C 2 Contrast PC to Monopoly

1. C2 Contrast PC to Monopoly and Policies regarding Monopolies P116-119

2. Learning Objectives • Explain, using diagrams, why the profit maximizing choices of a monopoly firm lead to allocative inefficiency (welfare loss) and productive inefficiency. • Explain why, despite inefficiencies, a monopoly may be considered desirable for a variety of reasons, including the ability to finance research and development (R&D) from economic profits, the need to innovate to maintain economic profit, and the possibility of economies of scale. • Evaluate the role of legislation and regulation in reducing monopoly power. • Draw diagrams and use them to compare and contrast a monopoly market with a perfectly competitive market, with reference to factors including efficiency, price and output, research and development (R&D) and economies of scale.

3. Recall: Allocative efficiency Where S = D in the market, (i.eMC = AR) For a competitive firm, price equals marginal cost. For a monopoly firm, price exceeds marginal cost.

4. Monopoly PC price price Marginal revenue Monopoly quantity PC quantity LO 1Diagram that shows the Inefficiency of Monopoly Allocative inefficient price and quantity Price Marginal cost Allocative efficient price and quantity Demand 0 Quantity

5. LO #4i Contrast PC to Monopoly What do the following areas or points represent : A B C D G CFAO DGBO

6. Answers to graph exercise A = monopoly output B = perfect comp output C = monopoly price D = perfect comp price G= perfect comp equilibrium point CFAO = monopoly total revenue DGBO= perfect comp total revenue But what is triangle FGH?

7. Demonstrating deadweight loss for a Monopoly • While a market with perfect competition will always move to the output where demand =supply (AR=MC), a monopoly will operate where MC=MR which restricts output and increases the price causing a deadweight loss

8. LO #3 Public Policy Toward Monopolies • Pass Antitrust laws • To prevent formation of mergers. • To break up large companies. • To prevent companies from performing activities which make markets less competitive. • In NZ the Commerce Commission aims to promote competition in markets. • Turning some private monopolies into public enterprises (usually natural monopolies). • Regulate pricing • Doing nothing at all – why not?

9. 2 basic approaches to price regulation (either government owned or private) • Regulating the price to Allocative Efficiency (e.g. in NZ the government runs the Rail Service) – but may have to subsidisea loss. • Regulate the price to a low or normal profit situation. (no subsidy required but neither is it allocatively efficient.)

10. Average total cost Loss Regulated price Marginal-Cost Pricing for a government owned (or subsidised) Natural Monopoly... Price Marginal cost Average total cost Demand 0 Quantity

11. Regulated price Average Cost Pricing for a Natural Monopoly... Price Marginal cost Average total cost Demand 0 Quantity

12. Markup pricing AC pricing MC pricing Three pricing options mc ac ar mr

13. LO 2,4 Task: Explain and illustrate why, despite inefficiencies, a monopoly may be considered desirable for a variety of reasons, including: • the ability to finance research and development (R&D) from economic profits • the need to innovate to maintain economic profit, and • economies of scale that results in lower prices than a competitive market (even at mark-up pricing).