQB(Q)− QMC(Q)B(Q) = P(z)dz =0Q∫area under demand. The optimality condition is:∂B∂Q= Q∂MC∂Q+ MC(Q) Pmn= price paid by monopsonist Qmn= quantity produced by monopsonistMC(Q) = marginal cost of producers.Price paid by monopsonyMO= marginal outlay = MC(Q)+∂MC∂Q.=> Monopsonist: Underbuys and underpays. Monopolist: Underbuys and oversells.7Welfare under Middlemen A middleman is the only buyer and seller of product. QMM= middlemen outputPMMS= price paid by middlemen to suppliersPMMB= price paid to middlemen by buyersPMMBCE PMMS= middlemen
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