63. Single-Price Monopoly and Competition Compared

Comparing Price and Output

• Perfect Competition: The market demand curve (D) in perfect competition is the same demand curve that the firm faces in monopoly. The market supply curve (S) in perfect competition is the horizontal sum of the individual firm’s marginal cost curves. This supply curve also is the monopoly’s marginal cost curve, so in the figure above the supply curve is labeled MC. In a competitive market, equilibrium occurs where the quantity demanded equals the quantity supplied. In the figure above, the competitive equilibrium quantity is 30 units and the competitive equilibrium price is $2.50 per unit.

• Monopoly: The monopoly produces where MR = MC and sets its price using its demand curve. In the figure, the monopoly produces 20 units of output and sets a price of $3.00 per unit.

• Compared to a perfectly competitive industry, a single-price monopoly produces less output and sets a higher price.

Efficiency Comparison and Redistribution of Surpluses

• A perfectly competitive industry produces the efficient quantity of output, where MSB = MSC. Because a single-price monopoly produces less output (where MSB > MR = MC = MSC), it underproduces and creates a deadweight loss.

• Consumer surplus is smaller with a monopoly than with perfect competition. In the figure above, the consumer surplus under perfect competition is the area under the demand curve and above the competitive equilibrium price of $2.50 per unit. Under monopoly the consumer surplus is the area under the demand curve and above the monopoly price of $3.00.

• Though the monopoly creates a deadweight loss, the monopoly’s owners benefit because it earns an economic profit. A monopoly’s owners benefits because the monopoly redistributes some of the consumer surplus away from the consumer and to the monopoly.

Rent Seeking

• Any surplus—consumer surplus, producer surplus, and economic profit—is called economic rent. Rent seeking is the pursuit of wealth by capturing economic rent.

• Rent seeking can occur when someone uses resources seeking the opportunity to buy a monopoly for a price less than the monopoly’s economic profit.

• Rent seeking also can occur when someone uses resources lobbying the government to create a monopoly. Because of rent seeking, the social cost of monopoly exceeds the deadweight loss it creates.

• The resources used up in rent seeking are a cost to society that adds to the monopoly’s deadweight loss. Because there are no barriers to entry in the activity of rent seeking, the resources used up can equal the monopoly’s potential economic profit, reducing monopoly profit.

63. Price Discrimination

Price discrimination is the practice of selling different units of a good or service for different prices. Price discrimination converts consumer surplus into economic profit. To be able to price discriminate, a firm must:

• Identify and separate different buyer types.

• Sell a product that cannot be resold

Capturing Consumer Surplus

• Price discrimination occurs because of different willingnesses to pay for the good. A firm can charge the same buyer different prices for different units of a good or a firm can charge different prices to different groups of buyers.

• Discriminating Among Groups of Buyers: A firm can charge different customers different prices for the product. Groups with a higher willingness to pay are charged a higher price and groups with a lower willingness to pay are charged a lower price. For example, business airline travelers who have a high willingness to pay and often make last-minute reservations are charged a higher price than leisure travelers, who have a low willingness to pay and often make advance reservations.

• Discriminating Among Units of a Good: A firm can charge a higher price for the first units purchased and a lower price for later units purchased. An example is pizza delivery, where the second pizza is generally cheaper than the first.

• Perfect price discrimination occurs if a firm is able to sell each unit of output for the highest price anyone is willing to pay for it. In this case, the price of each unit is the same as the unit’s marginal revenue, so the firm’s (downward sloping) demand curve becomes the same as its marginal revenue curve. Output increases to the point where the demand (= marginal revenue) curve intersects the marginal cost and the efficient quantity is produced. The deadweight loss is eliminated. The firm’s economic profit is the greatest possible. But consumer surplus equals zero because the firm captures the entire consumer surplus.

• The more perfectly a monopoly can price discriminate, the greater the amount of its output and the more efficient the outcome.

• Because the producer grabs the entire surplus in perfect price discrimination, rent seeking becomes profitable, and the long-run equilibrium outcome is that rent seekers use up the entire producer surplus.